Case Sheds Light on Goldman’s Role as Lender in Short Sales
Fair Game
By GRETCHEN MORGENSON JAN. 29, 2016
http://www.nytimes.com/2016/01/31/business/ca...f=dealbook
It would be easy to overlook the case against Goldman Sachs filed by the Securities and Exchange Commission on Jan. 14. It involved a complex piece of Wall Street plumbing, led to a minuscule $15 million fine and came on the same day that Goldman agreed to pay up to $5 billion to settle prosecutors’ claims that it sold faulty mortgage securities to investors.
But the smaller settlement merits close study because it sheds light on one of Wall Street’s most secretive and profitable arenas: securities lending and short-selling.
Although the firm settled the matter without admitting to or denying the S.E.C.’s allegations, some of Goldman’s customers may now be able to recover damages from the firm, securities lawyers say.
Essentially the regulator said Goldman advised its clients that it had performed crucial services for them when it often had not. Customers who paid handsomely for those services may want their money back.
The $15 million punishment is just petty cash for Goldman, but this case tells us a lot about one of the most important duties that Wall Street firms perform for their clients — executing trades for hedge funds and other large investors. When these clients want to bet against a company’s stock, known as selling it short, they rely on brokerage firms to locate the shares they must borrow and deliver to a buyer.
Selling stock short without first locating the shares for delivery is known as naked shorting. It is a violation of Regulation SHO, a 2005 S.E.C. rule. Goldman’s failure meant that some of its clients were unknowingly breaching this important rule.
The S.E.C. has said that naked shorting can be abusive and may drive down a company’s shares. Therefore, brokerage firms are barred from accepting orders for short sales unless they have borrowed the stock or have “reasonable grounds” to believe it can be secured. This is known as the “locate” requirement.
Goldman violated the rule from November 2008 through mid-2013, the S.E.C. said. Through that period, which included the market decline of early 2009, the firm was “improperly providing locates to customers where it had not performed an adequate review of the securities to be located.”
Nor was the firm helpful when the S.E.C. staff questioned its practices. For example, Goldman “created the incorrect impression” with the regulator that it had in fact conducted an individualized review for all locate requests, the order noted. Goldman’s “incomplete and unclear responses” hampered and prolonged the inquiry, the S.E.C. said.
How might Goldman be liable beyond the $15 million fine? While the firm was improperly advising customers that it had located shares for their transactions, some of those customers were very likely paying for a service the firm wasn’t providing.
Costs to borrow shares can be considerable under normal circumstances, but they rocket when there is more demand by investors to short a company’s stock than there is stock to borrow. Clients may have to pay 25 percent or more of the trade’s value to secure the shares.
If Goldman charged borrowing fees when it had not actually located the shares, its customers might well try to recover those costs, said Lewis D. Lowenfels, an expert in securities law in New York and an adjunct professor at Seton Hall University Law School.
“Goldman Sachs employees performed inadequate reviews in response to customer requests to locate stocks for short sales, according to the S.E.C.’s order,” Mr. Lowenfels said. “Depending upon the specific factual circumstances, Goldman could incur private damage liabilities to its customers for these actions.”
It’s unclear how many customers may have been affected by Goldman’s failures. The S.E.C. order is silent on that; it noted that the firm was “generally able to meet its settlement obligations” during the five-and-a-half-year period.
“The S.E.C. settlement concerns the provision of locates,” said Michael DuVally, a Goldman spokesman, “and Goldman does not charge its clients for locates. As is common industry practice, clients are only charged if they establish a short position. The S.E.C. order noted that Goldman’s rate of fails to deliver remained low.”
This case is not the only one related to securities lending that the S.E.C. has brought against Goldman. In 2010, the regulator sued the firm, saying it had violated Regulation SHO in December 2008 and January 2009 “by failing to deliver certain securities or immediately purchase or borrow securities” to close out positions properly. The firm paid $225,000 to settle, again neither admitting nor denying the allegations.
Some market participants have long suspected that big brokerage firms were charging high fees to short-selling customers while not actually locating the shares these investors needed under the rules.
A 2006 antitrust lawsuit against 11 leading Wall Street firms, including Goldman, filed in federal court in New York made such an allegation. In addition to accusing the firms of illegal price-fixing in their conduct surrounding short sales, the plaintiffs contended that the firms charged “improper fees for purportedly locating securities, when in many instances, defendants failed to locate and/or borrow the securities.” But the court dismissed that case in 2007, citing a “clear incompatibility between the securities laws and antitrust laws.”
