Zero Hedge

And Northern Trust thought it had problems when Barney Frank went postal for the company's House Of Blues romp. A smoking gun lawsuit filed March 30 in Northern Illinois District Court (09-cv-01934) by Joseph Diebold on behalf of the pension scheme of one of the world's largest companies, Exxon Mobil, alleges Northern Trust breached its fiduciary responsibility under ERISA and claims Northern Trust invested the fund's capital since 2007 "recklessly and imprudently, by acting disloyally and causing massive losses."

One could surmise that Northern Trust, despite having pledged to repay its $1.6 billion in TARP funding, should at this point promptly change its mind and keep that cash, as this lawsuit may potentially have staggering adverse consequences.

This could be a seachange in terms of corporate pension funds, who are on the hook for massive losses, turning their anger instead at pension plan custodians and managers.

In a nutshell, the lawsuit purports that collateral collected from lending out of shares, had been invested too riskily by Northern Trust. Pension schemes traditionally use custodians and investment managers to lend out certain securities in their portfolios to hedge funds and other third parties. In exchange, the schemes receive collateral payments that are further invested to create additional returns. As once securities are returned the collateral has to be repaid immediately, investors generically prefer investing in liquid, low-risk assets. It appears this is where NTRS has made a big blunder, and effectively ended up generating losses for the ExxonMobil pension estate.

The Exxon Mobil pension fund, which is represented in the lawsuit by Joseph Diebold, Jr., and is pursuing class action status, was worth $13 billion at the end of 2007, and states in the lawsuit that "defendants inappropriately invested the collateral in collateral pools that were illiquid, highly-leveraged, and unduly risky, containing mortgage-backed securities and other securitized debt instruments. These investments were inappropriately risky for retirement plan investments - especially when compared to the relatively small amount of gains that the plans could expect to receive from securities lending arrangements."

While no definitive figures have been set for total losses yet, the lawsuit is set for class-action status, and other plaintiffs are being sought to join the class-action suit, according to a news release from the four law firms representing plaintiffs. The suit represents 600 pension schemes for which Northern Trust was carrying out securities lending collateral investment services.

While on one hand it is surprising that NTRS could generate losses on lender arrangements, which traditionally have a 0 lower return bound, what is much more shocking, is that such a large company as Exxon is taking legal action to recover pension losses. This will likely soon become the modus operandi for all major corporate pension schemes that have experienced losses, who piggy back on this example as a means of recouping at least a portion of losses. And taking from Newton's 3rd law, the defendants will likely end up having to pony up billions of new dollars.

Lastly, as Northern Trust (at least for now), and many of the other collateral custodians, are TARP recipients, this will present a brand new and unanticipated cog in the taxpayer-bank relationship, as banks will end up having to potentially pay out taxpayer money to pension funds, which invest the capital of these very same taxpayers. The circularity is enough to make one's head spin.