State Street to pay $88.8M for mutual fund overcharges

The overcharges included a secret markup that State Street tacked on to the cost of sending secured financial messages through the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network.

Without admitting or denying the SEC’s findings, State Street agreed to cease and desist from committing or causing any future violations of these provisions, to pay disgorgement and prejudgment interest of $48.8 million, and to pay a civil penalty of $40 million.

As described in the SEC order, State Street’s clients agreed to pay the firm back for out-of-pocket custodial expenses the firm paid on the clients’ behalf. Instead of charging clients for the actual amount of the expenses, however, the SEC order finds State Street routinely overbilled its clients. According to the SEC order, from 1998 to 2015, State Street collected $170 million from the overcharges, with $110 million coming from the hidden SWIFT markup charged to thousands of its registered investment company clients. Subsequently, State Street has been and undertakes to continue reimbursing these overcharges, with interest, to affected 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,” said Paul Levenson, director of the SEC’s Boston Regional Office. “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.”

The SEC order finds State Street violated Section 34(b) of the Investment Company Act of 1940 and caused violations of Section 31(a) of the Investment Company Act and Rules 31a-1(a) and 31a-1(b) thereunder.

Remedial steps

The SEC order recognized that State Street self-reported its conduct to the Commission and it provided substantial cooperation to the Commission staff during the investigation. In addition, the Commission said it considered that State Street “promptly announced that it would reimburse its custodial clients for the amounts that it determined were in excess of its costs, with interest.”

In imposing the sanctions, the SEC said it has also considered State Street’s representations to the staff that State Street took the following remedial steps:

• An initiative to centralize invoicing with a goal of reducing the risk of systematic invoicing errors;
• Technological enhancements to reduce invoicing risk through process and controls automation and reductions in manual processing;
• Enhanced governance and oversight related to accuracy in customer invoicing, including new controls to monitor and test quarterly costs and usage for SWIFT messaging and other expense categories;
• Development of new standard fee schedule templates designed to reduce ambiguity and potential for misunderstanding as to State Street’s invoicing methodologies and implementation of a fee schedule exception approval process;
• New ethical training, testing, and conduct programs to continue to improve compliance culture; and
• Additional enhancements to compliance programs and controls systems.

The SEC order noted, too, that State Street “engaged a consulting firm with financial and forensic accounting experience to assess State Street’s processes to identify the categories of expenses that were overbilled, to identify the clients that were affected, and to assess State Street’s method of calculating the amount of client reimbursements.”