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On May 16, 2016, the U.S. Securities and Exchange Commission (“SEC”) sued then 44-year-old Ross I. McLellan of Hingham, Massachusetts, for securities fraud. The case was brought in the Federal Court for the District of Massachusetts, an apt location as McLellan had committed the fraud while employed as Senior Managing Director and Global Head of …[the] Portfolio Solutions Group of State Street Corporation. State Street Corporation is the holding company parent of State Street Bank and Trust, a banking institution headquartered in Boston, with (as of June 30, 2024), $4.4 trillion in assets under management and $44.3 trillion in assets under custodial arrangements. Originally founded in 1792 as a trust company under Massachusetts law, State Street Corporation (“State Street”) includes its subsidiary State Street Global Markets, LLC (“Global Markets”). Global Markets is, in turn, (according to State Street’s website), the largest custodial bank in the world. Global Markets (again per the website) specializes in providing services to mutual funds, collective investment funds, pension funds, and insurance funds in the U.S. and abroad, as well as foreign sovereign wealth funds. Global Markets was and remains an SEC-registered broker/dealer. The Portfolio Solutions Group is a unit of Global Markets.
According to the July 15, 2020, issue of Institutional Investor (the “Article”), Ross I. Martin was born into a working-class family in Warwick, Rhode Island, on Feb. 17, 1972. After high school, he earned a bachelor’s degree in accounting from Stonehill College, a liberal arts school outside Boston, and went to work as an accountant in the fund industry in Boston. Seeking advancement, he studied for and obtained an M.B.A. in Finance from Boston College at night (bolstering his data analyzing skills), while working during the day. Married by age 26, he was hired in 1997 by Global Markets as a “transition specialist” reporting to Nick Bonn, another Hingham resident. McLellan also became an SEC-registered representative in November 1997, continuing until November 2011. As the SEC states in its May 16, 2016 Complaint (the “Complaint”) against McLellan:
Transition Management is a service provided by financial institutions to clients that are undergoing a “transition.” Typically, Transition Management services are marketed to customers, such as pension funds or investment managers, which are changing fund managers or investment strategies and face large and complex changes to their portfolio of assets.
…virtually all customers required [Transition] services that included the buying or selling of securities that traded in the United States, including equities…and fixed income instruments.
Global Markets marketed itself as different from other banks, in that Global Markets “would play an un-conflicted fiduciary role”; because unlike other banks, Global Markets would execute transactions for its customers without operating a proprietary trading program for its own account. Global Markets “touted [itself] as a founding signatory to the T-Charter, voluntary, best-practices code for transition managers,” which Global Markets entered in 2007. T-Charter principals stated that a:
…transition manager will not apply commissions or charges, adjust prices or apply mark-ups other than as agreed with the client in the contracting documentation and as disclosed in a disclosure statement.
By 2009, McLellan had 11 years of experience at Global Markets, and when Bonn moved to another unit in State Street, McLellan was pushed by senior management into applying for a promotion to Global Head of the Transition Management unit. In that new position, in 2010 he visited the Global Markets office in London, where he met both Richard Boomgaardt, the London-based Senior Managing Director of Europe, Middle East, and Africa (“EMEA”), and his deputy, Edward Pennings, Head of EMEA Transition Management Desk for Global Markets’ Portfolio Solutions Group. The Complaint states that Boomgaardt’s primary role was to bring in new Transition Management customers and to maintain relations with existing customers. Pennings supervised a team of analysts and provided both daily updates and post-trade reports to Global Markets customers.
McLellan had learned on the job the much more restrictive obligations when dealing with customers whose holdings and activities were subject to the Employment Retirement Income Security Act (“ERISA”). He disclosed, in an interview (the “Interview”) published in the Article, that trades for customers subject to ERISA were routed through independent institutions (he mentioned UBS and Deutsche Bank), whereas transition trading for non-ERISA situations were handled by Global Markets, whose own income maximization was a primary consideration. When McLellan met Boomgaardt and Pennings, they were (according to McLellan in the same interview) quick to emphasize that “We don’t have ERISA here.” A new Global Markets employee, Raymond Pestana, who had just joined Global Markets from a competitor, told McLellan, “This is how it works here.” McLellan told his interviewer “It was the Wild West [in London].”
