Ex-Employee Claims State Street Hierarchy ‘Approved’ Middle East SWF Overcharging

(December 3, 2012) – A member of State Street’s dismissed transition management team has claimed senior management within the bank approved the practice of taking “undisclosed mark-ups” on client transactions and accused the firm of making him a fall guy. 

Edward Pennings, who led the division in Europe, the Middle East and Africa for State Street, told an employment tribunal in London on Friday that he had been informed a group–including David Puth, the firm’s former global head of global markets who left shortly after Pennings and Ian Holden, the former head of agency trading in EMEA for the bank–had approved a business model that would allow the transition management team to make secret profits from clients’ portfolio shuffles. 

Pennings told the tribunal that he had been informed by his immediate boss, Ross McLellan who was also dismissed by the company, that the model had been approved and that the client was not to be made aware that mark-ups would be made by the bank. 

The tribunal was brought by Pennings in London, who has claimed he was unfairly dismissed by the bank last year after the discovery of the practice that saw the bank repay several million pounds and euros to affected large pension fund investors. State Street maintains Pennings was dismissed for having lied to clients. 

To support his case, Pennings said a deal with the $296 billion Kuwait Investment Authority (KIA), a Middle Eastern sovereign wealth fund (SWF), had been the first where the business model was implemented. The model would see State Street buying a bond on the open market, selling it on to its transition management client at a premium and booking the revenue without the client’s knowledge. He said McLellan had told him that the senior group had approved the new model of taking undisclosed mark-ups for the deal. 

The lawyer representing State Street at the tribunal denied this was the case, stating that his law firm, Freshfields, had found no evidence such approval had been given. He said the KIA had itself removed a clause from an agreement between the two parties that would have prevented State Street from making this type of revenue. Pennings responded that this was not evidence that the SWF had agreed to the practice, but that it was not fully aware of what the clause meant. 

In the autumn of 2011, State Street dismissed several people within the State Street Global Markets division and reshuffled various others over the transition management mark-ups. The United Kingdom’s Royal Mail pension fund and the Irish National Treasury Management Agency (NTMA), which was investing pension fund money, were refunded the value of the mark-ups made on their bond portfolio transitions. 

At the tribunal Pennings queried why the allegations against him changed from actually taking these undisclosed mark ups to repeatedly lying to the bank’s client, Royal Mail when confronted about the charges. 

State Street’s lawyer said that even if the business model had been approved by the higher echelons of the bank, lying to a client warranted a charge of gross misconduct and was a sackable offence. 

Pennings retaliated that there had been a culture of “don’t ask, don’t tell” about the mark-ups. He said: “I thought ‘non-disclosed’ meant non-disclosed. We had never discussed what would happen if a client ever asked about it.” 

The Royal Mail contacted Pennings after having engaged consultant Inalytics to analyse the data of the transition. Over the course of several emails, the State Street employee responded that a $1 million overcharge on the US bond portfolio “did not seem right” and he would investigate and revert with information for the fund. 

A further $2 million made on the transition of the European bond portfolio was never raised by Pennings, despite a call for full disclosure by Inalytics, State Street’s lawyer said. 

Pennings maintained that Inalytics was solely investigating the US bond portfolio due to the Trade Reporting and Compliance Engine (TRACE), which tracks US bond trades and is not present in Europe. Judge Housego, who was overseeing the tribunal, questioned this point due to the letter from the consulting firm asking for a picture of the “global bond” portfolio. Pennings added, however, that he and other members of the portfolio solutions group had wanted to reveal the full extent of the mark-ups, but had been overruled by senior management. This was refuted by State Street’s legal representative. 

The lawyer then accused Pennings of misleading the bank’s compliance team over the matter. He said Pennings had told Mark Leaden within the compliance team, that the $1 million to be repaid to Royal Mail had been due to an inputting error, rather than having been made intentionally. Pennings strenuously denied this claim, saying Leaden had been mistaken in his reporting of the conversation the two had on the matter. Pennings quoted Leaden as saying: “I used to be a bond trader, I know how you bond guys make your money,” then adding that the letter to be sent to the Royal Mail pension fund would be deliberately vague. State Street refuted the claim. 

Regarding the excess revenue made on transitions for Royal Mail and NTMA, which totalled around $5.5 million, Pennings said sector heads in Europe would have known where it had come from as it had been booked in a different place than usual. He said Steve Smit, formerly State Street’s head of Global Markets Europe and Investor Services UKMEA who co-signed the Royal Mail agreement with a stated fee of just over £227,000, and back office/operations department heads Ian Scott and Patrick Waller would also have known where the excess revenue had come from. Pennings claimed he raised the issue of undisclosed mark-ups in relation to the $5.5 million revenue at a meeting with senior EMEA State Street managers, but the bank’s lawyers said there was no mention of this in the minutes to support the claim. 

The bank’s lawyers said Pennings and his boss McLellan had been boosting the department’s revenue for personal gain. This was repeatedly denied by Pennings, who said the pair was trying to protect the bank and its business model. He added that the same practice had been standard when trading foreign exchange on clients’ behalf for over 15 years, but it had become accepted by all sides rather than vilified. 

He added that anyone investigating the matter inside State Street – Richard Lacaille, executive vice president in the bank’s asset management unit who had led the probe into Pennings’ activity and was present at the tribunal– would have realised that the practice was widely known, or he would have to conclude that there was a cover-up being initiated by the bank. After the tribunal, a spokesperson from State Street told aiCIO: “Mr Pennings’ actions fell seriously short of the standards and conduct expected of any employee at State Street and we have zero tolerance for this. We have addressed the issues directly with the clients that were impacted. His allegations regarding broader involvement of State Street management in approving his actions are completely without merit. We are disappointed that he has been unable to take responsibility for his behaviour and that he has chosen this current course of action.” 

The tribunal concluded today with lawyers from either side entering submissions to the tribunal on their client’s behalf. A decision on whether Pennings was unfairly dismissed is expected before the end of the year.