On Friday, July 29, Scott Pruitt of Oklahoma became the latest attorney general to claim that custodial banks may have improperly manipulated foreign currency trading prices on behalf of his states pension funds and pocketed the difference.
He joins attorneys general and treasurers whove launched investigations or lawsuits in California, Florida, North Carolina and Virginia against banks alleged to have participated in this practice of improperly manipulating foreign currency trade prices to maximize their own profits. Claims have been made against some banks, questioning the discrepancy between the time of day the currency transactions are made and the trade price that is charged to the fund.
The concern is that foreign currency exchange rates were manipulated, possibly in violation of law or contracts. Pruitt states the investigation could result in criminal charges and civil litigation and he aims to recover more than $200 million for state pension funds. A bank could choose a less favorable exchange rate instead of giving a pension fund the price based on the actual time of the trade.
In Oklahoma, it is estimated that of the seven pension systems with combined assets of $21.4 billion, about 15 percent or $3 billion is invested overseas, with 20 percent of a portfolio typically invested internationally.
And the custodial banks mentioned in these and other investigations are the two largest: Bank of New York Mellon and State Street Bank. BNY Mellon is facing a number of lawsuits from U.S. states and individual companies. Lawsuits are pending in Florida and Virginia against the bank over allegations that the custodian had priced foreign exchange trades that diminished clients payouts. In 2009, FX Analytics a Delaware partnership that is being used to hide the identity of whistleblowers launched a lawsuit in Virginia claiming that BNY Mellon had used false reporting to mark up or down trade prices since at least 2000. The two large custodial banks deny wrongdoing.
In June, Ohio state treasurer Josh Mandel requested the states attorney general, Mike DeWine, to start an investigation into whether banks conducting foreign currency exchange transfers on behalf of the state exploited Ohio retirees, businesses and taxpayers.
Mandel, the custodian of Ohio's five public employee pension funds that actively invest in foreign assets, approximately $39 billion in international securities, has asked the Attorney General to investigate whether violations of state laws or contracts occurred; the state should seek to recover the money. The concern is that custodial banks on contract with the state may have manipulated foreign currency exchange rates to mark up for buys or mark down for sales the prices paid by these funds. Rather than charging the market rate at the time of the order, these banks may have inflated their profits by charging close to the highest or lowest prices of the day depending on what was advantageous to them and not their client.
If the banks engaged in this practice, the net result could be that in thousands of international transactions for over more than a dozen years Ohio pensioners and businesses may have paid tens of millions of dollars more than market rates.
A claim was also brought against its custodial bank relating to the Massachusetts Pension Reserves Investment Management Board. A class action was proposed against the custodian in March by its client the Southeastern Pennsylvania Transportation Authority (SEPTA) hoping to claim on behalf of all impacted BNY Mellon clients except those named in the whistleblower lawsuits. Septa says claims exceed $5 million.
Ohios Mandel requested the state Attorney General launch an investigation looking at custodian BNY Mellon. He also called for the state's attorney general to investigate State Street Corporation. In February, State Street settled a dispute with the Washington State Investment Board over foreign exchange trading transactions and their pricing. The two parties reached a $11.7 million settlement without a lawsuit being filed.
The world's second largest custodian, State Street, with about $22.8 trillion in assets under custody has been rehired as the global custodian to CalPERS, the California Public Employees' Retirement System, just two years after CalPERS sued it for "unconscionable fraud" over its foreign exchange transaction pricing.
State Street has revealed that the Securities and Exchange Commission (SEC) and other regulators have made inquiries and issued subpoenas concerning its foreign exchange pricing. State Street says it will cooperate fully with the SEC in its inquiry and stands behind its business practices, continuing to defend itself against any allegations of wrongdoing. The firm through its spokesperson says that it intends to vigorously defend the allegations made recently concerning its FX business.
"Legal actions and investigations like these will hold the banks accountable to a higher standard and this will help a great deal," says Ray Kamrath, CEO of Faros Trading in Stamford, Connecticut, which provides foreign exchange execution services to institutional clients. "There is a common misconception that because the forex market, which is the largest market in the world, transacting $4 trillion per day according to the most recent statistics from the Bank of International Settlements, must be efficient. But, the truth is that the foreign exchange markets are unregulated and fragmented, thus incredibly opaque."
Kamarath agrees that it's very difficult for institutional investors to know with certainty that they are getting quality executions. "It's certainly possible that any trading counterparty, including custodial banks has used the lack of transparency as an opportunity to earn more and possibly excessive revenue."