Diving into BNY Mellon’s Legal FX Issues Involving Pensions and SWFs
Over the past few years, public investors have been keen and attentive on custodial banks’ foreign exchange practices. Public investors rely on financial institutions to uphold their fiduciary responsibilities. When investment returns were high and assets were growing, many pension funds neglected to pay much attention to custodial fees and foreign exchange costs. The global financial crisis coupled with cost pressures have opened the eyes of public pensions, sovereign wealth funds, monetary authorities, and law firms on the practices of custodial banks. Financial firms like Bank of New York Mellon and State Street have come under fire from public pension funds, endowments, and public officials regarding certain foreign exchange services and practices. In fact, in the Fall of 2009, a representative from the Alaska Permanent Fund Corporation inquired if BNY Mellon followed in similar conduct as State Street. Previously, State Street was sued by then California Attorney General Jerry Brown regarding overcharging California’s public pensions on a series of foreign exchange trades.
Foreign exchange issues with standard instruction prompted investigative action by the U.S. government and other authorities. By October 4, 2011, the New York Attorney General’s Office, the New York City Comptroller and various city pension and benefit funds filed a lawsuit against BNY Mellon. That same day the United States Department of Justice filed a civil lawsuit with charges related to mail and wire fraud alleging that they cheated clients on foreign exchange services. The civil fraud action states that the Bank of New York Mellon schemed to defraud custodial clients who used their standing instruction foreign exchange service. BNY Mellon contended that institutional investors understood the program and had the right not to participate in it. Many leading public investors do business with BNY Mellon and use their foreign exchange services, including present and past, Kuwait Investment Authority, Saudi Arabian Monetary Authority, Alaska Permanent Fund, Florida State Board of Administration, and so on.
Transparency is the enemy of financial firms and eats at their profits.
In rebuttal to the NY AG lawsuit, BNY Mellon sent out a press release stating, “Importantly, our clients and their investment managers make the decision where and how to execute foreign exchange transactions, not BNY Mellon. Our clients are smart and sophisticated institutional investors with professional investment managers who are responsible for deciding which of the numerous FX services available from BNY Mellon and other market participants they should use. If the prices we provided were not competitive, clients and their investment managers would not continue to use our services.”
What is Standing Instruction in Regards to Foreign Exchange?
Custodial banks offer “standing instruction” foreign exchange services in which the bank will automatically provide currency exchange service on as needed basis. Unlike a directly negotiated transaction, the bank unilaterally determines the price its clients receive for standing instruction transactions. According to the U.S. Department of Justice, from 2007 to 2010, the Bank of New York generated more than US$ 1.5 billion in revenues from their top 200 standing instruction clients. This business is very profitable for custodial banks compared to direct negotiated transactions. Interesting is that BNY Mellon internally knew that providing best execution and pricing transparency would dramatically reduce revenues for standing instruction transactions. The bank never provided time stamps to its clients on when the trades were executed.
Sales Margin by Year USD from BNY Mellon FX Services
|Select Public Institution||2007||2008||2009||2010||Total|
|Florida Retirement System||2,543,799||11,162,547||13,508,747||5,675,659||32,890,752|
|North Carolina State||1,991,458||4,528,278||5,019,251||4,886,609||16,425,596|
|Saudi Arabian Monetary Agency||7,474,106||5,972,295||1,501,319||14,947,720|
|Kuwait Investment Authority||2,465,689||1,082,647||597,031||4,145,367|
|Abu Dhabi Investment Authority||588,162||3,131,704||1,131,652||730,884||5,582,402|
|Alaska Permanent Fund||2,531,204||4,472,220||3,613,590||3,592,103||14,209,117|
Source: EXHIBIT A – Second Amended Complaint