Hidden costs imposed by banks on trading clients are at issue again today with the Securities and Exchange Commission announcing a $382.4 million settlement with State Street over misleading mutual funds and other custody account clients.
A custody bank holds assets and securities for safekeeping. This includes stocks, bonds and commodities. As part of these duties, it may arrange for settlement of transactions involving these assets and securities.
In the case of State Street, it offered customers the ability to buy and sell foreign currencies when needed to settle transactions involving foreign currencies. These services are known as Indirect FX because the client is not speculating on the movement of the currency – they are only transacting in the currency in order to complete the desired result for a transaction which would otherwise leave them owning a foreign currency. On these trades, State Street told customers that they would provide best execution and competitive market rates.
Instead, State Street charged its customers set prices based on uniform markups and failed to give customers the best possible prices. For misleading customers, the SEC will find that State Street violated portions of the Investment Company Act of 1940. In total, the SEC penalties, disgorgement and interest totaled $167.4 million.
The settlement also involved a resolution of potential charges by the Justice Department and the Department of Labor. The Labor Dept. protects ERISA plan clients (retirement accounts).
The government investigations reportedly started after whistleblowers alerted multiple authorities to the losses by public pension funds. A group called Associates Against Insider FX Trading, which includes Bernie Madoff whistleblower Harry Markopolos, filed lawsuits across the country years ago. It is unclear yet whether an award will be issued either under the False Claims Act or through the SEC whistleblower program.
The False Claims Act offers 15 to 30 percent of the government’s recovery to the relators. However, the scope of the applicable penalty is unclear since it would turn on the definition of “alternate remedy“. The potential for an award based on the total government fine would be better under the SEC program, which allows for rewards based on “related actions”.
State Street has additionally reserved almost $150 million to settle private class action lawsuits by customers.