In 2010, Market Global “began to experience a shortage of major Transition Management deals, which impacted the financial performance of the Portfolio Solutions business.” Although the Complaint does not attempt to explain the reasons for the fall-off, one may speculate that this was part of the economic consequences of the Great Recession (2007-2009). In any event, McLellan was told by his ultimate supervisor, David Puth (according to the Interview) in no uncertain terms, to “push as much of …[the Group’s] client order flow as… possible” to State Street’s traders. Puth stressed the need to “extract more value from order flow,” pointing to State Street’s foreign exchange operations results, which were so high that McLellan referred to them as “crack cocaine for the bottom line.”
McLellan, after his promotion, became a State Street Executive Vice President and the Global Head of the Portfolio Solutions Group, and in that position he supervised all Transition Management employees, both in the U.S. and in Europe. He was also the President and Member of the Executive Management Group of Global Markets. By 2010, McLellan and his wife had had four daughters. In this post-Recession setting, complete with management pressure to perform, McLellan, together with Boomgaardt and Pennings (termed the “State Street Co-Schemers” in the Complaint), conceived of a plan to “earn” significant additional income for State Street by structuring, for non-ERISA customers, Transition trades with concealed mark-ups. McLellan later claimed in his defense that he had been part of discussions with State Street management, including Melissa McKay, Esq. (an in-house Harvard-educated lawyer), who had “signed off” on using the more aggressive foreign exchange model for non-ERISA transition trades in London. In any event, the Complaint alleged:
…during the period from February 2010 through September 2011, McLellan and the State Street Co-Schemers engaged in a pattern of fraudulent acts and practices in order to extract additional revenues from concealed mark-ups. In addition to instructing his subordinates generally to execute the hidden mark-up scheme, in multiple instances McLellan gave specific instructions aimed at keeping mark-ups hidden, including what prices to charge and what levels at which to execute trades.
In March 2010, after what the Complaint describes as “lengthy negotiations” concerning the cost of the Transition services desired by the Kuwaiti Sovereign Wealth Fund to “terminate a fixed income portfolio of U.S. Treasury bills, and to acquire European, U.S., and Canadian securities, Global Markets won the contract to execute the transition trades. Despite telling the Fund that the transition trades would be done on a zero-commission basis, with Global Markets receiving compensation from the winning counterparty to each transaction, McLellan and Company structured the trades so that State Street “earned” $2.7 million on those trades.” In May of 2010, McLellan and Company handled another Transition for that Fund, this one involving a $4 billion portfolio of European, U.S., and Canadian fixed income securities, where again Global Markets appeared to charge a zero commission. In fact, the trades were structured so that State Street received some $7 million. Then in December 2010, State Street was awarded a transition for the National Treasury Management Agency of Ireland to trade some €4.7 billion of securities, where the Agency eventually agreed to pay a fixed management fee of 1.65 basis points, which was reduced to 1.25 basis points for the third tranche of securities being traded. But the Complaint alleged:
[State Street] charged the Irish Government Agency hidden commissions on the equity trades on both the first and third tranches, and charged hidden mark-ups on the fixed income trades across all three tranches.
Under the terms of the transition services contract with the Agency, “State Street earned a contractual fee for the transition totaling approximately $1,634,085. Using the hidden commissions, State Street “took additional revenue of approximately $3.7 million from the hidden mark-ups and commissions.”
Then in February 2011, State Street was awarded a transition contract for the British Royal Mail Pension Plan, where the contract called for a fixed fee of 1.75 basis points, so that the agreed fee was $922,107, but the trades were structured so that State Street “earned” an additional $3 million plus from the hidden mark-ups. As the Article discussed, that $3 million came not from an institution, but “out of the pockets” of thousands of retired British postal workers. In addition to the four previously-discussed transition service contracts, McLellan and Company handled transitions for a £850 million bond portfolio for a British pension fund; a €1.6 billion transition in the Netherlands involving the restructuring of fixed income portfolios for two pension plans; and a €1 billion “global equities and fixed income” portfolio for an Irish telecommunications agency. These three transactions yielded another $3 million plus from hidden mark-ups.