The most famous litigation alleging violations of short-sale regulations was brought in 2007 by Overstock.com, a closeout retailer based in Salt Lake City, and a group of its shareholders. Overstock and its chief executive, Patrick M. Byrne, contended that abusive naked short-selling had driven down the company’s share price and harmed its capital-raising efforts. A slightly different group of 11 Wall Street firms, Overstock said, essentially created stock out of thin air that could be sold by investors.
Overstock shares were exceedingly hard to borrow; fees ran as high as 35 percent.
Some of the firms settled with Overstock in 2010, paying $4.4 million in total. Others were removed from the case, leaving Goldman and Merrill Lynch as defendants. The court subsequently dismissed Goldman from the suit, but the firm settled with Overstock on a refiled case last June, paying an undisclosed amount. On Thursday, Overstock announced that Merrill was settling the case with a $20 million payment.
The Overstock suit generated a trove of emails and other documents that shed light on questionable Wall Street practices in the securities lending arena.
For example, in a deposition in the case, which Goldman had sought to seal, Marc Cohodes, the former head of Copper River Partners, said that he had paid Goldman more than $100 million to handle its short sales over many years.
But in the deposition, he said he soon began to doubt that Goldman had actually borrowed some of those shares. Mr. Cohodes also said he suspected that Goldman’s failure to borrow the shares was behind his firm’s collapse in the financial crisis.
Goldman has disputed this contention.
I asked Mr. Cohodes, who no longer manages money, what he thought of the S.E.C.’s recent findings on Goldman. He forwarded my request to his lawyer, David W. Shapiro, in San Francisco.
In an interview, Mr. Shapiro, a former federal prosecutor and United States attorney, questioned the recent S.E.C. settlement. “I’m very curious to understand what Goldman Sachs admitted to the S.E.C.,” he said, “and why $15 million was considered to be an adequate punishment.”
A version of this article appears in print on January 31, 2016, on page BU1 of the New York edition with the headline: Short Sellers Sold Short by Goldman.
http://www.nytimes.com/2016/01/31/business/ca...f=dealbook
Fair Game
By GRETCHEN MORGENSON JAN. 29, 2016
http://www.nytimes.com/2016/01/31/business/ca...f=dealbook
It would be easy to overlook the case against Goldman Sachs filed by the Securities and Exchange Commission on Jan. 14. It involved a complex piece of Wall Street plumbing, led to a minuscule $15 million fine and came on the same day that Goldman agreed to pay up to $5 billion to settle prosecutors’ claims that it sold faulty mortgage securities to investors.
But the smaller settlement merits close study because it sheds light on one of Wall Street’s most secretive and profitable arenas: securities lending and short-selling.
Although the firm settled the matter without admitting to or denying the S.E.C.’s allegations, some of Goldman’s customers may now be able to recover damages from the firm, securities lawyers say.
Essentially the regulator said Goldman advised its clients that it had performed crucial services for them when it often had not. Customers who paid handsomely for those services may want their money back.
The $15 million punishment is just petty cash for Goldman, but this case tells us a lot about one of the most important duties that Wall Street firms perform for their clients — executing trades for hedge funds and other large investors. When these clients want to bet against a company’s stock, known as selling it short, they rely on brokerage firms to locate the shares they must borrow and deliver to a buyer.
Selling stock short without first locating the shares for delivery is known as naked shorting. It is a violation of Regulation SHO, a 2005 S.E.C. rule. Goldman’s failure meant that some of its clients were unknowingly breaching this important rule.
The S.E.C. has said that naked shorting can be abusive and may drive down a company’s shares. Therefore, brokerage firms are barred from accepting orders for short sales unless they have borrowed the stock or have “reasonable grounds” to believe it can be secured. This is known as the “locate” requirement.
Goldman violated the rule from November 2008 through mid-2013, the S.E.C. said. Through that period, which included the market decline of early 2009, the firm was “improperly providing locates to customers where it had not performed an adequate review of the securities to be located.”
Nor was the firm helpful when the S.E.C. staff questioned its practices. For example, Goldman “created the incorrect impression” with the regulator that it had in fact conducted an individualized review for all locate requests, the order noted. Goldman’s “incomplete and unclear responses” hampered and prolonged the inquiry, the S.E.C. said.
