State Street Settles Three Lawsuits For $70 Million
Earlier this week, State Street (NYSE:STT) settled three lawsuits – one by investors and two others by the custody bank’s employees – seeking damages for the huge losses shareholders incurred when the bank’s share price tanked during the economic downturn of 2008. The lawsuits alleged that the bank misled investors about its foreign exchange revenues and also about the quality of mortgage-backed securities – factors that hit its share price in the wake of the recession. [1] The bank will be paying $70 million to put this issue to rest, with $60 million going to investors and the remaining $10 million being directed to employees who had a sizable number of State Street shares in their retirement portfolios. The settlement will figure in State Street’s Q2 2014 results as a one-time increase in its non-interest expenses, and could materially drag down the overall results – given that the bank’s average pre-tax income over the last six quarters has been just above $600 million.
See our full analysis for State Street
The three lawsuits in question were largely triggered by the legal action that California’s attorney general initiated against State Street in October 2009, alleging that the global custodian overcharged pension funds for its foreign exchange services. Improper foreign exchange pricing policy by custody banks came under significant fire over subsequent years, with State Street and its larger competitor BNY Mellon (NYSE:BK) seeing a string of forex-related lawsuits by several states over 2010-2011. The banks have cleared a majority of their legal backlogs since then, and have also brought in more transparency to the way their foreign exchange arms work.
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Fee revenues generated by offering securities trading and financing services to clients are an important source of value for State Street. Based on our analysis of the bank, we estimate that these services contribute almost 14% of its share value, as shown in the chart above. More importantly, foreign exchange trading is responsible for a bulk of this figure, as it brought in revenues of $589 million in 2013 – roughly 42% of the $1.42 billion in total revenues from securities trading and financing. And the bank is quite keen on growing these revenues, as evidenced by the new forex offerings over recent months (see State Street Eyes Higher Forex Revenues From New Benchmark Trading Product). It is natural, therefore, for the bank to try to clear all legal overhang around its foreign exchange business to ensure adoption and use among existing and potential clients. This is where the recent settlements come in, as they intend to bring this long-drawn issue to a close. Notably, the bank continues to deny the allegations.
The impact of the one-time increase in expenses on State Street’s share value can be understood by making changes to the chart below, which captures the bank’s operating margin.
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Notes:- State Street settles shareholder, employee lawsuits for $70 million, Reuters, Jul 9 2014 [↩]