Hedges Winge
New York - Get your hankies ready: Hedge funds feel they're the
newest victims.
A long-simmering issue may soon come to a boil, potentially putting
Wall Street's largest firms on the hook for billions more in
liabilities years after the research scandal that extracted $1.4
billion in legal fines from ten of the most influential investment
banks.
This time, prime brokers face scrutiny for the fees they charge hedge
fund clients, with securities lending being a particular focus.
Attorneys at plaintiffs' firm Milberg, Weiss, Bershad & Schulmanare
investigating securities lending fees and other practices by the
biggest prime brokers and are considering bringing a class-action
lawsuit on behalf of hedge funds.
Steven Schulman, a partner at the firm, said Tuesday that it's still
investigating the issues and declined to discuss details of any
lawsuit. But he did say, "We're thinking about what we need to do."
Prime brokerage is the business of catering to hedge funds,
everything from loaning securities so funds can sell them short to
providing office space for startup funds. The business has
consolidated among the biggest three: Goldman Sachs Group (nyse: GS -
news - people ), Morgan Stanley (nyse: MS - news - people ) and Bear
Stearns Cos. (nyse: BSC - news - people ) in recent years, though
several other banks have tried to get bigger in it, including Bank of
America (nyse: BAC - news - people ), Credit Suisse (nyse: CSR -
news - people ) and Merrill Lynch (nyse: MER - news - people ).
Securities lending is among the most lucrative of prime brokerage
services to the banks, reaping some $10 billion in annual fees, and
the business just keeps growing as more hedge funds pop up. But it is
also among the most opaque of businesses, with plenty of opportunity
for abuse, lawyers unconnected with the Milberg firm say.
Hedge funds have alleged privately for years that they are being
overcharged for prime brokerage services or charged wrongly for
services that haven't been performed. Most of the griping has to do
with securities loaned but never delivered, the allegation being that
the prime brokers are lending securities at high fees without
actually having possession of the securities to lend in the first
place.
Playing by the rules, a trader can't sell short a security without
having possession of it by the settlement date, or the trade would be
what's called a naked short. A trade is often made while the
settlement process continues, and most trades wind up with the
security being delivered in ten days. Prime brokers lending
securities to clients presumably assure their client that the
borrowed securities will be delivered.
The hedge fund pays a fee to borrow the shares, presumably with the
knowledge that the delivery will occur. The allegation of fraud comes
in when the prime broker takes the fee and never delivers the shares
and doesn't intend to.
The New York Stock Exchange and the Nasdaq keep lists of stocks that
routinely fail to deliver, and some of the companies that have been
on those lists since a new rule was enacted in January 2005 say they
are the victims of naked short-selling. The most famous of these is
Overstock.com (nasdaq: OSTK - news - people ), whose chairman,
Patrick Byrne, has been on a mission to bring the issue to the
attention of regulators and lawmakers.
Bringing prime brokers into the loop would put the biggest firms at
the center of yet another potentially explosive scandal. Lawyers not
connected with the Milberg firm say a lawsuit could attract the
attention of state attorneys general, who were instrumental in
assessing the fines in the conflicts-of-interest scandal and in the
mutual fund trading-abuse cases of recent years. Why? Hedge funds
increasingly manage investments from pensions and endowments, meaning
regular investors could be bearing the brunt of abusive fee schemes
in the form of lower returns on their investments.
A spokesman for New York State Attorney General Eliot Spitzer, who
led the conflicts and mutual fund trading-abuse cases, had no
immediate comment.
"Some hedge funds feel they have been taken advantage of by their
prime broker," says Josh Galper, principal at Vodia Group, a New York
consulting firm. "Naked short-selling is an example of how pricing
abuses can enter the market."
newest victims.
A long-simmering issue may soon come to a boil, potentially putting
Wall Street's largest firms on the hook for billions more in
liabilities years after the research scandal that extracted $1.4
billion in legal fines from ten of the most influential investment
banks.
This time, prime brokers face scrutiny for the fees they charge hedge
fund clients, with securities lending being a particular focus.
Attorneys at plaintiffs' firm Milberg, Weiss, Bershad & Schulmanare
investigating securities lending fees and other practices by the
biggest prime brokers and are considering bringing a class-action
lawsuit on behalf of hedge funds.
Steven Schulman, a partner at the firm, said Tuesday that it's still
investigating the issues and declined to discuss details of any
lawsuit. But he did say, "We're thinking about what we need to do."
Prime brokerage is the business of catering to hedge funds,
everything from loaning securities so funds can sell them short to
providing office space for startup funds. The business has
consolidated among the biggest three: Goldman Sachs Group (nyse: GS -
news - people ), Morgan Stanley (nyse: MS - news - people ) and Bear
Stearns Cos. (nyse: BSC - news - people ) in recent years, though
several other banks have tried to get bigger in it, including Bank of
America (nyse: BAC - news - people ), Credit Suisse (nyse: CSR -
news - people ) and Merrill Lynch (nyse: MER - news - people ).
Securities lending is among the most lucrative of prime brokerage
services to the banks, reaping some $10 billion in annual fees, and
the business just keeps growing as more hedge funds pop up. But it is
also among the most opaque of businesses, with plenty of opportunity
for abuse, lawyers unconnected with the Milberg firm say.
Hedge funds have alleged privately for years that they are being
overcharged for prime brokerage services or charged wrongly for
services that haven't been performed. Most of the griping has to do
with securities loaned but never delivered, the allegation being that
the prime brokers are lending securities at high fees without
actually having possession of the securities to lend in the first
place.
Playing by the rules, a trader can't sell short a security without
having possession of it by the settlement date, or the trade would be
what's called a naked short. A trade is often made while the
settlement process continues, and most trades wind up with the
security being delivered in ten days. Prime brokers lending
securities to clients presumably assure their client that the
borrowed securities will be delivered.
The hedge fund pays a fee to borrow the shares, presumably with the
knowledge that the delivery will occur. The allegation of fraud comes
in when the prime broker takes the fee and never delivers the shares
and doesn't intend to.
The New York Stock Exchange and the Nasdaq keep lists of stocks that
routinely fail to deliver, and some of the companies that have been
on those lists since a new rule was enacted in January 2005 say they
are the victims of naked short-selling. The most famous of these is
Overstock.com (nasdaq: OSTK - news - people ), whose chairman,
Patrick Byrne, has been on a mission to bring the issue to the
attention of regulators and lawmakers.
Bringing prime brokers into the loop would put the biggest firms at
the center of yet another potentially explosive scandal. Lawyers not
connected with the Milberg firm say a lawsuit could attract the
attention of state attorneys general, who were instrumental in
assessing the fines in the conflicts-of-interest scandal and in the
mutual fund trading-abuse cases of recent years. Why? Hedge funds
increasingly manage investments from pensions and endowments, meaning
regular investors could be bearing the brunt of abusive fee schemes
in the form of lower returns on their investments.
A spokesman for New York State Attorney General Eliot Spitzer, who
led the conflicts and mutual fund trading-abuse cases, had no
immediate comment.
"Some hedge funds feel they have been taken advantage of by their
prime broker," says Josh Galper, principal at Vodia Group, a New York
consulting firm. "Naked short-selling is an example of how pricing
abuses can enter the market."