Guest Post: Exxon Pension Fund Sues Northern Trust Alleging "Reckless, Massive Losses"

Posted by Tyler Durden, Publisher of 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.

NTRS zerohedge

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  1. alex black

    Please tell me this doesn’t mean that all the TARP money is about to be allocated to attorneys’ fees.

  2. Anonymous

    That big red button with he words “JUBILEE” will be pushed, but after much destruction I fear.

    The sharks going after their own kind, this is a millstone moment (break it and no bread), and it will increase (breeding and environment thing).

    A hole lot of top people are going to have to re-learn the phrase SORRY and HUMILITY if they wish any hope of survival.


  3. Darcy

    Exxon and law firms want their piece of the TARP too. Who’s next in line? Wonder how long before fights break out about positions in the free dinner queue.

    Wish i had the lawyers to go in to bat for my piece of the TARP, sadly i am just a pleb being fleeced by the lengthening line of squabbling aristocrats.

    “From the crooked timber of humanity no truly striaght thing can be made” Kant

  4. cap vandal

    Joseph E Diabold is a participant in the Exxon pension fund.
    I doubt that Exxon is suing Northern Trust on this.

    I don’t know if this will get traction, but the driver are the legal fees from a class action.

  5. Anonymous

    “sadly i am just a pleb being fleeced by the lengthening line of squabbling aristocrats.”
    Little wonder with an attitude like that.

    This is BS, it’s easy to say with the benefit of hindsight that the plan investments were inappropriately risky. Exxon is an institutional client, it should be embarassed to file a lawsuit like this.

  6. doc holiday

    Re: “Northern Trust breached its fiduciary responsibility under ERISA”

    What a joke, ERISA was highly abused by Department of Labor under Bush, to a point of being criminal. DOL cut so many deals with underwriters that it seriously was not funny, as they granted exemptions from prohibited activities on a routine basis.

    The whole reason I came to NC was to bitch about that and to scream about fiduciary responsibilities, but no one ever wanted to listen or respond and that includes reporters from several newspapers who were sent long emails, in addition to phone calls.

    Bitch, bitch, bitch, that was so long ago, and I really should care less now and the people from Exxon that are involved in this are so late to catch on, that it is funny! Were they too busy making billions and forgot to notice that wall street and The DOL were screwing them? This is pathetic and they look like ambulance chasers!

    Off with all their heads!

    Potter gets the last word again: “But I’ll tell you what I’m going to do for you,
    George. Since the state examiner is
    still here, as a stockholder of the
    Building and Loan, I’m going to swear
    out a warrant for your arrest.
    Misappropriation of funds –
    manipulation – malfeasance…”

  7. cap vandal

    I looked at the press release for the suit.

    No way Exxon has anything to do with it.

    These are 4 plaintiff law firms — Exxon uses lawyers on the other side of the street.

    The suit was filed as an ERISA claim to use the higher duty of care to bolster the claim.

  8. doc holiday

    Who needs pensions?

    Nash has also developed work on the role of money in society. In the context that people can be so controlled and motivated by money that they may not be able to reason rationally about it, he has criticized interest groups that promote quasi-doctrines based on Keynesian economics that permit manipulative short-term inflation and debt tactics that ultimately undermine currencies. He has suggested a global “industrial consumption price index” system that would support the development of more “ideal money” that people could trust, rather than more unstable “bad money”. He notes that some of his thinking parallels economist and political philosopher Friedrich Hayek’s thinking regarding money and a nontypical viewpoint of the function of the authorities.

  9. Anonymous


    I spent how many years of loss for these miscreant’s. I would like to use some of the skillz hard won, on their asses, Irony! But at last to many books in the way for me to respond in that matter, so here I am to respond in words.


  10. Anonymous

    Soooo . . . the well-paid folks at Exxon responsible for supervising the companies that manage their pension funds somehow failed to notice that risky investments were being made?? In 2007??!!?? The cat was already out of the bag by then. This mess is going to keep spreading out further and further until many of us finally say “Enough. If you made mistakes, YOU pay for them, not me.”

  11. Leo Kolivakis

    Exxon, BP and I believe Chevron all have undefunded pension plans. The only thing is that they have the cash to fund them.

    But Tyler’s post exposes some of the reckless risks that were taken.

    Excellent post, thanks.


  12. Darcy

    The inquisitive, ingenious and amoral apes that we are, will always find a way to cheat, steal and collude, to get ahead of the crowd.

    Market regulations are in a constant arms race against human nature. Inevitably we get booms and busts, it can only ever be so, whilst we practice Darwinian economics. After each bust there is a clean out, the villains get punished, rules change until the next generational crisis and fraud.

