Counterintuitively, CalPERS Sues State Street — and Then Rehires Them

(July 6, 2011) –The California Public Employees’ Retirement System (CalPERS) is currently suing State Street over foreign-exchange issues — but, counterintuitively, has just rehired them.

California Governor Jerry Brown — when he was working as attorney general — sued State Street in 2009 for “unconscionable fraud” against pensions over foreign-exchange pricing. The new contract with State Street, which CalPERS has said is worth about $5.7 million in annual revenue, signals that despite the string of lawsuits by pensions around the country against the nation’s largest custody banks, their relationship may be unaffected. 

“It does seem contradictory,” George Diehr, a CalPERS board member representing state employees, said in a telephone interview with Bloomberg. “It was difficult to find someone who would provide all the services and at the terms we required.”

In the midst of the various lawsuits facing State Street, CalPERS Chief Matt Flynn of the Operations, Performance and Technology Division provided an explanation of the fund’s continued relationship with the custody bank in a December 13, 2010 discussion of the contract, noting that State Street’s services are competitively priced and provide transparency. “The State Street service offering was considerably better valued than the next two competitors that were finalists in this competition, to the fact that it was approximately one half the estimated total annual cost of the next nearest competitor. So we felt that was significant. But what was important about the State Street proposal is that they offered an entirely new service model that met all of our requirements but did so at a competitive price,” Flynn said.

When asked specifically about State Street allegedly cheating pensions and how CalPERS could be sure it wouldn’t happen again, Flynn replied: “The reporting — the transparency that we required them to — we frankly required all firms to include in their proposal – and State Street’s just happened to be the best – if you look at the tools that they’re providing us today vis-a-vis this proposal, it gives us the transparency that we had been looking for in previous arrangements. So we get complete daily transparency about pricing, sources of pricing, the exact markup and spread that’s available that’s being applied to all transactions. And that level of information was just not available previously.”

In direct contrast with Flynn, others like Chris Havener, Founder & Managing Director of Royal Oak Capital Management, are more doubtful, believing that instances of custody banks allegedly cheating pensions will not be erased. “This isn’t a perfect world, and despite greater scrutiny, this problem will persist,” Havener told aiCIO in May, following news that the Securities and Exchange Commission (SEC) was probing into whether State Street and BNY Mellon made proper representations to pension fund clients about the manner in which their currency trades were handled and priced. While State Street had already revealed the investigation by the SEC into its currency trades, it hadn’t been previously known that the SEC was examining BNY Mellon’s activities. “This is the problem when you have people running other people’s money. Even though banks have a fiduciary responsibility to their clients, pension funds have dropped the ball on this…Perhaps, but not likely, this will serve as a wakeup call to act upon their naivety,” he said.

The solution to avoid misrepresentations in regards to foreign-exchange trading is for banks and pensions to form contractually-bound agreements, setting more specific details on the pricing of currency trades, according to Havener. However, smaller companies will not have the clout of larger funds in negotiating contracts, he added.

Public pension funds around the country have been increasingly vocal about custody banks allegedly cheating them on foreign-exchange trading. Last month, the Massachusetts Pension Reserves Investment Management (MassPRIM) claimed Bank of New York Mellon overcharged the fund more than $30 million on foreign exchange (FX) trading since 2000. The new figure upwardly revises an original accusation of $20 million in overcharges announced at a June 13 press conference. “Given our initial findings, we wanted to take as comprehensive a look at past foreign currency exchanges done on our behalf,’’ State Treasurer Steven Grossman, who is chairman of the state pension board, said in a statement. “It’s imperative that pension beneficiaries and taxpayers are treated fairly and that banks do not profit disproportionately at their expense.”

On June 15, Ohio Treasurer Josh Mandel called for a state investigation into both BNY Mellon and State Street’s handling of the state’s public pension funds’ FX trades. Ohio’s investigation joins lawsuits and investigations by a number of states including California, Florida, and Virginia into possible FX overcharges.