Brokers make unfair profits lending stocks, pension funds say

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A federal magistrate recently recommended class action status for an antitrust action involving stock lending.

Spencer Platt/Getty Images

Five of Wall Street’s biggest brokerages are set to defend class action lawsuits that they conspired to extract unfair profits from the nearly $2 trillion stock lending market.

Successful class action lawsuit could slash profits for defendants’ major brokerage units

Goldman Sachs

(symbol: GS), Morgan Stanley (MS),


(UBS), the

JP Morgan

unit of JPMorgan Chase (JPM) and the Merrill Lynch unit of

Bank of America


On June 30, Manhattan Federal Magistrate Judge Sarah Cave recommended class-action status for an antitrust case in which a trio of pension funds allege that big brokers run a cartel that derives unfair profits from lending money. shares. Stock lending is a key component of short selling and options trading by hedge funds, as well as a source of profit for pension funds and mutual funds.

When a hedge fund wants to short the shares of a particular company, it first borrows those shares from long-term investors such as investment firms, pension and endowment funds, and investment companies. insurance. Principal brokers sit between the borrower and the lender and have exclusive knowledge of stock stocks and trading strategies. The lawsuit alleges that they are abusing this position.

For investment giants like

black rock

or Fidelity which manages US pensions and savings, stock lending has become an important source of income and one of the reasons they have been able to lower fees on mutual funds. If the lawsuit is successful, these companies could derive even more revenue from stock lending.

Stock lending is one of the last major over-the-counter financial markets in the United States, and its opacity has been labeled a “market failure” by the United States Securities and Exchange Commission. “This asymmetric information between those at the center of the lending market and those at the periphery may lead to lower terms for those at the periphery,” the SEC said in December, when it proposed new reporting requirements. on stock loans.

The main defendant brokers abused their central position to skim profits from lenders and borrowers, according to the antitrust lawsuit filed by three pension funds in Manhattan Federal District Court in 2017. The defendant brokers conspired to freeze the challengers who had attempted to introduce transparent pricing and central clearing to the stock lending industry, the complaint says, citing conversations in which brokerage executives compared themselves to the five New York mob crime families. When one of the stock lending start-ups introduced its product in 2008, the complaint quotes a securities clearing executive who replied, “That sounds great, but who’s going to start your car tomorrow? morning ?”

If U.S. District Judge Katherine Polk Failla follows last week’s recommendation for class action certification, the three funds that filed the lawsuit – the Iowa Public Employees Retirement System, the Orange County employees and the Sonoma County Employee Retirement System – could seek damages on behalf of hundreds of others.

They are represented by legal teams led by Daniel Brockett, of Quinn Emanuel Urquhart & Sullivan, and Michael Eisenkraft, of Cohen Milstein Sellers & Toll. Lawyers have secured billions from big banks in settlements of other class action lawsuits over banks’ behavior in the credit default swap, bond and mortgage-backed securities markets.

“We are pleased with Judge Cave’s ruling on class certification,” Brockett said, “and look forward to continued litigation against the banks to maximize recoveries for the benefit of class members.”

Asked about the antitrust suit’s allegations, Goldman Sachs and UBS declined to comment. Morgan Stanley, JP Morgan and Merrill Lynch did not respond.

Credit Suisse Group

(CS) was also named in the original lawsuit, but after quitting the prime brokerage business following the Archegos Capital Management debacle, Credit Suisse settled the lawsuit for $81 million, without admitting the allegations.

The brokers deny that their equity loans violate antitrust law and have unsuccessfully sought to have the case dismissed. In a day-long hearing before Judge Cave in April, lawyers for major brokers claimed that the over-the-counter structure of stock lending helped pension funds find borrowers for less sought-after stocks and helped hedge funds become difficult to…borrow stocks. A more transparent stock lending market would threaten the confidentiality of short sellers’ positions, brokers said.

At the April hearing, pension fund plaintiffs pointed to several foreign markets that have introduced central clearing and public pricing of securities lending. In the United States, public platforms for trading in securities like US Treasuries have reduced transaction costs for customers. Economists working with the plaintiffs told Judge Cave that the major brokers’ hold on stock lending damaged pension funds by at least $5 billion and hedge funds by more than $2 billion.

Although antitrust plaintiffs are seeking damages on behalf of the hedge fund industry, not all funds wanted to participate in the case. Pre-trial discovery was stalled for months in 2020, when attorneys representing 22 hedge funds told the court they feared their proprietary trading strategies would be exposed in the stock loan filings plaintiffs were obtaining of major brokers. Anonymization procedures were established, but even then seven major quantitative funds pulled out of the case, including Citadel LLC, Two Sigma Investments, Renaissance Technologies and DE Shaw.

Email Bill Alpert at [email protected]