I haven’t had time to write about this until now, but last week State Street Corp. agreed to pay a $115 million criminal penalty and accept a compliance monitor for two years, to settle charges that the bank deliberately overcharged its clients for years. If you want an example of how invasive compliance monitorships can be, this is a settlement worth reading.
We can start with the misconduct itself, which was not good. As described in a statement of facts from the Justice Department, State Street executives engaged in a billing fraud scheme from 1998 to 2015, where they over-charged mutual funds for various services that State Street provided to the funds.
The fraud itself was simple: State Street added secret mark-ups to charges it was passing off to clients as “out of pocket expenses” supposedly billed at cost. For example, State Street would sometimes incur charges from SWIFT for financial transactions, which might range from $0.02 to $0.15 per transaction. But rather than pass along those relatively low charges, State Street would bill its clients $5 per transaction, and never disclose the mark-up.
Through that scheme, State Street eventually bilked its clients for more than $290 million.
The real question here, however, is the deliberate intent of State Street executives to deceive customers. The Justice Department listed eight people as co-conspirators in the fraud: senior vice presidents, vice presidents, managing directors, and even a controller. These are people who should have known the importance of good business conduct.
One telling example was this exchange, from co-conspirator 4 (a State Street senior vice president) to one of his minions:
[Co-conspirator 4] e-mailed an assistant vice president in State Street’s accounting operations group, “The issue [is] we are charging $5 for a SWIFT message but the cost is much less … We can’t be in a position on [a client] that they discover that we are taking them to the cleaners on SWIFT charges.” The assistant vice president replied: “Sometime back at the beginning of time there was some form of analysis that arrived at the $5 per message … Today that figure is grossly inaccurate in terms of actual costs or even any legitimately defendable ‘fully loaded cost.’ I would absolutely not charge this rate to any new clients.”
That exchange happened in 2007. The billing fraud in question then continued at State Street for another eight years. So senior executives knew what they were doing was fraud, and then did it anyway. That is a corporate culture problem.
Hence the settlement announced last week: a $115 million criminal penalty, a deferred-prosecution agreement, and a compliance monitor for two years.
Monitor’s Mandate at State Street
State Street’s monitor (a specific person hasn’t been appointed yet; that will come in the next few weeks) will review three broad areas of the bank’s operations:
- Its billing system, to assure that internal controls and procedures work to prevent billing fraud
- The compliance program State Street uses to detect any billing fraud that employees might attempt anyway
- The training State Street uses to develop a strong ethical culture
How will that work in practice? First, State Street will need to produce three action plans for the compliance monitor within 45 days of his or her arrival; one plan for each of the above bullet points. Here’s how the settlement describes what should go into the Culture Plan, which corresponds to our third bullet point above:
A plan for Culture Training, including training new hires about misconduct, and an assessment of the effectiveness of current Culture Training programs, including the results of a survey of employees related to Culture Training (“Culture Plan”) … The Culture Plan shall include a certification from the Head of Human Resources stating whether the Company’s employees have completed required Culture Training. The Monitor may direct that the Culture Plan address specific issues, and may also require the Company to submit additional periodic survey questions on Culture Training to a subset of directors, officers, or employees.
After that first Culture Plan is delivered at Day 45, State Street will need to provide updated Culture Plans at least once every six months, or whenever else the monitor wants to see one.
Even more specific, however, are the requirements for the Compliance Plan, corresponding to our second bullet point above. That plan needs to “describe the compliance resources … including the identity of each employee whose principal function is to design, evaluate, or test internal controls intended to detect and reduce billing misconduct.” And likewise, that plan will be updated at least once every six months.
So specific compliance function employees will be named in the plan. That’s one way to define roles and responsibility.
Moreover, the chief compliance officer at State Street (that’s Jacqueline Angell, for the record) will need to certify that she believes the compliance function has enough resources “to maintain a reasonably effective system to detect and reduce billing misconduct.” Meanwhile, the head of HR will need to certify that all employees involved in designing, testing, or evaluating internal controls for billing fraud are indeed listed in the Compliance Plan.
That’s a lot of accountability the compliance monitor will be enforcing at State Street.
What Else Is There?
My question is this: What happens if the monitor finds evidence of other misconduct at State Street during his or her tenure?
After all, the evidence in this specific case points to a deeply flawed culture at the bank. I’m hard-pressed to believe that flawed culture only manifested as bogus up-charges State Street billed to mutual funds.
Indeed, prior misconduct at State Street is already on the record. Just days before the end of the Obama Administration in 2017, State Street paid a $32.3 criminal penalty and agreed to a deferred-prosecution agreement to settle charges that the bank had defrauded clients by secretly applying commissions to securities trades.
So that’s another example of billing fraud that presumably overlapped with this latest incident of billing fraud.
To be fair, State Street seems to have worked hard to clean up its act over the last five years. The bank did win credit from the Justice Department for voluntarily disclosing this misconduct; cooperating with the Justice Department’s investigation, including providing evidence against the individuals involved; paying restitution to the victim mutual funds; and paying roughly $97 million in civil penalties to the SEC and state regulators.
State Street also has undertaken lots of compliance program remediation work already, in addition to whateve the monitor might want to see as part of those three bullet points above.
Still, a bad corporate culture is a many-splendored thing. You have to wonder what else is in the closet.