Banks were not liable under ERISA as functional fiduciaries for fraudulent manipulation of foreign exchange transactions

The alleged fraudulent manipulation of benchmark rates by banks to maximize profits from foreign exchange transactions involving plan assets did not constitute sufficient discretionary control over plan assets to subject the banks to liability under ERISA as functional fiduciaries, according to U.S. Court of Appeals in New York (CA-2). The transactions involved plan assets, but were initiated by the plans’ investment managers and executed pursuant to instructions that precluded the banks from controlling their own compensation.

Foreign exchange transactions involving plan assets

Participants in multiple plans brought suit under ERISA alleging that twelve banks and their affiliates engaged in fraudulent conduct in executing foreign exchange (FX) transactions involving plan assets during the period of January 2003 through 2014.

Note: Foreign exchange transactions involving plan assets are not uncommon. ERISA plans often trade currency to settle purchases of foreign securities, or to repatriate dividends, interest, and redemptions that are paired in foreign currencies, rather than as a mode of investment. Plan investment managers authorize FX transactions with plan assets when the investment strategy designed for the plan requires the exchange of one currency for another.

The banks and their affiliates did not initiate the transactions at issue, but only executed a transaction pursuant to direction or written authorization from an investment manager, each of whom was an independent plan fiduciary. The plan participants, however, alleged that the banks took advantage of their dominant positions in the wholesale (market between banks) and retail (market between banks and non-bank customers (e.g., plans)) FX markets to collude with one another to collectively benefit from customer order information, to the detriment of the plans. Specifically, the participants charged that the banks manipulated benchmark fixing rates and coordinated the bid/ask spread for various currency pairs, effectively eliminating competition and fixing prices.

The participants’ complaint maintained that the banks breached the fiduciary duties of prudence and loyalty under ERISA Sec. 404 and engaged in self-interested transactions with plan assets in violation of ERISA Sec. 406(b). A federal trial court was not persuaded, finding that the banks’ alleged fraudulent behavior in conducting the FX transactions was not sufficient to establish their status as functional fiduciaries subject to ERISA.

FX transactions did not constitute fiduciary function

On appeal, the participants argued that the banks acquired functional fiduciary status under ERISA by exercising control over the disposition of plan assets. The banks countered that, regardless of any fraudulent misconduct, they were never empowered to exercise control over plan assets sufficient to subject them to fiduciary liability.

The appeals court concluded that, while the FX transactions at issue involved plan assets, the banks did not exercise sufficient control or authority over those assets to subject them to liability as functional fiduciaries. Thus, the banks were not performing a fiduciary function when they executed the FX transactions.

The Second Circuit’s decision was based primarily on the fact that the FX transactions at issue were not initiated by the banks, but were executed at the direction of the plans’ investment managers. The banks had a “salesmanship” relationship with the plans’ investment managers, the court explained, stressing that they lacked authority to exercise control over plan assets or the investment managers’ decisions to enter into a transaction. Such arm’s length dealings, the court reasoned, “do not admit an inference that the banks controlled the disposition of the Plan’s assets so as thereby to be deemed ERISA functional fiduciaries of the Plans.”

The court acknowledged that the alleged market manipulations may have allowed the banks to increase their compensation for a FX transaction. However, the banks lacked the unfettered ability to dictate their compensation. The instructions provided by the investment managers, the court noted, did not allow the banks control over the myriad factors that actually determined the amount of their compensation.

Source: Allen v. Credit Suisse Securities (USA) (CA-2).

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