How might Goldman be liable beyond the $15 million fine? While the firm was improperly advising customers that it had located shares for their transactions, some of those customers were very likely paying for a service the firm wasn’t providing.
Costs to borrow shares can be considerable under normal circumstances, but they rocket when there is more demand by investors to short a company’s stock than there is stock to borrow. Clients may have to pay 25 percent or more of the trade’s value to secure the shares.
If Goldman charged borrowing fees when it had not actually located the shares, its customers might well try to recover those costs, said Lewis D. Lowenfels, an expert in securities law in New York and an adjunct professor at Seton Hall University Law School.
“Goldman Sachs employees performed inadequate reviews in response to customer requests to locate stocks for short sales, according to the S.E.C.’s order,” Mr. Lowenfels said. “Depending upon the specific factual circumstances, Goldman could incur private damage liabilities to its customers for these actions.”
It’s unclear how many customers may have been affected by Goldman’s failures. The S.E.C. order is silent on that; it noted that the firm was “generally able to meet its settlement obligations” during the five-and-a-half-year period.
“The S.E.C. settlement concerns the provision of locates,” said Michael DuVally, a Goldman spokesman, “and Goldman does not charge its clients for locates. As is common industry practice, clients are only charged if they establish a short position. The S.E.C. order noted that Goldman’s rate of fails to deliver remained low.”
This case is not the only one related to securities lending that the S.E.C. has brought against Goldman. In 2010, the regulator sued the firm, saying it had violated Regulation SHO in December 2008 and January 2009 “by failing to deliver certain securities or immediately purchase or borrow securities” to close out positions properly. The firm paid $225,000 to settle, again neither admitting nor denying the allegations.
Some market participants have long suspected that big brokerage firms were charging high fees to short-selling customers while not actually locating the shares these investors needed under the rules.
A 2006 antitrust lawsuit against 11 leading Wall Street firms, including Goldman, filed in federal court in New York made such an allegation. In addition to accusing the firms of illegal price-fixing in their conduct surrounding short sales, the plaintiffs contended that the firms charged “improper fees for purportedly locating securities, when in many instances, defendants failed to locate and/or borrow the securities.” But the court dismissed that case in 2007, citing a “clear incompatibility between the securities laws and antitrust laws.”
The most famous litigation alleging violations of short-sale regulations was brought in 2007 by Overstock.com, a closeout retailer based in Salt Lake City, and a group of its shareholders. Overstock and its chief executive, Patrick M. Byrne, contended that abusive naked short-selling had driven down the company’s share price and harmed its capital-raising efforts. A slightly different group of 11 Wall Street firms, Overstock said, essentially created stock out of thin air that could be sold by investors.
Overstock shares were exceedingly hard to borrow; fees ran as high as 35 percent.
Some of the firms settled with Overstock in 2010, paying $4.4 million in total. Others were removed from the case, leaving Goldman and Merrill Lynch as defendants. The court subsequently dismissed Goldman from the suit, but the firm settled with Overstock on a refiled case last June, paying an undisclosed amount. On Thursday, Overstock announced that Merrill was settling the case with a $20 million payment.
The Overstock suit generated a trove of emails and other documents that shed light on questionable Wall Street practices in the securities lending arena.
For example, in a deposition in the case, which Goldman had sought to seal, Marc Cohodes, the former head of Copper River Partners, said that he had paid Goldman more than $100 million to handle its short sales over many years.
But in the deposition, he said he soon began to doubt that Goldman had actually borrowed some of those shares. Mr. Cohodes also said he suspected that Goldman’s failure to borrow the shares was behind his firm’s collapse in the financial crisis.
Goldman has disputed this contention.
I asked Mr. Cohodes, who no longer manages money, what he thought of the S.E.C.’s recent findings on Goldman. He forwarded my request to his lawyer, David W. Shapiro, in San Francisco.
In an interview, Mr. Shapiro, a former federal prosecutor and United States attorney, questioned the recent S.E.C. settlement. “I’m very curious to understand what Goldman Sachs admitted to the S.E.C.,” he said, “and why $15 million was considered to be an adequate punishment.”
A version of this article appears in print on January 31, 2016, on page BU1 of the New York edition with the headline: Short Sellers Sold Short by Goldman.
http://www.nytimes.com/2016/01/31/business/ca...f=dealbook
