State Street Proves That You Get What You Pay For

I still have a little PTSD about bankers saying "we need to be very creative here."

I confess I'd never really heard of "transition management" until a couple of weeks ago. Apparently, it is a service provided by some banks and dealers to big investors who need to sell, or buy, or sell and then buy, a bunch of securities all at once. This would happen if, for instance, the investors "were changing fund managers or investment strategies," because I guess you can't just have your old fund manager messenger over all your stuff to the new fund manager? 1 (The strategies bit I get.)

I heard about it a few weeks ago because ConvergEx got in some trouble with the Securities and Exchange Commission for mismanaging transitions. Just from the structure of the business you can understand how this would happen. If you're selling like $5 billion worth of stuff, and then buying it all back again, for whatever reason you do that for, you will simultaneously:

  • care a whole whole lot about how much you're paying in commissions, because two cents a share might work for your everyday trades but not for trading all of your stuff at once; and
  • not really have the desire or ability to keep track of exactly what's happening what with all the buying and the selling, because there are just so many trades.

And so you get ConvergEx's SEC settlement, where ConvergEx charged clients small, highly competitive, fully disclosed commissions to execute their transitions, and then snuck in secret markups whenever the clients weren't looking. Literally -- ConvergEx would pay attention to time differences and charge markups on trades that happened when the clients were asleep.

Today the UK Financial Conduct Authority settled a pretty similar case with some UK bits of State Street Corp., which the FCA found overcharged six clients by a total of just over $20 million. The Final Notice is full of funny quotes; let's read some!

First there is Client A, who had a 4.7 billion euro portfolio to transition. It hired State Street's Portfolio Solutions Group ("PSG," or "EMEA PSG" since it covered Europe, the Middle East and Africa) to do it, for a flat management fee of 1.65 basis points, later reduced to 1.25 basis points for a portion of the trade. How did State Street decide on that price?

In deciding what bid to make to Client A, a series of emails were sent between members of PSG senior management which included the following comments on how revenue would be earned from the transition:

"Gotta win this one! Any ideas how to get more revenue would be appreciated."

"How about a 1bp management fee or something of that nature, no commissions and then take a spread? We need to charge fee then otherwise they get suspicious."

"Just to clarify - 1.25bps is the management fee. The extra quarter point makes it look like we actually thought about it and did the calculations."

My favorite word there is "the": "we actually thought about it and did the calculations," as though there were some math that could produce the right answer for how much State Street should make on these trades. There are no calculations! It's just, what feels right to the client, what can you get away with, etc. State Street quite charmingly thought that a number with three significant digits would seem more real than a number with one, and that that would help it get away with more. Surely no one who takes the time to write three whole digits and a decimal point would rip you off. Only harmless nerds would write three digits where one would suffice.

But, nope, State Street, like ConvergEx before it, charged various secret undisclosed markups. 2 State Street was supposed to make $1.6 million from Client A in agreed fees, but made an additional $3.7 million from undisclosed markups. 3 Clients B, C, D and F are similar: State Street agreed to various small fees and then also took a bunch of larger undisclosed markups.

But my favorite is Client E, who did two fixed income transitions with a total value of about $6 billion. This client was focused on paying zero:

Following communications between EMEA PSG senior management and Client E prior to the first transition, in which Client E requested that no explicit commission be charged, EMEA PSG senior management proposed to undertake the transition on a zero commission (and no management fee) basis.

In a series of communications between EMEA PSG senior management and Client E, EMEA PSG senior management made clear that State Street UK preferred to charge a disclosed commission, but in this instance it had arranged to receive:

"a share of the spread from the 'other side' (the successful/winning counterparty for each individual security as chosen by us as your agent in a competitive bid process)"

So the FCA quibbles with State Street's use of the "other side" -- obviously, Client E was paying more to buy a security than its seller was selling it for, and that was going to State Street -- but there are more interesting things going on here. For starters, note that Client E wanted to pay zero. Client E was not an idiot, or not exactly: It knew that it was going to pay State Street for its time and transition-management mojo. It just didn't want to pay any explicit commission, for whatever reason, and that reason probably wasn't a good one. 4

And State Street knew that, and said, no, please, we want to charge you an explicit commission. I like to imagine that this was because it knew that it couldn't resist temptation. And there's no temptation like zero commissions. Here's how State Street management reacted to learning it was getting a zero-commission mandate:

On being awarded the second fixed income transition for Client E, members of EMEA PSG management exchanged emails commenting: "Nice!" and "Back up the truck!"

Right? State Street made $9.7 million on this one, almost half of all the overcharging that the FCA identified. There's nothing more profitable than a zero-commission trade. If you've agreed to a 1.65 basis point commission, I guess you can go ahead and charge secret markups, but you'll know that you're being a jerk by doing it. But if you've agreed to do a trade for nothing? The client knows that you're sneaking something in somewhere. They're practically asking you to back up the truck. State Street was happy to oblige.

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  1. Similarly, the FCA says "TM services may be required when a client needs a large portfolio of securities to be restructured, or when a client decides to remove or replace asset managers." Even odder is Wikipedia: "A typical example would be a mutual fund has decided to merge two funds into one larger fund."

  2. And they plotted it as obnoxiously as possible:

    members of PSG senior management continued to discuss possible other sources of revenue over email:

    A: "need to be very creative here"

    B: "we will."

    Uggghhh uggghhh ugggggghhhhhh. Nothing good has ever happened after a banker says "need to be very creative here." If I were designing the e-mail and instant-message blocker software at a bank, I'd block "creative." "Creative" is a terrible word.

  3. Your guess is as good as mine as to how 1.25-1.65 basis points of 4.7 billion euros came out to $1.6 million. (This is sometime in 2010-2011, when a euro was between say $1.20 and $1.50.)

  4. Someone, somewhere, was getting a report from Client E saying "here's how much we paid in commissions," and Client E wanted that report to say "nothing, aren't we great." And was willing to pay more in trading-costs-not-labeled-commissions to achieve that goal.

(Matt Levine writes about Wall Street and the financial world for Bloomberg View.)

To contact the author on this story:
Matthew S Levine at

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