The practice of finan-
cial firms insisting that registered accounts not hold foreign currency is going on trial. An aggrieved investor has filed a class-action suit over the practice of routinely converting these balances to Canadian dollars and earning fees in the process.

On Aug. 2, James MacDonald of Stouffville, Ont., filed a lawsuit against BMO Nesbitt Burns Inc., BMO Trust Co. and Bank of Montreal in the Ontario Superior Court of Justice on behalf of all of these firms’ clients who have incurred foreign exchange conversion charges in their registered accounts since June 14, 2001.

The lawsuit alleges that the firms systematically and unnecessarily converted foreign currency balances in these accounts to C$. In June 2001, the Income Tax Act was changed so investors could hold foreign currency in their registered accounts. Up until that point, foreign currency and deposits denominated in foreign currency did not qualify as investments that could be held in these kinds of accounts.

The lawsuit argues that, after the rules were changed, the defendants continued to make these currency conversions automatically — for example, converting dividends earned on foreign equities or the proceeds of the sale of foreign equities within these accounts. The lawsuit maintains the firms carried out these conversions without consent of the accountholders, and that they also charged a currency conversion fee, which the lawsuit says was not disclosed.

By carrying out these trades, the lawsuit alleges the firms enriched themselves, both on the spread charged on the transactions and by levying a currency conversion fee. The lawsuit seeks $100 million in damages for the fees it says clients were charged for these trades, and an additional $10 million in punitive damages.

The allegations have not been proven. A BMO spokesman declined to comment on them, citing company policy against commenting on cases that are before the courts.

The lawsuit is seeking certification as a class action, but the statement of claim spells out the essence of the complaint in MacDonald’s particular case — detailing a transaction in which MacDonald lost money despite the fact that the stock he traded went up while he held it.

MacDonald opened an RRSP with BMO Trust and a LIRA with BMO Nesbitt Burns in 1999. According to his claim, he paid C$11,317.57 for 500 shares of Tyco International Ltd. in March 2003, when it was trading at US$14.89 a share. He sold the stock two months later, when it was up to US$16.04 a share, receiving proceeds of C$10,950.81. Therefore, he lost $366.76 on the trade, although the stock went up.

MacDonald claims he authorized the conversion from Canadian currency to U.S. dollars to buy the stock, but not the conversion back to C$ following the sale. And he alleges he was charged an undisclosed fee on the trades both ways. The lawsuit alleges that these fees aren’t disclosed separately on account statements, but are shown as part of an overall “conversion rate” for FX trades. The claim argues that these fees are deliberately not disclosed to clients, in violation of the firms’ contractual and fiduciary duties.

The lawsuit also claims the FX fees charged to client accounts bear no relationship to the bank’s actual transaction costs. Instead, it says, these fees are simply a source of revenue for the firms.

That is why, it alleges, the firms didn’t change their policy of automatically converting foreign currency into C$ in these accounts after the income tax laws were altered. The claim argues that this practice amounts to breach of fiduciary duty, breach of contract, unjust enrichment and negligence.

The lawsuit’s outcome could be significant for the entire brokerage industry, as many firms have been and may still be following the same procedure. Earlier this year, the Investment Dealers Association of Canada issued a bulletin noting that foreign currency cash balances have been treated as non-allowable assets in registered accounts because they were not insured by either the Canadian Deposit Insurance Corp. or the Quebec Deposit Insurance Corp.

However, the IDA allows that this was “inconsistent” with assets held in other types of accounts for which insurance coverage wasn’t required. Therefore, the IDA amended its rules for foreign currency balances held within registered accounts.

“With the elimination of the RRSP foreign-content limit and expected increase in the flow of foreign currency funds into RRSP accounts, it was necessary to make the amendments to correct the inconsistent and inappropriate treatment of these funds,” the IDA bulletin says. The amendments allow foreign currency cash balances in RRSP accounts to be classified as allowable assets.

@page_break@The Canadian industry will certainly be watching this lawsuit closely. The size of FX conversion fees has also recently been the subject of class-action lawsuits in the U.S. Three of the large credit card companies and several banks recently settled a case of this kind for US$336 million.

The plaintiffs had claimed that various financial firms violated federal and state anti-trust laws, disclosure laws and other legal requirements in charging these fees. The defendants denied any wrongdoing.

The court never ruled on the merits of that case, but a settlement was reached after years of litigation and negotiations with the assistance of a mediator. Under the settlement, the defendants will create a fund to pay claims by eligible cardholders, along with covering costs and lawyers’ fees. The settlement, which is awaiting court approval, also includes provisions relating to disclosure on account statements and other documents.

As well, the U.S. banking regulator, the Office of the Comptroller of the Currency, issued guidance in mid-August requiring up-front disclosure of currency conversion fees, among other things, on gift cards.

Whatever the outcome of this lawsuit, there are a couple of lessons in it for investors: that transaction costs negatively impact returns, and trading in foreign securities carries a significant FX risk — at least, over the short term.

Financial services firms may learn a lesson from it, as well. IE