A group of Nuveen Investments Inc. funds sued American International Group Inc. Tuesday, alleging that the insurance company committed a subprime mortgage market-related fraud that cost the funds billions of dollars in losses.

The lawsuit, filed in federal court in Chicago, alleges that from March 2006 to September 2008, AIG violated securities laws and engaged in “common law fraud and unjust enrichment” with respect to issuing credit default swaps, which were designed to provide a sort of insurance on collateralized debt obligations that were backed by subprime mortgage bonds and other securities.

In September 2008, the federal government extended what eventually became a $182 billion bailout to AIG, saving the company from collapse under the weight of its billions of dollars in losses on the swaps. The value of AIG stock and bonds plummeted with the event. The government has since sold most of the 80% AIG stake it received in the transaction.

The Nuveen funds, which had purchased AIG stock and bonds, allege that the company and former top executives committed fraud by making false and misleading statements to investors about the losses that were bearing down on it.

AIG and Chicago-based Nuveen declined to comment.

Other institutional investors, including investment funds and pension funds, also have sued AIG alleging the same wrongdoing; those cases were consolidated in U.S. District Court in New York, where the plaintiffs are seeking class action status.

“Even though AIG was aware of the downward turn of the mortgage market, it did not undertake to hedge the CDS portfolio because doing so would have undercut the profitability of the business,” the lawsuit says.

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By late 2005, AIG stopped writing swaps for CDOs, but by then AIG was already insuring about $80 billion of the securities, most of which were backed by the more risky subprime mortgages, the lawsuit says.

“Not only was AIG brought down by 'unconscionable bets' that went terribly wrong, plaintiffs suffered tens of billions of dollars of losses, at the least, based on false and materially misleading statements that AIG, certain of its executives, directors, underwriters and outside auditor made concerning the company's financial results, business operations and condition,” the Nuveen funds said in the lawsuit.

The U.S. Justice Department decided not to take action against certain AIG executives involved in the company's swap activities despite a two-year investigation, according to reports in 2010.

The U.S. Securities and Exchange Commission extended monitoring of the company following the subprime crisis. The monitoring began in connection with the 2006 settlement of separate unrelated fraud charges brought by the New York attorney general.

Lynne Marek writes for Crain's Chicago Business, a sister publication of Business Insurance.