A former State Street executive was found guilty of defrauding sovereign funds and other institutional investors by tacking hidden commissions onto billions of dollars’ worth of trades, dispensing with an oft-used defense that such practices are just business as usual on Wall Street.
Once again, a jury was asked to decide whether a banker committed fraud or just behaved as any car dealer would by cutting a sharp deal. And once again, the banker was found guilty, in a verdict that could have reverberations on Wall Street, where bankers are loath to be compared to car salesmen — except, it seems, when they’re on trial.
The banker, Ross McLellan, was accused of directing a scheme to lure institutional investors to State Street’s transition-management program, where the bank promised to help the funds liquidate complex investments for a low fee and no hidden costs. State Street then defrauded the clients by secretly applying millions of dollars in commissions to the trades, according to a deferred prosecution agreement between the bank and the Justice Department.
McLellan is scheduled to be sentenced by U.S. District Judge Leo Sorokin on Oct. 10. His lawyer, Martin Weinberg, said he would appeal the verdict.
Two former London-based State Street bankers, who reported to McLellan, previously pleaded guilty in the case, and both testified at a trial this month in Boston on behalf of the government.
In his closing argument on Monday, Weinberg cautioned jurors against criminalizing conduct that he said was worthy of no more than a business dispute.
“Business is not always black and white,” Weinberg said. “Businesses don’t always have a duty to spell things out.”
The government’s case was focused on McLellan and the millions of dollars in hidden commissions that the Boston-based custodial bank admits it tacked on to the clients’ trades. The jurors reached its decision a day after they began deliberating, in a verdict that could be felt throughout the financial sector.
In the 10 years since the financial crisis, the Justice Department has compiled a spotty record in bringing criminal charges against bankers accused of defrauding clients or investors.
Prosecutors in Manhattan succeeded in prosecuting a network of insider trading from 2009 to 2013, only to have some of those convictions overturned on appeal. In Brooklyn, two hedge fund managers at Bear Stearns were acquitted in 2009 of charges that they defrauded investors.
More recently, prosecutors have gone after bond salesmen from Wall Street firms, accusing them of lying to customers about how much the bonds they were selling were worth. Several of those cases resulted in acquittals, while two separate convictions of a former Jefferies Group salesman, Jesse Litvak, have been overturned on appeal.
The McLellan prosecution was different, however, because it was based on agreements in which State Street explicitly promised to help multibillion-dollar retirement funds unwind trading positions for a low flat fee.
In order to win transition-management clients, State Street consistently underbid its competitors for some of the world’s biggest institutional investors, including the Kuwaiti Investment Authority, Ireland’s National Treasury Management Association, the U.K. Royal Mail pension fund and the Sainsbury’s grocery chain’s pension plan.
McLellan’s team won the accounts by using a “thin to win” strategy of undercutting competitors’ bids and agreeing to manage the transitions for a flat fee of between 1% and 2%, with the promise that the bank wouldn’t charge the clients with additional commissions on trading.
The bank, after admitting that it secretly overcharged six clients in 2010 and 2011 by a total of $20 million, refunded the money. State Street also paid close to $100 million in penalties to the Justice Department, the SEC and the U.K.’s Financial Conduct Authority to resolve the matter.
In its deferred prosecution agreement with the Justice Department, State Street pledged to tighten its oversight of the transition-management business. As part of a corporate restructuring, State Street shut its transition-management operations in London and Hong Kong last year.
Two of McLellan’s subordinates, Edward Pennings and Richard Boomgaardt, pleaded guilty to being part of a scheme to defraud the bank’s clients. They testified about the steps they took — with the approval or support of McLellan — to hide trading commissions from clients, which included the Kuwaiti Investment Authority, the U.K. postal service pension fund and others.
Persuading a jury to convict a banker in a complex securities case can be challenging. Defense lawyers often argue that the purported victims are sophisticated institutional investors who are well-equipped to look after their own interests. That was the case with McLellan, who volunteered to refund $1 million to the U.K. postal service pension fund after it discovered the hidden commissions.
At the trial of Litvak, the former Jefferies salesman, his lawyers compared the bond market with a used-car lot, where the seller’s job is to get the highest price, and the buyer’s responsibility is to negotiate downwards. Litvak was convicted by two separate juries, but both convictions were overturned on appeal because of errors made by the trial judges.
That car-industry theme also emerged in McLellan’s trial in Boston, where Weinberg, in his closing argument, said an auto dealer offering a new car for $24,000 was under no obligation to disclose to a buyer that the manufacturer would rebate $4,000 of that total back to the dealer, thus disguising the fact that the vehicle was actually worth $20,000.
“Businesses don’t tell everybody everything,” he said.
‘NEED TO KNOW’
In his rebuttal, prosecutor Stephen Frank said State Street’s hidden commissions weren’t byproducts of typical business disputes but were instead the fruits of a conspiracy among a small group of people at the bank who operated on a “need-to-know” basis.
If McLellan believed that the conduct was perfectly legal, Frank said, “Why was it such a secret at the bank? The hallmark of a conspiracy is secrecy.”
Frank pointed to a recorded call between McLellan and the two alleged co-conspirators, Pennings and Boomgaardt, in which they discussed ways to explain the bank’s commissions to a client who had figured out what was going on.
“I don’t know, you gotta come clean,” McLellan said on the call, which the company recorded and the government played for the jury. “You gotta come clean with everything.”
“‘Coming clean’ is the language of liars and criminals,” Frank said.