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State Street fine shows increasingly active FCA

10 February 2014. Published by Jake Hardy, Legal Director

On Friday 31 January 2013, the Financial Conduct Authority ("FCA") released its Final Notice in relation to an investigation of two of State Street's UK businesses.

The FCA's investigation related to the charges which State Street had levied on its portfolio transition management customers.  The FCA held that State Street's UK transition management business had "developed and executed a deliberate and targeted strategy to change substantial mark ups on certain transitions … that were deliberately not agreed with clients or disclosed to them".

The FCA found that six such customers had been overcharged by a total in excess of $20 million (representing 25% of the profits of the transition management business over the relevant period).  It has fined State Street £22.85 million, a figure which incorporates a 30% discount for early settlement.  State Street has already compensated, or is in the process of compensating, the six customers considered in the FCA investigation.

The Final Notice is couched in the strongest possible terms.  It finds that through its employees State Street committed egregious and deliberate breaches of duties as a fiduciary and as a "trusted advisor", and in the process deliberately provided false and misleading information to its clients.  In essence, State Street had purported to charge for managing portfolio transitions on a variety of bases including percentages and fixed fees.  What State Street had not told its customers was that it was in fact charging additional mark-ups and commissions which it disguised in a number of ways, for instance hiding them in the bid/offer spread it reported for a transaction.

When eventually challenged by a customer which noticed that the prices reported to it did not reflect the market, State Street's deliberate concealment continued. The relevant management at State Street refunded the challenged fees on the false basis that they were the result of an inadvertent mistake, while still concealing the fact that other similar charges had been levied to that client on other transactions within the same portfolio transition.

The FCA found that State Street breached the following Principles for Businesses:

  • Principle 6, which requires that "A firm must pay due regard to the interests of its customers and treat them fairly"
  • Principle 7, which requires that "A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading"
  • Principle 3, which requires that "A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems".

The FCA's commentary on the breaches of Principles 6 and 3 include observations that State Street "allowed a culture to develop … in which the interests of customers were subordinated to the generation of revenue for the firm" and that it "allowed business practices to develop whereby acting in the client's interests was less of a priority than profit making".

The State Street Final Notice is part of an ongoing review of transition management by the FCA.  Reportedly, although the FCA has not uncovered any other instances of secret mark-ups, it intends to recommend changes in the way the sector operates.  The State Street example reveals very serious wrongdoing.  A picture is steadily emerging of investment banks seeking to take advantage of institutional investors in a variety of ways, whether via the manipulation of benchmark rates or, in this instance in undisclosed transaction fees. The rather dispiriting conclusion is that institutional investors and asset managers ought to consider auditing with great care material transactions entered into with the investment banks and will no doubt come under increasing pressure from their own investors to do so.