    What we have not seen yet is anyone being punished.

    Everyone knows American and European plutocrats have stolen the till, we have watched them do it yet they are now demanding we buy them a new one. This is to say the least a bit inflammatory. They are hoping smoke, mirrors and some fancy card shuffling will be enough to confuse the populace.

    Cheaters need to be punished or society breaks down. No one has an interest in paying taxes or acting altruistically if cheating is rife. Punishing cheaters is a gut visceral inbuilt animal mechanism and why the anger created is so dangerous when roused. Whole top echelons can be put in gulags or shot if they push things too far.

    What we have is a global breakdown in trust in the top tier of society. People need to see real punishment and changes, or its going to get real ugly.

    Even turn the other cheek Jesus was proactive when it came to regulating and punishing bankers 2 millenia ago.

    The messianic O needs to find his backbone and fast.

  13. Swedish Lex

    By adding layers of legal and economic bailout complexity upon the anarchy of the casino economy, the lawyers will inevitably have a fiesta in the coming years.

    Lawyers will have all the (billable) time in the world to go back and scrutinise the deals and the arrangements that the (mindless) masters of the universe entered into when they were still invincible.

    Lawyers are good at making former heroes look like fools. That should not be too difficult this time.

  14. fresno dan

    What will happen with pensions is a perfect example of unintended consequences of low interest rates. Everybody (almost) loved the low interest rate party. But when the return on safe, secure treasuries becomes 0, people look for an “alternate” safe return. And with government imprinteur on the rating companies giving a gold stamp to all the so-called “securities” that were anything but secure, here we are.

    What happens when Calpers (retirement system) has to rejigger there return assumptions?
    California bankrupt?

  15. Anonymous

    Why pension funds allow their shares to be loaned out is perhaps the better question. The small income generated would seem to be outweighed by the big downside risk of allowing hedge funds to manipulate the share price.

    I also read that AIG lost huge amounts in the same fashion as Northern Trust. Once again this share loaning practice seems to have backfired mightily.

  16. Anonymous

    Big companies have a choice either they pump more money in, they get their employees to pump more money in or they sue the pension administrators and pension managers. Most likely they do all 3, but the importance here is that if this test case wins then it opens the flood gates. This off course works its way back through insurers and hedge funds back to banks who will need more bail out money. Nobody can yet get used to the idea that you are going to have to pay a proper risk adjusted price for pensions, for loans and any financial transaction and politicians don’t want to tell the electorate that in the new world they will have to pay a little bit more.

  17. cap vandal

    This is a test case, perhaps — but it isn’t employers suing.
    Check out the web sites of the law firms.
    Exxon is not a plaintiff.

  18. Anonymous

    Meanwhile I wish someone knowledgeable in economics would comment on Casey Mulligan’s piece in the NYT Economix section(“Encourage the Sellers, not the Buyers…”)

    After reviewing the ‘conventional wisdom’ (one can always be sure a writer is about to dismiss wisdom if it is described as ‘conventional’) Dr. Mulligan proceeds to defend the Geithner plan thus:

    “The market [in bank mortgage assets] stagnated because of the ultimately correct anticipation of a government subsidy.”

    To this lay observer with no training in economics, this is what he appears to be saying:

    Government subsidies cause market stagnation, which is why the Geithner-organized government subsidy was needed – to stop the market stagnation.

    Folks at NC, I beg for you help: I’m feeling a little dizzy. I can’t tell if this is because I don’t have a background in economics, or because of what looks an awful lot like circular logic.

  19. cap vandal

    “The market [in bank mortgage assets] stagnated because of the ultimately correct anticipation of a government subsidy.”

    There was never much of a market in a lot of this stuff. It was meant to buy and hold to maturity.

    The idea that government subsidies cause market stagnation is just speculation. It is unmeasurable and unfalsifiable.

    Here is the way I look at it. Prior to the meltdown, you had a leveraged carry trade in this stuff with entities buying long term assets (CDO’s) using shorter term financing. The financing for this disappeared, so you had deleveraging.

    Any valuation has two pieces — assumed cash flows and an interest rate required.

    The mortgage securities took hits on both pieces — cash flows are distressed and the required rate of return went way up.

    The idea of financing a leveraged “carry trade” similar to the shadow banking system pre meltdown is the basis of the Treasury plan.

    I would advise anyone to actually read the term sheets, since the majority of blog comments get them wrong.

    Anyway, the Treasury is allowing the new investors to use leverage and decrease the market interest rate on mortgage securities. This will raise the prices. Price and yield are inverse.

    This is the same type of deal as hedge funds were using, except that the financing will match the duration of the assets and will be much lower (about 2%). This will allow the market interest rate to decrease significantly which will raise asset prices.

