by T. GormanPosted on Posted in SECActions

The former Senior Managing Director and Global Head of State Street Corporation’s Transition Management line was found guilty by a jury of conspiracy and securities fraud. U.S. v. McLellan, No. 1:16-cr-10094 (D. Mass.). Defendant Ross McLellan was found guilty of one count of conspiracy to commit securities fraud and wire fraud, two counts of securities fraud and two counts of wire fraud.

The charges stem from a scheme to defraud clients in the bank’s transition management business, conducted for institutional clients transitioning or liquidating a portfolio, according to papers in the criminal and parallel SEC civil action. From early 2010, through the fall of 2011, State Street offered transition services to customers in the U.S. and elsewhere. State Street claimed to offer a unique transition model that was conflict free and in which it acted as a fiduciary. Potential customers were informed that the institution followed the best practices code. It set forth principles relating to disclosure and remuneration. Specifically, the bank represented that the transition manager would not apply commissions or charges, adjust prices or apply mark-ups other than as agreed with the client in the contracting documents.

State Street typically charged a commission when trading equities and a mark-up on trades in fixed income instruments in the transition services segment. In some instances a fee was charged. The compensation was disclosed to customers in key contractual documents provide by State Street.

In 2010 State Street began to experience a shortage of major transition management deals. That impacted the financial performance of the business segment. From February 2010 through September 2011 Mr. McLellan, along with others, charged hidden mark-ups to transition management customers to generate additional revenue. Mr. McLellan also gave specific instructions to keep the additional charges hidden. During the period additional charges were added to the transition for six different clients.

The jury deliberated five hours before returning verdicts of guilty on five of six counts. Previously two other State Street employees pleaded guilty to participating in the scheme. See also SEC v. McLellan, Civil Action No. 1:16-cv-10874 (D. Mass. Filed May 13, 2016). The U.K.’s Financial Conduct Authority found that State Street deliberately overcharged six customers $20,169,602 and imposed a financial penalty of £22,885,000.

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by T. GormanPosted on Posted in SECActions

There has been much debate regarding the adoption of a fiduciary standard for brokers. In contrast, investment advisers have long been subject to such to such requirements. Brokers are, however, required to have a reasonable basis when they make a recommendation to an investor. That principle is the predicate for the Commission’s most recent settled proceeding against a large brokerage firm. In the Matter of Wells Fargo Advisers, LLC, Adm. Proc. File No. 3-18556 (June 25, 2018).

Respondent is a registered broker-dealer and investment adviser. The firm is a combination of Wells Fargo Investments LLC and Wachovia Securities. This action centers on a four year period beginning in January 2009 and certain sales practices for complex products. Specifically, the case centers on the sale and redemption of market-linked investments or MLIs, a fixed maturity financial product tied to a reference asset or market measure.

MLIs are structured financial products with a fixed maturity. The product has two components. One is a certificate of deposit or a zero-coupon bond. The other is an embedded derivative or combination of derivatives which provides synthetic exposure to the performance of a reference asset or market measure. The reference can be an index such as the S&P 500 or another, similar item. The product was generally issued by Respondent and structured by an affiliate.

MLIs were not suitable for short-term trading due to their limited liquidity, according to disclosure provided to investors by Respondent. Rather, they represented a buy and hold investment. One reason for this, in addition to the liquidity issue, is the cost. Customers typically incur significant costs of 5% to 6% of the principal amount when purchasing the product. Selling costs can run up to 3%. There are additional costs for selling prior to maturity.

During the period here, certain representatives at Wells Fargo Advisers engaged in a sustained practice of soliciting customers to purchase MLIs, redeem them prior to maturity and purchase new MLIs. In many instances those redemptions occurred within a year despite firm policy to the contrary. This meant that customers incurred substantial costs while Wells Fargo Advisers profited.

The rationale for soliciting customers to redeem early and then repurchase another MLI was to “lock in gains.” While this claim has some validity in limited circumstances, in essence it depended on the particular circumstances. Representatives who in fact repeatedly solicited customers to use MLIs as short term investments did not in fact conduct the appropriate analysis despite the fact that such a recommendation is based on an implied representation that it has a reasonable basis, according to the Order. Supervisors routinely approved such transactions with little analysis. As a result, Respondent violated Securities Act sections 17(a)(2) and (a)(3).

To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Respondent will pay disgorgement of $930,377, prejudgment interest of $178,064.27 and a penalty of $4 million.

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