State Street Bank and Trust Co. has agreed to pay nearly $89 million to settle SEC charges that it overcharged mutual funds. However, the seemingly large penalty only represents just over half of what the firm raked in from overcharges based on the SEC’s allegations.
According to the SEC’s cease-and-desist order, State Street overcharged its mutual fund clients and other registered investment companies (RIC) for 17 years for certain reimbursable expenses.
“State Street entered into contracts with its RIC clients providing that State Street would bill them for out-of-pocket expenses that State Street incurred in providing services to the RICs,” said the order. “Instead, State Street charged the RICs a total of over $170 million more than State Street’s costs.”
That would indicate that, minus the penalty, the firm still ended up netting more than $81 million from overcharging its clients. The $89 million penalty includes disgorgement of just under $48.5 million, a civil penalty of $40 million, and prejudgment interest of just over $300,000.
Although the SEC declined to comment on why State Street only has to pay just under 52% of what it overcharged clients, the likely reason is because the regulator was hampered by a relatively new statute of limitations on when it can collect disgorgement fees.
In 2017, the US Supreme Court ruled in Kokesh v. SEC that the SEC’s disgorgement fines constitute a “penalty,” and are therefore subject to a five-year statute of limitations. That means that the SEC can no longer ask for disgorgement of ill-gotten gains more than five years after the violations occurred.
Because the alleged violations committed by State Street ended in 2015, that means the statute of limitations to collect disgorgement fines was set to expire at some point next year.
Stephanie Avakian and Steven Peikin, co-directors of the SEC’s Division of Enforcement, testified before Congress last year about the “significant impact” the Kokesh decision had already had within the division.
“Many securities frauds are complex and can take significant time to uncover and investigate,” Avakian and Peikin said in their May 2018 testimony. “In certain cases, Kokesh threatens to severely limit the recovery available to harmed investors. Wrongdoers should not benefit because they succeeded in concealing their misconduct.”
The State Street overcharges included expenses related to Society of Worldwide Interbank Financial Telecommunication (SWIFT) messages, a secured messaging network used by banks and other financial institutions. State Street allegedly misled RICs by identifying SWIFT messages as an out-of-pocket expense in client fee schedules and invoices when in reality State Street applied a large undisclosed markup to SWIFT billings.
The SEC said State Street overcharged approximately 5,000 RICs by a total of more than $110 million for SWIFT messages alone between 1998 and 2015.
According to the order, in April 2009, some employees in State Street’s US Investor Services business unit, which primarily serviced RIC clients, questioned whether the $5 charge was necessary to cover the firm’s SWIFT-related overhead costs. The employees were informed by a USIS finance assistant vice president that the estimated SWIFT overhead was approximately $0.25 per message.
Later in 2009, State Street’s business finance group implemented a rate reduction to $0.25 from $5.00. However, the SEC said State Street did not move all clients to the new rate, and only offered it to new clients and clients who had not previously been charged for SWIFT. Existing clients continued to pay 20 times as much per message as new clients.
“For years, State Street sent clients a bill for expense reimbursement, without disclosing that State Street had added extra compensation for itself—compensation that clients had not agreed to pay,” Paul Levenson, director of the SEC’s Boston Regional Office, said in a statement. “Fund expenses make a big difference to mutual fund investors and advisers; they have a right to receive honest information about what they’re paying for.”
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