July 6 (Bloomberg) -- California Governor Jerry Brown sued State Street Corp. in 2009, when he was attorney general, for “unconscionable fraud” against pension funds over foreign- exchange pricing. That didn’t stop the largest of the funds from striking a new three-year deal with the firm.
The $232 billion California Public Employees’ Retirement System last week signed a contract for Boston-based State Street to continue handling all its custody work, said Wayne Davis, a pension spokesman. Calpers, as the Sacramento-based fund is known, passed over competing bids from New York’s JPMorgan Chase & Co. and Bank of New York Mellon Corp.
“It does seem contradictory,” George Diehr, a Calpers board member representing state employees, said in a telephone interview. “It was difficult to find someone who would provide all the services and at the terms we required.”
The contract, which Calpers says is worth about $5.7 million in annual revenue, suggests lawsuits facing State Street and rival BNY Mellon will do little damage to the custody banks’ ability to retain business from public pension funds. State Street also is being sued in Arkansas over foreign-exchange pricing, and BNY Mellon faces legal action in Virginia, Florida and Pennsylvania.
“That’s pretty good evidence the suits won’t have substantial impact on moving business around,” Brian Bedell, a New York-based equity analyst with ISI Group Inc., said of the new contract. “The funds are choosing the custodian that best serves their needs and at a good price.”
Calpers, which provides benefits to more than 1.6 million workers and retirees, is the nation’s biggest public pension fund.
Staff members told the fund board’s investment committee in December that State Street offered “considerably better” pricing than its competitors, and that the bank provides more transparency than it did from 2001 through 2008, when it was accused of overcharging.
State Street and BNY Mellon have denied the accusations in the separate cases and said they will defend against them.
The new contract is “rather amazing,” said Keith Bishop, a partner at Los Angeles law firm Allen, Matkins, Leck, Gamble, Mallory & Natsis LLP and a former California commissioner of corporations.
“If they felt someone had breached a contract with them, it’s certainly surprising they would enter a new contract,” Bishop said in a telephone interview.
Gil Duran, a spokesman for Brown, referred questions to Calpers and Attorney General Kamala D. Harris, who is pursuing the case against State Street after being elected last year. Becca MacLaren, a spokeswoman for Harris, declined to comment.
Anne Stausboll, chief executive officer of Calpers, declined to comment. Asked whether the Calpers staff stood behind the claims in the California lawsuit, Clark McKinley, a spokesman for the fund, said in an e-mail, “We support the investigation and continue to cooperate with the attorney general’s office.”
The suit, initiated by a whistle-blower group, alleged State Street violated the state’s False Claims Act by overcharging Calpers and the California State Teachers’ Retirement System, or Calstrs, by $56 million when pricing certain foreign-exchange transactions.
Brown investigated and stepped in, taking over the case on behalf of the plaintiffs in October 2009. The state seeks more than $200 million in damages and penalties.
Brown, writing on the Huffington Post website on Oct. 21, 2009, expressed surprise the case hadn’t attracted outrage. “If street thugs were to hold up a convenience store and drive off with $1 million, it would be national news,” he wrote.
Ricardo Duran, a Calstrs spokesman, said that fund supports the allegations against State Street. Calstrs remains in an open-ended custody agreement with State Street, he said.
The Arkansas Teacher Retirement system has sued State Street, and attorneys general in Virginia and Florida have taken over whistle-blower cases against BNY Mellon. The Southeastern Pennsylvania Transportation Authority is suing BNY Mellon.
The accusations center on standing-instruction transactions, or smaller exchanges a custodian handles automatically without a negotiated rate. For larger amounts, managers typically contact the foreign-exchange desk of one or more large banks to negotiate a rate.
‘Fair and Reasonable’
State Street, in a June 3 motion to dismiss the Arkansas suit, said its prices included “compensation for the additional services provided and for the risks taken in executing” standing-instruction foreign exchange.
Massachusetts officials, the latest to enter the dispute, stopped short of accusing BNY Mellon of defrauding the state’s public pension system while saying last month the bank reaped $30.5 million in overcharges over 12 years. Treasurer Steven Grossman said he would meet with the state’s attorney general to discuss legal options and with BNY Mellon executives to try to recoup the money.
“They are entitled to earn a fee,” Grossman said in a June 17 interview in Boston. “The only question is what is fair and reasonable.”
Grossman’s stance differed from the claims leveled by California and the other states, which say the custody banks had promised to charge the interbank exchange rate without any additional mark-up.
Standing-instruction rates were disclosed and the pension fund had the ability to opt out of the trades on a daily basis, said Kevin Heine, a spokesman for the bank.
“The bank is simply seeking the best price it can get,” Richard X. Bove, an analyst at Rochdale Securities LLC in Lutz, Florida, wrote in a May 23 research note. “If the buyer is unhappy with that price it has the right to negotiate the price lower, buy the product from another vendor or simply walk away.”
The market may force lower prices from BNY Mellon because of the legal disputes, even as the bank did nothing “illegal, improper, or immoral,” he said.
David Hilder, senior equity analyst for Susquehanna Financial Group in New York, said that while switching custodians is a “hassle,” pension funds do jump for a better price or superior service.
“There are always choices,” he said in a telephone interview. “There are four very large, very capable firms that could execute any state pension fund’s business, and in the past they have competed aggressively.”
Four Main Competitors
In addition to State Street, BNY Mellon and JPMorgan, Hilder included Chicago’s Northern Trust Corp.
The pension funds connected to the litigation from Florida, Virginia and Pennsylvania remain custody clients of BNY Mellon, Heine said.
Florida’s State Board of Administration, which oversees the state’s $130.3 billion public pension plan, in May named BNY Mellon a finalist, along with State Street and JPMorgan, for a new custody contract when the current deal expires Dec. 31, Dennis MacKee, a Board of Administration spokesman, said in a telephone interview. He declined to comment further.
State Street is the third-largest custody bank, after BNY Mellon and JPMorgan. Custody banks keep records, track performance and lend securities for institutional investors including mutual funds, pension funds and hedge funds.
BNY Mellon oversaw $25.5 trillion in assets under custody and administration as of March 31. State Street had $22.6 trillion under custody.
--Editors: Josh Friedman, Larry Edelman
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