Following Pension Lead, Asset Managers Investigate Alleged FX Overcharges

(April 3, 2011) – Multiple pension funds have already sued custody banks over alleged foreign exchange fee inflation, and now two large asset managers – Fidelity and BlackRock – may soon do the same.

According to the Wall Street Journal, BlackRock – the world’s largest asset manager – discovered alleged overcharges when it purchased a subsidiary with more detailed monitoring systems and, possibly due to this, received better quotes from custodian banks on its foreign exchange transactions. And, while Fidelity executes the majority of its foreign exchange transactions in-house, the firm is “monitoring information and allegations concerning custodian bank practices,” according to the firm.

The suspicion stems from the way custodians allegedly dealt with foreign exchange orders from their clients. According to the numerous lawsuits already brought against Bank of New York Mellon and State Street, the custodial banks would often – and with client approval – bundle foreign exchange orders and inform clients of the price after the fact. While they claimed such transactions were pursued with “best execution standards,” the custodians allegedly failed to put time-stamps on the trades. This allowed the custodians to charge clients at the worst rates of the day while executing at the best – and pocket the difference.

The rising suspicion from asset managers over custodial overcharging mimics that seen in the pension world. Most recently, the Southeastern Pennsylvania Transit Authority (SEPTA) sued Bank of New York Mellon over this practice. The states of Virginia and South Carolina have also launched lawsuits against the bank over foreign exchange costs.

Bank of New York Mellon is not alone, however. In early February, State Street was sued over allegedly similar practices by the Arkansas Teacher Retirement System. The suit alleged that State Street, the custody bank for more than 40% of US public pension funds, generated as much as $500 million in profits annually – a rate of profit that accounts for about 50% of State Street’s foreign exchange profits over the last decade – from overcharging clients. In response, State Street said that the company is “firmly committed to providing its clients with quality service and transparency in meeting their FX needs. We will vigorously defend the allegations made in the complaint and we stand by our business practices.”

The case is Arkansas Teacher Retirement System v State Street Corp et al, U.S. District Court, District of Massachusetts.

This case followed a nearly identical lawsuit, which is ongoing, brought by the nation’s two largest public pension systems – the $226.6 billion California Public Employees’ Retirement System (CalPERS) and the $146.4 billion California State Teachers’ Retirement System (CalSTRS) – which launched a case in 2009 against State Street over it’s foreign-exchange fees.

“State Street bankers committed unconscionable fraud by misappropriating millions of dollars that rightfully belonged to California’s public pension funds,” then-Attorney General and now-Governor Jerry Brown told The New York Times at the time. “This is just the latest example of how clever financial traders violate laws and rip off the public trust.” The suit emerged from an inquiry by state investigators triggered by whistle-blowers claiming that the bank secretly inflated prices. According to The Times, the whistle-blowers claimed this practice cost the bank’s clients upward of $400 million over the past 11 years, and was conducted by using false exchange rates and reporting false prices in account statements.

In October of 2010, Washington State revealed it had recovered $11.7 million from State Street over foreign exchange trade costs during a 10-year period.