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Calpers v. State Street Underscores Need for Precision in Forex Trades

Securities Industry News

Custodian banks spend millions of dollars each year to ensure they have the best technology to process transactions across the globe for fund managers and pension plan sponsors.

They have also spent millions of dollars to ensure that their client reporting is up to snuff. That means understanding the intricacies of just what the customer is paying for, at what price and when.

But when it comes to executing foreign exchange trades-a basic service related to buying and selling securities outside the home market of the plan sponsor-custodian banks may have fallen short of the mark.

Sometimes they disclose the time and price at which they executed a foreign exchange transaction; sometimes they don't. The reason is often unclear; sometimes bank systems aren't coded to provide such detail and at other times they simply don't want the client to know the real cost of the deal-and what the bank is making off of it.

Until now that is. An October 2009 lawsuit versus State Street Bank highlights just what plan sponsors and banks should and shouldn't do. The lawsuit seeks more than $200 million in overcharges and damages on behalf of the California Public Employees Retirement System (Calpers) and the California State Teachers Retirement System (Calsters).

The suit filed in Superior Court in Sacramento by California Attorney General Jerry Brown alleges that the Boston-based global custodian-one of the world's largest-transacted tens of thousands of transactions over an eight-year period at unfavorable rates to the plan sponsors. The suit contends State Street made too much profit off of the two customers-and didn't follow the terms of its contracts.

Calpers and Calsters claim they asked State Street to base the price of foreign exchange trades on interbank rates. However, State Street consistently executed trades in excess of the interbank rate when the bank converted dollars into foreign currencies. And when State Street executed FX trades to repatriate foreign currency into US dollars for the two pension plans, it marked down the price the pension plans received to an amount far below the interbank rate.

The interbank rate-the rate at which major banks buy and sell currency-is considered the best rate for a plan sponsor to conduct a foreign exchange trade because it results in the tightest spread.

According to the lawsuit, State Street then concealed its fraudulent pricing practices by entering erroneous exchange rates into its online reporting database, That is where the pension funds found reports detailing their account activity. State Street further disguised its fraud, the plan sponsors say, by failing to timestamp the trades which would indicate when they were executed.

Calpers and Calsters declined to provide Securities Industry News with an interview on the lawsuit. Calpers referred all written inquiries to Brown's office, which did not respond by presstime. Carolyn Cichon, a spokeswoman for State Street in Boston, would only say that the bank "vehemently denies any wrongdoing."

Among the questions which Calpers and Brown's office declined to address are: Is Calpers still using State Street as its custodian bank? And is Calpers still executing foreign exchange trades through State Street?

Calpers, Calsters and Brown's office also would not comment on whether Calpers and Calsters ever audited State Street's foreign exchange transactions either themselves or through a consultant over the course of the eight years. Such auditing is commonplace among large pension plans, say industry consultants with knowledge of the foreign exchange and securities services businesses.

In his written response to SIN's questions, Ricardo Duran, a spokesman for Calsters, would only say that Calsters continues to use State Street as its custodian bank.

"State Street has provided master custodial services to Calsters since about 1986. The duties performed include recordkeeping, performance reports, custody of assets, securities settlement, money transfers, performance measurements and risk measurements," Duran wrote.

He emphasized that Calpers is cooperating with the California Attorney General's office in its investigation of State Street.

Whistleblower Twist

Brown's office did issue a statement last October in which it explained that the alleged fraud against Calpers and Calsters was brought to its attention by whistleblowers. Notably, those whistleblowers stand to earn an undisclosed percentage of whatever Calpers and Calsters win, if the case goes to trial. Calpers, Calsters and Brown's office also would not comment on the status of the suit or disposition of any amounts that might be won.

Pension plans don't typically do a large number of foreign exchange trades to hedge the risk that changes in the value of currencies in which they are invested will have a sizable impact on the value of their holdings.

Fund Repatriation