State sues bank over trading fees

A Boston bank cheated California’s two largest employee pension funds of nearly $57 million by inflating fees it charged for foreign currency trades, according to a suit filed Tuesday by the state attorney general’s office.

The pension funds, including the giant California Public Employees’ Retirement System, didn’t even know they were being fleeced by State Street Corp., the state’s lawyers said. The scheme was uncovered by whistle-blowers with firsthand knowledge of how State Street operated, they said.

The accusations mark another hit to CalPERS. Investment losses have wiped out nearly a fifth of what once was a $248-billion portfolio. The fund also is investigating about $50 million in fees paid to a placement firm, headed by former board member Alfred Villalobos, that directed hundreds of millions of CalPERS dollars into private investor funds.

CalPERS officials were outraged that State Street, their primary banker for the last 17 years, allegedly ripped off retirement money owed to the fund’s 1.6 million members, including state, county and municipal employees.


“We don’t tolerate fraud; we don’t tolerate abuse,” said CalPERS spokeswoman Pat Macht. “Our members are happy to know when we are actively engaged in bringing back every penny that we believe could be wrongfully denied.”

Sherry Reser, spokeswoman for the other fund, the California State Teachers’ Retirement System, declined to comment on the lawsuit, other than to say that it “raises serious allegations.”

State Street, which is running out of reserves to cover numerous legal actions it faces, said it would vigorously fight California’s accusations. “We categorically deny any allegations of wrongdoing and will defend ourselves against any litigation,” spokeswoman Carolyn Cichon said.

The whistle-blowers, who are not identified beyond a partnership they formed, disclosed the issue last year in sealed court documents. The attorney general’s office initiated an investigation.

According to the lawsuit, State Street “raided” the two state pension funds by fraudulently pricing foreign currency trades State Street executed for them. The fraud occurred whenever CalPERS and CalSTRS needed foreign currency to close foreign securities trades or when the funds had foreign currency they wanted to convert back into dollars.

Contractually, State Street was obligated to charge the funds the most competitive transaction rates based upon the official “interbank rate” at the time the trades took place. The interbank rate, which banks charge one another, fluctuates during the trading day.

However, the suit alleged, State Street “consistently ‘marked-up’ the prices using rates far in excess of the interbank rate,” but within the daily highs of the trades. The bank also allegedly marked down the price when CalPERS and CalSTRS bought dollars.

State Street concealed its fraudulent pricing practices by entering false exchange rates into electronic trading databases, which automatically debited the funds’ bank accounts, and by reporting false exchange rates in numerous documents, the suit alleged.


According to the attorney general’s office, the sophisticated electronic posting of fraudulent exchange rates was done in such a manner that CalPERS and CalSTRS were not even aware that they were being overcharged over eight years.

“They did not know about the fraud,” said Deputy Atty. Gen. Jeffrey L. Simpton. “There were certain things that State Street did to hide the fact that they were committing fraud.”

The lawsuit seeks more than $200 million in damages and penalties.

“This is an unprecedented fraud,” Atty. Gen. Jerry Brown said at an Oakland news conference. “The complexity of Wall Street and these sorts of financial transactions allows those without morals to put money in their own pockets.”


Officials in California have been in contact with attorneys general and public pension funds in other states, Simpton said. Those states could follow California’s lead because “they also relied on State Street to conduct foreign exchange transactions,” said Richard Heimann, a San Francisco attorney for the whistle-blowers.

Under California, federal and some other states’ laws, such whistle-blowers are eligible to receive a large portion of any jury award or settlement.

Brown’s announcement of State Street’s alleged fraud comes at an awkward time for CalPERS. It is coping with a rash of bad publicity, including its revelation last week that it is investigating the payment by outside investment companies of more than $50 million in fees to Villalobos’ firm. Besides serving on the funds’ board from 1992 to 1995, he also was a Los Angeles deputy mayor for five months in 1993.

There is no link between the possible placement agent scandal and the fraud lawsuit against State Street, CalPERS stressed.


CalPERS also has been under fire for its steep, recession-related losses. The fund is now valued at about $200 billion, down about 19% from its high two years ago. It also racked up a $1-billion loss on a residential land investment in the 15,000-acre Newhall Ranch near Valencia. CalPERS may lose an additional $500 million on a residential real estate investment in New York City called Stuyvesant Town and Peter Cooper Village.

The fund’s financial hemorrhaging is making local governments and school districts nervous about making added payments to the system to recoup losses.

The spate of bad publicity threatens to overshadow CalPERS’ track record as a pioneer among institutional investors in pushing for better corporate governance and investment transparency, said Kent Hughes, managing director for Egan-Jones, an advisor to CalPERS and other funds on corporate governance issues.

The California lawsuit also presents more legal troubles for State Street. In August, the company indicated in regulatory findings that it could run out of reserves set aside for possible legal settlements of lawsuits and enforcement actions brought by federal and state financial regulators. The agencies are looking into allegations that State Street misled investors about the safety of bond funds.


State Street shares fell $4.41, or 8.4%, to $47.84 on Tuesday after the company lowered its annual earnings forecast and Brown announced his lawsuit.


Times special correspondent Dan Fost contributed to this report.