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Florida pension funds take $30 million hit as big banks profit

Florida's giant pension fund took a $30 million hit from 2001-2010 because of lax oversight by a state agency and questionable trading practices by two large banks hired to safeguard the fund, records show.

A Florida lawsuit accusing one of the banks of shortchanging the state's pension fund was filed last month, and similar cases have been filed in California and Virginia.

"What we are seeing across the country is evidence that these big banks took pension funds for a ride, hiding exorbitant markups from them and pocketing billions of dollars in unearned profits in the process," said financial fraud investigator Harry Markopolos, who is helping to build the case against the banks.

Hundreds of pages of documents, obtained by the St. Petersburg Times through a public records request, raise questions about the high price of some foreign trading activities. But they also point to inadequate monitoring by the State Board of Administration, which oversees $145 billion in Florida pensions and public funds.

Bank of New York Mellon Corp. and Boston-based State Street Corp. deny wrongdoing and say the new reports are flawed.

But Markopolos, who helped expose Bernard Madoff's financial scheme, sees banks handling billions of dollars in retirement money as the next big scam.

"At a time when pension funds are losing billions of dollars in value for their retirees because of the staggering economy . . . the banks they put their trust in cost them billions more through their deceptive acts,'' Markopolos said in an e-mail to the Times.

Who and why

The State Board of Administration manages investments for a million public employees and retirees and hundreds of cities, counties, school districts and other public agencies. The SBA is overseen by Florida's three top elected officials — the governor, attorney general and chief financial officer.

But its success is in the hands of Wall Street.

Nearly every penny goes through a so-called custody bank that buys and sells securities, collects dividends, prices investments and provides financial reports. Many of these are overseas deals requiring foreign currency.

If Florida wants to purchase a Japanese stock, for example, U.S. dollars must be converted into yen. Dividends or interest income would be paid in yen, which would be converted back to U.S. dollars.

Foreign currency exchanges usually work one of two ways: negotiated trades, in which private money managers working for the SBA shop for the best exchange rate; and non-negotiated trades, in which the custody bank oversees the transaction and picks the exchange rate.

To save time and money, many large investors such as the SBA let custody banks handle non-negotiated trades, often deals of less than $1-million.

That's where the alleged overcharges occurred.

New revelations

As the SBA did more business overseas in the last decade, it needed to buy and sell more foreign currency. And those transactions got more expensive.

With BNY Mellon acting as custody bank, the SBA paid ''excess costs'' of $26.8 million for non-negotiated foreign currency trades between July 2005 and May 2010, one report shows.

During that same period, the SBA got far better deals when its investment managers negotiated directly, rather than letting the custody bank oversee transactions, according to Mercer Sentinel Group, an investment consulting firm.

Those findings, based on Mercer's analysis of more than 100,000 trades, were consistent with another consultant's report. The SBA commissioned both reports last year after bank insiders complained about high trading costs.

The new documents raise questions about whether the SBA was paying careful attention to costs or was knowledgeable about foreign currency exchanges.

Kevin Heine, a spokesman for BNY Mellon, called the Mercer report "fundamentally flawed'' for unfairly comparing negotiated trades, which tend to be larger, with non-negotiated trades, which tend to be smaller, costlier and riskier to the bank.

Heine also said the SBA got daily reports with guaranteed price ranges on currency exchanges. If it wanted, he said, the SBA could have opted out.

In fact, the Mercer report says that while such practices are opaque and expensive, the SBA may have fared better overall than many institutional investors.

BNY Mellon became the custody bank in 2005 as the SBA sought to lower costs. Under its previous custody bank, State Street, the SBA paid "excess costs'' of $4.9 million for non-negotiated trades. That's according to another report by Mercer, which examined trades from 2001-2005.

State Street has denied shortchanging any client. Spokeswoman Alicia Curran Sweeney said the bank disagrees with Mercer's findings because they do not account for the sizes of trades, "a key factor in determining how (foreign currency) trades are priced.''

How it worked

Markopolos, 54, a former securities industry executive, first warned regulators about Madoff in 2000. His tips were brushed aside for a decade.

But when Markopolos and whistleblowing insiders accused banks of defrauding pension funds with secret markups, people started listening.

"These banks did this across the country. This is a 50-state case,'' Markopolos said in the e-mail to the Times.

The whistleblowers filed lawsuits in 2008 and 2009 in California, Florida and Virginia. Here's an example of how they say the scheme worked:

On Oct. 1, 2009, BNY Mellon learned that its clients would need to sell $12.5-million U.S. dollars in exchange for Canadian dollars. At 7 a.m., it cost 1.0730 Canadian dollars to buy one U.S. dollar, but the exchange rate fluctuated through the day.

The whistleblowers say the bank made the $12.5 million trade at 1.0795, but reported the very lowest price of the day, 1.0682, to its clients, pocketing a difference of $130,847.61.

Had the clients negotiated the rate directly, BNY Mellon likely would have made about $3,125.

"In the current economic climate,'' the whistleblowers said in their Florida lawsuit, "fraud against (the Florida retirement system) is especially pernicious as (BNY Mellon) continues to effortlessly generate millions in risk-free revenue while the pension fund struggles to meet funding requirements.''

The fallout

Foreign currency costs began to drop last year after the SBA stepped up oversight.

But a report in February from a New York financial research firm raised new questions about old practices.

Without singling out anyone, the report said some clients of custody banks may have "knowingly and willingly'' overpaid for foreign exchange trades. And some may have allowed themselves to be overcharged "as a quid quo pro'' for getting a good price on basic custody services from the banks.

Brad Hintz, an analyst for Sanford C. Bernstein and Co., said "bundled pricing'' arrangements that combine several financial services may be "tolerated'' because pension boards tend to pay more attention to basic custody service fees than to intricate trading costs.

Florida paid $2.75 million a year to BNY Mellon for basic safekeeping of pension funds. But the bank made more in foreign currency exchange trades and other services.

The lawsuit filed last month by Attorney General Pam Bondi does not specify how much Florida lost. Bondi would not comment for this story. As of last year, Florida's pension fund faced a $17 billion shortfall.

"Due to BNY Mellon's misconduct, the state will ultimately have to provide millions of additional dollars to (the Florida retirement system),'' the lawsuit says, "monies that otherwise could have been made available for essential services to it its citizens.''

Times researchers Natalie Watson and Carolyn Edds contributed to this report.

How it worked

Here's an example of how the whistleblowers say the exchange scheme worked:

» On Oct. 1, 2009, BNY Mellon sells $12.5 million U.S. dollars in exchange for Canadian dollars.

» The bank made the trade at the rate of 1.0795 Canadian dollars to the U.S. dollar, but reported the very lowest price of the day, 1.0682, to its clients.

» BNY Mellon pockets the difference: $130,847.61.

» Had the clients negotiated the rate directly, the bank likely would have made about $3,125.

Florida pension funds take $30 million hit as big banks profit 09/22/11 [Last modified: Friday, September 23, 2011 8:50am]

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