June 29 (Bloomberg) -- State Street Corp., the world’s largest asset manager for institutions, may be sued by federal regulators over bond funds that investors said lost money because of bets on risky mortgage-backed securities.

The company, based in Boston, said in a regulatory filing that it received a Wells notice stemming from a U.S. Securities and Exchange Commission investigation into disclosures and management of fixed-income investments through 2007. The notification typically lets recipients respond to investigators’ claims before the agency’s five-member commission approves legal action. The SEC may decide not to pursue a case.

State Street, the manager of $1.4 trillion as of March 31, has been sued by investors claiming its funds took too much risk by investing in securities tied to home mortgages. The firm set aside $618 million in the fourth quarter of 2007 to settle legal claims stemming from losses linked to subprime home loans. It made $417 million of payouts as of Dec. 31.

“It’s not a long-term negative, but it could affect near- term earnings if they have to pay civil penalties,” Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine, said in an interview.

State Street said in the SEC filing that it’s cooperating with the agency and with related probes by securities regulators and the attorney general in Massachusetts. Arlene Roberts, a spokeswoman for State Street, and John Heine, a spokesman for the SEC in Washington, declined to comment.

The company rose 18 cents to $48.50 at 4:15 p.m. in New York Stock Exchange composite trading. It has gained 23 percent this year, compared with the 13 percent rise for the Standard & Poor’s index for asset managers and custody banks.

Prudential Lawsuit

Prudential Financial Inc., the second-largest U.S. life insurer, sued State Street in October 2007 on behalf of 200 retirement plans for $80 million, the amount lost in two bond funds that were designed to closely track benchmarks. About 28,000 retirement accounts were affected.

The suit, filed in federal court in Manhattan under the federal Employee Retirement Income Security Act, alleged State Street changed the investment strategies of the funds and made “undisclosed, highly leveraged investments in mortgage- related” assets.

State Street lost a bid to have the case thrown out in September. U.S. District Judge Richard Holwell rejected the company’s claim that investors haven’t been injured because Prudential reimbursed them.

Robert DeFillippo, a spokesman for Prudential, declined to comment on the SEC’s action.

Galvin Probe

Secretary of the Commonwealth William F. Galvin, the top securities regulator in Massachusetts, said in April his office was investigating State Street for allegedly misleading pension funds over the risks of their investments.

Evergreen Investments agreed this month to pay $40 million to settle claims by the SEC that it overstated the performance of its Ultra Short Opportunities Fund from February 2007 to its closing in June 2008. When values were changed, investors were informed selectively, the agency said. The fund has been liquidated. Boston-based Evergreen was acquired by Wells Fargo & Co. in its takeover of Wachovia Corp.

OppenheimerFunds, a unit of Springfield, Massachusetts- based Massachusetts Mutual Life Insurance Co., was sued this month by investors seeking to recoup losses allegedly caused by mismanagement of the Oppenheimer Pennsylvania Municipal Fund.

The SEC has opened more than 50 inquiries and brought at least 10 cases linked to subprime loans since rising defaults triggered the global credit crisis in 2007.

To contact the reporter on this story: Christopher Condon in Boston at ccondon4@bloomberg.net

Last Updated: June 29, 2009 16:47 EDT