State Street to Pay $530M to Settle FX Charges

State Street Bank has agreed to pay $530 million to settle allegations that it had charged clients hidden markups to foreign currency exchange trades.

According to the US Securities and Exchange Commission (SEC), one of a number of investigating authorities, State Street gained “substantial revenues by misleading custody clients.”

The SEC alleged that while State Street told clients it would guarantee “the most competitive rates available” on FX trades, it instead fixed prices “driven by predetermined, uniform markups and made no effort to obtain the best possible prices for these clients.”

“State Street misled custody clients about how it priced their trades and tucked its hidden markups into a corner where they were unlikely to notice,” said Andrew Ceresney, director of the SEC’s division of enforcement.

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As part of the settlement, the Boston-based firm admitted it had “generally” failed to price FX transactions at market rates.

The financial agreement includes a $167.4 million fine to the SEC, $155 million to the Department of Justice, at least $60 million to settle cases with the Department of Labor, and $147.6 million to resolve private class-action lawsuits. State Street has also settled with the Massachusetts Attorney General.

The FX trades in question occurred between 1998 and 2009, State Street said, and since then the firm has improved operations.

“In 2009, we significantly strengthened our disclosures around indirect foreign exchange, including publishing the spread relative to indicative interbank market rates at the time of pricing, and today believe we provide our clients with the most comprehensive disclosures in the industry,” Mike Rogers, State Street’s president and COO, said in a statement.

The settlement comes just three months after former State Street executives Ross McLellan and Edward Pennings were indicted on scheming to defraud at least six institutional clients of its transition management business.

US authorities claimed the duo had overcharged “secret commissions” to billions of dollars of trades between February 2010 and September 2011.

The allegedly defrauded clients include the UK’s Royal Mail Pension Plan, Ireland’s National Pension Reserve Fund, and the Kuwait Investment Authority.

AQR Founder Cliff Asness has warned that factor timing is “very difficult to do well.” But some hedge fund managers may have the skill to pull it off, according to new research.

A study focusing on factor timing ability of more than 3,000 hedge funds from January 1994 to April 2014 concluded that managers as a whole “do possess factor timing skills,” with the most skillful hedge funds delivering alpha of 0.96% annually through factor timing.

These top-performing funds tended to be younger and smaller, have higher incentive fees, have a smaller restriction period, and make use of leverage, found Netherlands-based KAS Bank analyst Bart Osinga and finance professors Marc Schauten and Remco Zwinkels of the Vrije Universiteit Amsterdam.

“These funds are more flexible to engage in factor timing strategies due to the younger and smaller environment,” they wrote. “More flexible funds have better factor timing skills.”

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Meanwhile, higher incentive fees and smaller restriction periods are likely to draw in more skillful managers, the authors argued.

“A shorter restriction period is preferable for investors,” they continued. “Thereby, funds with smaller restriction periods can theoretically attract more investors, which in turn can result in attracting higher skilled managers.”

Although skills varied across investment styles, the authors found managers overall possessed “strong” ability in timing market, size, and bond risk factors. The emerging markets factor, meanwhile, was the subject of “substantially negative timing”—a result they attributed to herding behavior.

“This study presents broad and strong evidence for the factor timing skills of hedge fund managers,” Osinga, Schauten, and Zwinkels concluded. “A better understanding of [these skills] is important for investors to make a better investment decision and important for the managers themselves to learn from.”

Read the full paper, “Timing is Money: The Factor Timing Ability of Hedge Fund Managers.”