SEC Charges State Street Employee For Fraudulent Fees
Transition Management is a service offered by securities professionals to pension funds and other investment managers who are changing fund managers, investment managers or making similar transitions and need to make significant changes in their portfolio of securities. One of its goals is to minimize the cost of such transactions. Sometimes that is not the case, however, as the SEC’s cases involving Convey Ex Executions Solutions LLC illustrate. There clients seeking to minimized costs were victimized by securities professionals who increased the cost by adding on secret, undisclosed commissions. See, e.g., SEC v. Bassily, Civil Action No. 16-cv-2733 (S.D.N.Y Filed April 12, 2016). Likewise, in SEC v. McLellan, Civil Action No. 1:16-cv-10874 (D. Mass. Filed May 13, 2016) the Transition Management group actually increased the cost of the service by adding secret commissions.
Ross McLellan, the defendant in the action cited above, was the Senior Managing Director and Global Head of State Street Corporation’s Transition Management line of business. He supervised the operations of the segment in the United States and Europe. Mr. McLellan was registered with the broker-dealer affiliated with State Street Global Markets LLC.
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. The firm represented to potential customers that it followed the best practices code known as the T-Charger. It set forth principles relating to disclosure and remuneration. Specifically, it states that the transition manager will 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 Portfolio Solutions business. From February 2010 through September 2011 Mr. McLellan, along with Employees A and B, charged hidden mark-ups to Transition Management customers to generate additional revenue. Mr. McLellan also gave specific instructions to keep the additional charges hidden.
Typically fixed income trades were selected for hiding additional mark-ups. State Street did not usually disclose pricing on fixed income trading and was rarely asked for a breakout of pricing. Mr. McLellan and the others also typically selected larger transitions for the addition of mark-ups. During the period additional charges were added to the transition for a Middle Eastern Sovereign Wealth Fund, an Irish Government Agency and a British Postal Company. For example, for one transition for a Middle Eastern Sovereign Wealth Fund which involved the termination of a fixed income portfolio of US Treasury Bills and trading European, US and Canadian securities, the firm agreed after extensive negotiations to work on a zero commission and no fee basis. State Street claimed it had arranged to be compensated by the “other side.” The claim was false – the Fund actually paid.
In another instance State Street was awarded a transition for a government agency that managed the assets and liabilities of the government of the Republic of Ireland. The transition involved fixed income and equities trading and was valued at about 4.7 billion Euros. The agency agreed to pay a fixed management fee of 1.65 basis points. That fee was reduced for the third Traunche of the transition. Mr. McLellan and State Street charged the agreed upon fee and, in addition, added others.
Similarly, State Street agreed to provide transition services to the British Postal Agency for a fixed fee of 1.75 basis points on the value of the portfolio. While the client was assured that this would be the only fee charged, in fact additional, undisclosed fees, were charged. When the firm later questioned the fees, Mr. McLellan falsely claimed that the undisclosed mark-ups were the result of a clerical error and only occurred on US trades. Eventually about $1 million was rebated to the firm as “inadvertent commissions.” The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23540 (May 13, 2016).
The U.S. Attorney’s Office for the District of Massachusetts filed a parallel criminal action against Mr. McLelland and another individual. The UK’s Financial Conduct Authority found that State Street deliberately overcharged six customers $20,169,602 and imposed a financial penalty of £22,885,000.