Friday, June 22, 2007
BusinessWeek has an interesting article (here) about a developing criminal investigation related to the stock lending practices at some of Wall Street's leading brokerage firms, including Morgan Stanley. The case involves possible kickbacks and other gratuities to employees who work in the stock loan departments of the firms from middlemen who help obtain shares as part of a shorting strategy in which borrowed shares are sold in the hope that the price will decline when the shares are repurchased at a later date. For those who like to play craps, it's a bit like betting the "don't come" line, and the strategy is not one that endears practitioners to other investors, most of whom are "long" on stocks. With the growth of large funds that use shorting to "hedge" their positions -- hence the term "hedge fund" -- there has been a corresponding increase in the demand for shares. The short interest ratio on the exchanges has hovered near an all-time high, and those shares have to come from some place.
It's not a great stretch to hear that some may have viewed such a situation as an opportunity to line their own pockets while their employers reaped lucrative fees from the business. Who gets hurt anyway, a bunch of rich hedge fund managers and even wealthier investors? An interesting question is how any such criminal charges will be framed, whether as a type of securities fraud or based on the right of honest services route with mail and wire fraud. The article notes that there are already three defendants who are cooperating, so look for a big media splash in the near future. Prosecutors in the Southern District of New York are probably hoping this investigation turns out better than the recent round of charges against floor brokers for alleged front-running that resulted in a number of acquittals and voluntary dismissals. (ph -- thanks to YMH for the "tip")