The SEC charges that State Street and three subsidiaries “fraudulently charged secret markups for transition management services and separately omitted material information” from its trading platform for U.S. Treasury securities.
The SEC reports that State Street, the venerable, Boston-based financial services company founded in 1792, has agreed to pay more than $35 million to settle charges that it “fraudulently charged secret markups for transition management services and separately omitted material information about the operation of its platform for trading U.S. Treasury securities.”
“Transition management,” the SEC says, is a “service provided by some financial institutions to institutional customers that are undergoing a ‘transition,’ such as changing investment advisers or investment strategies.”
Those “hidden” and “secret markups” took place between February 2010 to September 2011 and involved six transition-management customers.
The customers who were defrauded by the secret markups included a Mideast sovereign wealth fund, an Irish government agency, a U.K. postal agency, a U.K.-based pension fund, a Netherlands-based pension fund and a European telecommunications agency, according to the SEC’s settlement order.
The markups resulted in approximately $20 million in overcharges and “improper revenue,” the SEC says in its settlement order, adding that State Street used “false trading statements, pre-trade estimates, and post-trade reports to misrepresent its compensation on various transactions, especially purchases and sales of bonds and other securities that trade outside large transparent markets.”
According to the commission, “When one customer detected some hidden markups and confronted State Street employees, they falsely called it a ‘fat finger error’ and ‘inadvertent commissions’ in order to conceal the scheme.”
Those characterizations, made at the direction of a State Street executive vice president, were “materially false and misleading statements to the customer in order to conceal the hidden mark-ups,” the SEC charges.
That State Street EVP, according to the SEC’s order, is Ross I. McLellan, age 44, a resident of Hingham, Mass. In the relevant 2010-2011 period, he supervised the State Street employees who told the inquiring customer that the markups were simply a “fat finger error,” per the SEC. In October 2011, McLellan was discharged for his involvement in the secret markups. In 2012, he founded Harbor Analytics, a “transaction cost analytics and consulting firm focusing on measuring and managing costs for Asset Owners,” per McLellan’s Linkedin profile.
The relevant State Street subsidiaries have agreed to retain an “independent ethics and compliance consultant,” according to the SEC’s order.
McLellan and another former bank employee face possible criminal and civil court actions, according to press reports. In addition, two former State Street employees based in the U.K. face separate legal actions.
Martin Weinberg, an attorney for McLellan, confirmed that the former banker has “repeatedly and vigorously denied in both the
Ross I. McLellan, former EVP, State Street
SEC and Department of Justice proceedings that he is culpable and acted in any other than a transparent and appropriate way.” He also confirmed that his criminal trial is scheduled for June 2018, and that the SEC’s civil lawsuit against him has “been put on hold pending the outcome of the criminal case.”
Separately, the SEC contends that State Street “failed to inform subscribers to its government securities trading platform called GovEx that despite marketing the system as ‘fair and transparent’ it provided one subscriber with a ‘Last Look’ trading functionality that allowed a short period of time for the subscriber to reject a match to a submitted quote.”
According to the SEC, State Street did not inform subscribers who held GovEx accounts that “they had been connected to an account that could reject matched quotes using Last Look.”
State Street displayed one subscriber’s quotes to the other GovEx subscribers “without disclosing” that the subscriber “could — and did — use Last Look to reject matches.”
In fact, says the commission, that subscriber “rejected 57 of the 157 matches to quotes placed by the Last Look Account. These 57 matches each had a $1 million face value, for a total combined notional value of $57 million.”
Five other GovEx subscribers were counterparties to the 57 rejected matches, the SEC notes, adding that State Street “did not inform the five counterparties involved in these 57 matches that their orders had been rejected with the use of Last Look.”
State Street “even told one subscriber that the platform did not have Last Look functionality at all,” SEC adds, noting that State Street stopped using the GovEx platform for trading U.S. treasury securities in July 2015.
While Boston-based State Street neither admits nor denies guilt, the firm has agreed to pay $3 million to settle the SEC charge regarding its GovEx electronic platform disclosure failures.
Similarly, the firm’s State Street Global Markets LLC, State Street Global Advisors Funds Distributors LLC, and State Street Bank and Trust Company subsidiaries “have agreed to pay a $32.3 million penalty to settle the fraud charges for the hidden transition services markups, which violated Sections 17(a)(1) and (3) of the Securities Act of 1933 as well as Section 15(c)(1) and Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5(a) and (c),” the SEC says.
The commission notes also that “State Street Corporation and certain foreign subsidiaries previously agreed to pay separate penalties to U.S. criminal authorities and the United Kingdom’s Financial Conduct Authority.”
“Agreeing to a fee arrangement and then secretly tucking in hidden, unauthorized markups is fraudulent mistreatment of customers,” Paul G. Levenson, director of the SEC’s Boston regional office that investigated the overcharges, says in a statement.
“Today the US Securities Exchange Commission (SEC) announced a settlement with State Street to resolve its investigation concerning six EMEA-based transition management clients serviced by our transition management business that were charged amounts in excess of their contractual terms in 2010 and 2011,” the company said in a statement. “We announced the SEC’s agreement in principle in January of this year. We deeply regret that our clients were impacted and that a small number of our employees failed to meet our expectations. The impacted clients were fully reimbursed and over the past several years we have taken significant steps to strengthen our controls for our transition management business, and more broadly to enhance our compliance program, culture and operating environment. This brings to a conclusion all governmental investigations with respect to the Company arising out of the overcharging that occurred in 2010 and 2011.”
To view the entire SEC settlement order regarding the secret markups, click here.
To view the entire SEC settlement order regarding GovEx and Last Look, click here.
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