The legal battle over fees for foreign exchange trading could hit the bottom line of global custody banks if public pension plans are successful in their civil suits.
Five legal actions have been filed and attorneys general in at least 20 states are reviewing whether to sue over claims that public pension plans in their states were overcharged when they traded U.S. dollars and other currencies, sources said. The currency conversions at issue occurred when non-U.S. stocks were bought and sold and when stock dividends were converted into U.S. dollars.
The legal actions are all aimed at State Street Corp., Boston, and Bank of New York Mellon, New York, the two largest U.S. custodians.
Reducing the foreign exchange spreads for what is known as non-negotiated currency trades could potentially reduce custodian FX revenues by 55% for State Street, BNY Mellon and Northern Trust Corp., according to a February report by Sanford C. Bernstein and Co. Inc., New York. Those trades make up the bulk of currency trading between institutional investors and custodian banks, the report notes. FX trading represents roughly 8% of State Street's total revenue and about 7% of BNY Mellon's revenue, said Brad Hintz, the analyst who wrote the report.
FX trading also represents 12% of the revenue of Northern Trust. Northern Trust has not been named in any of the lawsuits
Although the first suit was filed in December 2009, this year has seen another wave of litigation against both State Street and BNY Mellon.
The most recent suit was filed March 7 against BNY Mellon by the Southeast Pennsylvania Transportation Authority, on behalf of its $800 million pension fund. State Street was sued by the $9.6 billion Arkansas Teacher Retirement System on Feb. 10, while attorneys general in Florida and Virginia began legal actions against BNY Mellon on Feb. 3 and Feb. 4, respectively, on behalf of public plans in their states.
Carolyn Cichon, spokeswoman for State Street, and Kevin Heine, spokesman for BNY Mellon, denied any wrongdoing by the banks on foreign currency overcharges.
The suit that started it all was filed by the California attorney general in December 2009. The suit said State Street, custodian for the $230.1 billion California Public Employees' Retirement System and the $150.1 billion California State Teachers' Retirement System, overcharged both systems by at least $56 million for currency trades between 2001 and 2008.
All of the suits focus on non-negotiated or standing instruction trades, rather than directly negotiated trades in which the currency rates are set in advance. The non-negotiated trades are usually $1 million or less and represent the bulk of trades by pension funds and their custodial banks.
The lawsuits maintain the banks didn't charge the lowest interbank rate, the rate banks charge each other, as their contracts had required.
In a written response to the California lawsuit, State Street didn't deny it added a surcharge, but said if the bank charged the interbank rate, it would not be able to make a profit. State Street said it fulfilled its promise because “the starting point of the rate calculations (is) ‘based on' interbank rates.”