The McLellan and Company scheme came to an end when Ian McKnight, the Royal Mail Pension Plan’s Chief Investment Officer, asked for confirmation that no compensation had been paid beyond that called for in the transition services contract; Pennings assured him that this was true. After McKnight was assured that no other compensation had been received, he responded that the Plan’s consultant (an independent British analytics firm), “using publicly available bond pricing information in the U.S., had identified mark-ups on certain U.S. fixed income trades which had not been disclosed.” In the first discussion among McLellan and Company after being confronted, McLellan, according to the Complaint, “proposed lying to the British Postal Company – to wit that State Street’s undisclosed mark-ups were the result of a ‘fat finger mistake’ (essentially a clerical or typing error).” At the direction of McLellan (and others), State Street agreed to rebate the Royal Mail Pension Plan approximately $1 million for the “inadvertent commissions.” The Complaint further noted that “[i]n order to avoid drawing attention from State Street’s compliance or legal personnel, McLellan and others… circumvented the usual processes and procedures to reimburse …[the Plan] without recording the repayment in State Street’s loss event tracking system.”
Despite the lies, evasive behavior, and “rebate,” the Plan chose to bring the discrepancies and Pennings’ statements to the attention of British authorities. It is worth noting that this occurred before Brexit, when Britain was still part of the EU, which may explain why there does not seem to have been investigations by Irish or Dutch regulators. In any event, McLellan was terminated by State Street on Oct. 4, 2011, when he was required to turn in his identification badge and his Nokia. At that meeting, Puth said “We’re going to cut the rope right here. Good Luck.” On Jan. 31, 2014, the British Financial Conduct Authority (“FCA”) found State Street had overcharged customers a total of $20,169,603, and imposed a penalty of £22,885,000. McLellan suspected (according to the Interview) that Pestana, who had by then left State Street, told his new employer, Russell Investments, about the undisclosed commissions to boost chances to take transactions away from State Street.
The FCA continued to pursue enforcement actions against Boomgaardt and Pennings. On June 28, 2017, Pennings pled guilty to security fraud and related offenses. On April 5, 2016, McLellan was arrested by the FBI, also for securities fraud, and faced trial in parallel actions – a criminal case brought by the U.S. Attorney for the District of Massachusetts and a civil case brought by the SEC. Both actions were heard by the Federal Court for the District of Massachusetts. In the October 2018 criminal action, in which Pennings was a prosecution witness, a jury found McLellan guilty of five of six counts for violations of Section 17(a) of the Securities Act of 1933, as amended; and of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder. He was sentenced to 18 months in a federal prison, but released to home confinement after six months due to a COVID-19 outbreak in the prison. The Article noted that McLellan’s wife had “stuck by him” throughout these years of job loss, legal expenses, judgment, and punishment. Finally, 14 years after the crimes began, the Massachusetts Federal Court, on June 14, 2024, entered a final judgment against McLellan in the civil action brought by the SEC enjoining him from future violations of the cited securities laws. The Complaint additionally had sought an order that he: i) disgorge ill-gotten gains plus prejudgment interest; and ii) pay a civil penalty as determined by the Court; but the Court determined that the injunction sufficed, given the criminal incarceration. It is likely that the Court also considered that McLellan’s financial condition had been materially damaged by his loss of employment, the legal expenses of his defense, and his probable difficulties in obtaining any new position in finance.
On Jan. 18, 2017, State Street entered into a Deferred Prosecution Agreement with the U.S. Department of Justice as a consequence of the “concealed commissions” scheme. Under that Agreement, State Street paid the Federal Government a fine of $32.3 million and the SEC a civil penalty of $32.3 million. Thus, the maximization of earnings urged by Puth to McLellan in 2010 had in fact cost State Street over $94 million (including the fine imposed by the FCA) — Hardly a good return on invested effort, let alone the reputational damage suffered by the institution. Over and apart from the consequences to the 232-year-old bank, the “concealed commissions” scheme inflicted devastating damages on McLellan, his wife, and their four daughters. There is a Theodore Dreiser-like “American Tragedy” quality to the story of Ross I. McLellan. As St. Paul wrote to his colleague Timothy, explaining the basis for unacceptable behavior in the Greek City-State of Ephesus (located in the Izmir State on the Ionian coast of Turkey):
For the love of money is the root of all evil. 1 Timothy 6:10
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