With allegations mounting in the US that banks have overcharged pension funds for foreign exchange transactions, mutual fund investors are asking whether they are being fleeced too.

The latest lawsuit was filed by the Southeastern Pennsylvania Transportation Authority, which accuses Bank of New York Mellon of bilking its pension fund during forex trades. The court case comes on the heels of similar suits charging that pension funds in four states had been defrauded by BNY or a competitor, State Street Corp.

Now Fidelity and the world’s biggest asset manager, BlackRock, have reportedly looked into whether they were overbilled. According to The Wall Street Journal, BlackRock discovered the allegedly questionable charges because a newly acquired subsidiary had better monitoring systems than it did and received better prices from custody banks, including Bank of New York Mellon Corp.

BlackRock declined to comment. Fidelity’s trading desk handles the vast majority of its funds’ forex transactions, although a subsidiary does use custodian banks for certain trades, Vincent Loporchio says in a statement. The firm is “monitoring information and allegations concerning custodian bank practices”, he says. There is no information as yet from Fidelity as to which banks are suspected.

Both BNY and State Street have denied wrongdoing.

The lawsuits allege the banks inflated the prices of forex trades in violation of their agreements with the pension funds. In addition to Septa, BNY is being sued by Virginia and Florida.

State Street faces lawsuits by California and Arkansas, and it agreed to pay the state of Washington a nearly $12m out-of-court settlement last year after similar accusations over the pricing of foreign exchange trades. Attorneys general in Massachusetts and Illinois are also said to be investigating.

“The first principles in any market where you don’t have transparency and regulation is that people are potential victims of predatory behaviour,” says Dennis Kelleher, chief executive of Better Markets, a Wall Street watchdog group. “The urgency to have transparency and regulation could not be more clear.”

Many mutual funds rely on custodian banks for forex trading in the same way pension funds do. “A few pennies of difference can cost a fund complex tens or hundreds of millions of dollars if they’re trading billions of dollars of securities,” says Ron Fernandes, chief executive of Raven Partners.

The funds’ managers are starting to demand more information from custodian banks.

“What’s it going to cost us? How are you going to charge us?” asks David Thelander, managing director of Promontory Financial Group. “There are ways to structure a revised agreement so both sides understand their responsibilities.”

The $4,000bn-a-day foreign exchange market is notoriously opaque.

If a US mutual fund seeks to buy or sell a foreign security, first it must convert its dollars to the appropriate currency. Many fund complexes – especially smaller firms, or large ones making difficult trades – use custodian banks to execute those foreign exchange transactions.

Custodian banks’ clients typically either directly negotiate the price of each transaction or place orders through “standing instruction” services, in which banks handle large numbers of transactions in bulk and the client learns the price later. The pension funds’ lawsuits allege the custodian banks used the opacity of standing instructions to game the system.

Septa’s lawsuit alleges BNY – which bills itself as “the world’s largest global custodian,” with more than $20,000bn in assets under custody – assured clients that standing instruction forex trades were subject to best execution standards, which require the bank to obtain the best possible prices for its clients.

However, the bank did not provide the transit system with time-stamped trading data that would have reflected the actual price of each trade, according to the lawsuit. Instead, the bank only disclosed to clients the full range of prices for the day, and “pocketed the difference” between its own relatively good trading prices and the worse prices it charged clients, the lawsuit charges.

“If some of the accusations are true, that’s a very serious manipulative activity,” says David Hearth, a partner at Paul, Hastings, Janofsky & Walker. “It could be a breach of the responsibilities the custodians have, depending on what the clients’ contracts say and what the custodian disclosed to its clients.”

BNY publishes a guaranteed range of rates each morning, allows clients to opt out by 11 am and reports prices to clients daily, spokesman Kevin Heine says. Clients choose its standing instruction services because they provide “substantial benefits,” including better-than-retail prices and relief from certain risks and costs, he says.

Foreign exchange trading is complex and demanding, and many fund managers do not have the desire or ability to negotiate their own trades, according to Mr Hearth. “The problem with it being automatic is the fund is a little bit of a captive customer,” he says.

Article from The Financial Times