  20. RebelEconomist

    Losses on securities lending have happened before – in 1994 when interest rates went up fast and 2002 when Enron and Worldcom went bust. Mellon Bank did compensate their clients in 1994 (see Global Custodian Magazine Spring 1995), so I would expect that custodian lenders are careful to ensure that their clients know what their securities lending programme involves. I find it hard to believe that Exxon did not know that they were exposing themselves to such losses.

  21. Anonymous

    “The idea of financing a leveraged “carry trade” similar to the shadow banking system pre meltdown is the basis of the Treasury plan.”

    Cap vandal (thanks for the quick reply by the way) – As far as I can tell, Joseph Stiglitz suggested as much in his 31 Mar column in the NYT. Stiglitz (“Obama’s Ersatz Capitalism, 31 Mar, NYT) opined: “Treasury hopes to get us out of the mess by replicating the flawed system that the private sector used to bring the world crashing down.”

    Today (1 April) C Mulligan refers to both P Krugman and J Stiglitz in his defense of the Geithner plan.

    The problem is, I can’t see how Mulligan’s ‘rebuttal’ actually works as a rebuttal.

    Like you, he feels that (“to a good approximation) a secondary market for legacy mortgages does not exist. ” What he is apparently disputing (with PK and JS) is WHY there was no market. He attributes to “the conventional wisdom” (presumably PK and JS) the notion that “this plan will fail because it creates no clarity [ about asset values], and it does little to separate banking from legacy mortgage ownership.”

    He then argues that the plan will succeed since: ” the biggest reason [for market stagnation] is not lack of clarity [on values], but rather the lack of a viable government policy to deal with the banking crisis.”

    In fact, he goes so far as to contradict his earlier statement that there was no market for the stuff: “Banks were not “unable” to sell their legacy mortgages; they were prudently unwilling to sell because they expected the government to eventually step in and help push the prices of those assets higher.”

    I must say, this is the first time I have read that this banking crisis was a product of prudent thinking.

    Prudent or no, I can’t see how this rebuts Stiglitz’ view that the government, by leveraging almost all of the price with a non-recourse loan, is effectively not leveraging the assets, but an option on same. The markets will thus buy, not the asset, but the option on those assets. This is not the same thing as what was on the table before: (Stiglitz) – “even in an imperfect market, one shouldn’t confuse the value of an asset with the value of the upside option of the asset.”

    The government owns the assets insofar as the losses are concerned. When the government ultimately takes losses, Stiglitz questions how this is going to help the economy – on which the banks, along with everyone else, depends.

    But as I said, I lack sufficient background, so I have no way of knowing if I’ve interpreted all of this correctly.

    Cap vandal, you say that most blogs have got it wrong. I’m not sure how to place this in the context of Stiglitz versus Mulligan.

  22. cap vandal

    I wouldn’t say most blogs, but definitely most blog comments.

    Stiglitz either misrepresents the plan or hasn’t read it. If you put up 1/12 for 1/2 of the profits, you have really put up 1/6, no?

    The greedy, vulture investors have to blow through their 18% before the FDIC sees any losses. However, the assets need to be bought to yield around 5% in order to provide the needed profit, so they have to blow through both their capital and the expected profit before they get into loss territory.

    The Treasury is taking a matching position, but they have an identical profit and loss profile to the vulture investors.

    One problem is that the economists have likely never bought or sold an interest bearing asset in their lives, so they perhaps have a theoretical appreciation for finance, but lack any real world grounding.

    Stiglitz’s example ignores interest, which is the main subsidy in the plan. Then he throws up an unrealistic outcome distribution (binomial) which maximizes variance — and then gets all lathered up about implicit puts.

    We are already subsidizing the hell out of home mortgages via the GSE’s. The FDIC is on the hook for a couple of trillion already — although it only has $50 billion.

    FDIC insured deposits are another huge subsidy.

    I find it hard to get worked up about another interest rate subsidy, since that is the only tool the Treasury/Fed has. This is just another variant of the same old same old.

    Read the blog, Accrued Interest if you want to see how a real bond trader would look at it.

    Meanwhile the rebuttal doesn’t make much sense either. Maybe less.

  23. Anonymous

    “Meanwhile the rebuttal doesn’t make much sense either. Maybe less.”

    Well, I am pleased that my instincts were not totally inaccurate.

    Cap vandal, if what you say is true, and not one but two economists (Mulligan and Stiglitz) got it wrong, then this does not bode well for any hope of comprehension by the great unwashed, amongst whose members I count myself.

    However I will take a look at ‘Accrued Interest’ as you suggested and shall try my best.

    Thanks for taking the time to reply, it is much appreciated.

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