Bank of New York Mellon Corp., accused by state and federalofficials of defrauding public pension funds on foreign-exchangetrades, is offering some of those customers a new pricingmodel.

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

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

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

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The lawsuits center on the bank's use of standing instructionarrangements, which are offered to clients for small currencytrades, as when money managers repatriate dividends and interestpayments from abroad. It relieves managers from the need tonegotiate and order large numbers of small deals one-by-one.

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

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The lawsuits claim BNY Mellon promised a rate that was betterthan the least favorable interbank rate in its contracts withseveral funds. The New York state case cites excerpts showing thebank promised some clients “the best rate of the day” or “mostcompetitive/attractive FX rates available to us.”

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

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

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State Street

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State Street Corp., BNY Mellon's Boston-based rival, facessimilar claims from California and Arkansas and settled a disputewith Washington state for $11.7 million before it resulted inlitigation. Carolyn Cichon, a spokeswoman for the firm, has saidState Street will defend itself vigorously and that its contractualobligations to Washington were “significantly different” than inthe other cases.

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

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Texas, which agreed to a custody contract with BNY Mellon inFebruary, replacing JPMorgan Chase & Co., isn't among statesthat have sued BNY Mellon.

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On transactions involving developed-market currencies, the bankoffered to charge four basis points above the benchmark raterecorded at 4 p.m. or 8 p.m. London time, said an executive fromanother state pension system, which is involved in thelawsuits.

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Trades in emerging market and other currencies would carry a10-basis-point margin and be priced once a day, said the official,who asked not to be named because he wasn't authorized to speakpublicly. One basis point equals 0.01 percentage point.

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The pricing model, offered to some clients as early as July, wascontingent on the fund maintaining its use of standing instructionat 80 percent of the previous year's volume or higher, the personsaid.

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“Our standing instruction services offer clients competitiverates in a transparent market,” Heine said. “We have continued todevelop and introduce innovative pricing and reporting options tomeet our clients' evolving needs.”

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Cassidy said the ongoing controversy over foreign-exchangepricing would put pressure on margins for BNY Mellon and itsrivals.

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“We believe they will have to start raising prices on theirbasic products,” he said. “Whether they will be successful onlytime will tell.”

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Custody banks safeguard securities, keep records, trackperformance and provide other services for institutional investorsincluding mutual funds and pension funds.

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The New York state lawsuit seeks recovery of about $2 billionBNY Mellon allegedly made in the transactions. It also seeksadditional penalties for each violation of New York state and cityfalse claims acts in relation to alleged fraud committed againstNew York City pension funds.

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Bloomberg News

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