Global Policy Forum

Suspicion of Forex Gouging Spreads

Two large US custodial banks, Bank of New York Mellon and State Street, are embroiled in a major currency trading scandal. Americans seeking to invest internationally must convert dollars into the currency of countries in which they want to invest. The process is reversed when they sell their investment and want to bring their money back to the US. The banks gouged their clients as they moved currency back and forth during investment deals. Now whistleblowers from the firms allege that the custody banks profited improperly from global currency trades.

By Gregory Zuckerman, Carrick Mollenkamp, and Lingling Wei

Wall Street Journal
February 10, 2011


Some of the largest investment firms in the U.S. have been overcharged by banks for currency trades, bank insiders and others claim, broadening the scope of alleged abuses in pockets of the $4 trillion foreign-exchange market.

BlackRock Inc., the world's largest fund manager, became concerned at the rates it and its clients were charged for some currency trades by custody banks including Bank of New York Mellon Corp. according to an internal BlackRock investigation about a year ago and people familiar with the firm.

BlackRock recently altered the way it trades currencies, either doing the trading itself or demanding evidence from custody banks that it is receiving prevailing market rates, said people familiar with the firm.

Bank of New York declined to discuss specific client work. It said it provides "efficient and cost-effective" foreign-exchange trading. "We are committed to providing clients with the best value," the bank said.

Separately, clients of a big unit of Fidelity Investments Inc. also were overcharged by banks for some currency trades, according to information from bank insiders.

Americans investing globally must convert U.S. dollars into the currencies of the countries where they invest. If a pension fund, for instance, buys stock in a South Korean company, the fund's dollars must be converted to won, and the opposite exchange made if the fund sells the stock. Institutions known as custody banks facilitate such foreign exchange.

The custody banks don't have to provide transaction-time records, so it's hard for clients to know exactly when a currency exchange took place or whether they received prevailing prices. "There is no common reporting requirement or time-stamp obligation for FX trades," said a report by investment firm Russell Investments last year.

The latest allegations raise fresh questions about how custody banks operate in the global currency market. Attorneys general in three states have filed or are joining lawsuits alleging that custody banks sometimes improperly profited by pocketing the difference between their cost of currencies and their clients' cost.

California sued State Street Corp., another custody bank; Virginia joined a suit against Bank of New York, and Florida said last week it will join a suit against Bank of New York. State Street and Bank of New York denied the claims and say they'll fight the lawsuits.

The cases were prompted by suits by several current and former bank employees who turned whistleblower; the cases potentially enable the whistleblowers to share in any money states recover.

The states are investigating whether custody banks violated understandings or agreements to provide "best-execution" practices or favorable and competitive pricing, according to court documents.

State Street said the responsibility to determine appropriate currency rates falls not to it but to the client and the client's money manager. The bank said it informs custody clients and their money managers of "pricing methodology," exchange rates for foreign currencies and how the price was calculated.

The bulk of custody-bank currency trading is controlled by four firms-Bank of New York, State Street, Northern Trust and J.P. Morgan Chase & Co.-analysts say. Northern Trust and J.P. Morgan haven't faced claims of mispricing.

BlackRock discovered what it believed to be questionable pricing as part of due diligence in its December 2009 purchase of Barclays Global Investors, or BGI, said people familiar with the matter.

The performance of BGI, the operator of iShares exchange-traded funds, seemed better than those of rivals with similar products. BGI executives shared with BlackRock a reason for the discrepancy: BGI had sophisticated analytical systems to monitor currency pricing and make sure it wasn't getting hurt by banks-methods that BlackRock and its competitors lacked-according to the people familiar with the matter.

Data from whistleblowers working with state attorneys general indicate that some BlackRock funds in the past were overcharged on currency prices by custody banks, including Bank of New York, according to a person familiar with that data.

BlackRock has brought up these pricing issues with Bank of New York and other custody banks as part of an annual review of its relationships with them, according to one person close to the matter.

It isn't clear how much BlackRock might have been hurt by any bad currency pricing. Until 2006, the bulk of its funds focused on U.S. investments. BlackRock didn't believe the alleged overcharging breached any contracts with the firm, according to the people familiar with BlackRock's investigation into the issue.

But BlackRock concluded that when it bought or sold foreign currencies, it sometimes received prices that were higher or lower than they should have been, according to the people familiar with BlackRock's research.

After closing the BGI acquisition, BlackRock used BGI's metrics and tracking systems to analyze its foreign-exchange transactions. That spurred a shift over the past year by BlackRock to trade some currencies itself, not through custody banks. BlackRock is negotiating better terms with custody banks it still uses, such as by asking for time-stamps on trades, the people say.

A BlackRock spokeswoman declined to comment on the firm's trading or foreign-exchange practices.

For asset managers, there are several options for exchanging currency. At the heart of the pricing concerns is how rates are set under an option known as "standing instruction," where a client allows a custody bank to handle the foreign-exchange transactions. This option, as opposed to a so-called negotiated trade, can result in a less-advantageous exchange rate for the client.

Bank of New York said clients willing to invest in their own FX-trading infrastructure may choose negotiation, but others prefer to use "our standing instruction service-to outsource FX trading." The bank said: "We offer various options to choose depending on a client's objectives, capabilities and the size of their trades."

Some other large asset managers also have received disadvantageous currency prices, a person familiar with the situation alleged. Clients of Pyramis Global Advisors, a unit of Fidelity that manages $170 billion for clients, frequently received poor pricing for foreign-exchange transactions when relying on custody banks, according to a person familiar with data collected by bank whistleblowers.

Fidelity said that, "like virtually all other large asset managers, Pyramis transacts some FX trading through our clients' custodian banks, typically on a limited basis."

Fidelity said it assesses foreign-exchange "trading practices on an ongoing basis and, like others in the industry, we are monitoring information and allegations concerning custody-bank practices."


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