Bank of New York Mellon Corp., accused by state and federal officials of defrauding public pension funds on foreign-exchange trades, is offering some of those customers a new pricing model.

The bank has proposed applying fixed margins over benchmark currency rates when automatically executing currency trades for custody clients, said Mary Jane Wardlow, a spokeswoman for the Employees Retirement System of Texas. The bank would price the trades at specific times, rather than pick a rate that's favorable for the bank at the end of the day.

BNY Mellon, the world's largest custody bank, was sued last month by New York Attorney General Eric T. Schneiderman and the U.S. Attorney's Office in Manhattan, who said it made more than $2 billion over 10 years on fraudulent foreign-exchange transactions at the expense of clients including New York City pension funds. BNY Mellon, which has denied the accusations, is in early stage talks with federal prosecutors to settle, according to a person briefed on the discussions.

“The old way of doing business is not going to continue,” Gerard Cassidy, an analyst with RBC Capital Markets in Portland, Maine, said in a telephone interview.

The lawsuits center on the bank's use of standing instruction arrangements, which are offered to clients for small currency trades, as when money managers repatriate dividends and interest payments from abroad. It relieves managers from the need to negotiate and order large numbers of small deals one-by-one.

BNY Mellon currently links its pricing of standing instruction transactions to the daily range of the interbank exchange rate. The bank “tends to purchase currencies from our clients towards the low end of the interbank range and sell towards the high end,” according to Kevin Heine, a spokesman for BNY Mellon.

The lawsuits claim BNY Mellon promised a rate that was better than the least favorable interbank rate in its contracts with several funds. The New York state case cites excerpts showing the bank promised some clients “the best rate of the day” or “most competitive/attractive FX rates available to us.”

Attorneys general in Virginia and Florida, and Massachusetts's top securities regulator have also sued BNY Mellon.

The suits are based on a flawed understanding of global currency markets, Heine has said. He said the bank will fight the suits.

State Street

State Street Corp., BNY Mellon's Boston-based rival, faces similar claims from California and Arkansas and settled a dispute with Washington state for $11.7 million before it resulted in litigation. Carolyn Cichon, a spokeswoman for the firm, has said State Street will defend itself vigorously and that its contractual obligations to Washington were “significantly different” than in the other cases.

Under the new model, BNY Mellon would offer prices “tied to a WM/Reuters benchmark rate,” Wardlow said in an e-mail. She said the bank hadn't discontinued the old model, but was rolling out an alternative for customers.

Texas, which agreed to a custody contract with BNY Mellon in February, replacing JPMorgan Chase & Co., isn't among states that have sued BNY Mellon.

On transactions involving developed-market currencies, the bank offered to charge four basis points above the benchmark rate recorded at 4 p.m. or 8 p.m. London time, said an executive from another state pension system, which is involved in the lawsuits.

Trades in emerging market and other currencies would carry a 10-basis-point margin and be priced once a day, said the official, who asked not to be named because he wasn't authorized to speak publicly. One basis point equals 0.01 percentage point.

The pricing model, offered to some clients as early as July, was contingent on the fund maintaining its use of standing instruction at 80 percent of the previous year's volume or higher, the person said.

“Our standing instruction services offer clients competitive rates in a transparent market,” Heine said. “We have continued to develop and introduce innovative pricing and reporting options to meet our clients' evolving needs.”

Cassidy said the ongoing controversy over foreign-exchange pricing would put pressure on margins for BNY Mellon and its rivals.

“We believe they will have to start raising prices on their basic products,” he said. “Whether they will be successful only time will tell.”

Custody banks safeguard securities, keep records, track performance and provide other services for institutional investors including mutual funds and pension funds.

The New York state lawsuit seeks recovery of about $2 billion BNY Mellon allegedly made in the transactions. It also seeks additional penalties for each violation of New York state and city false claims acts in relation to alleged fraud committed against New York City pension funds.

Bloomberg News

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BNY Mellon Offers New FX Pricing

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