Federal Pensions Challenge Big Banks’ Securities Lending Practices

Three U.S. pension funds have filed a lawsuit against a group of the world’s biggest investment banks including Goldman Sachs, JPMorgan, Credit Suisse, UBS and Bank of America, over practices having to do with the lending of stocks.

The lawsuit alleges that the banks conspired to block competition in the securities lending marketplace through a variety of means.

It may be helpful for readers to note that the lending of stock by major asset holders (such as large pension plans, both public and private) is typically involved in short selling and other areas of the hedge fund marketplace. Retirement systems that hold a lot of stock on long-term plays will often lend their stock out to a short seller for compensation, using one of the large banks named in the suit as a middle man.  

The arguments presented in the new litigation, submitted to the U.S. District Court for the Southern District of New York, suggest the major providers in the marketplace for securities lending have colluded and purposefully allowed the market to remain inefficient and opaque. The plaintiffs argue the providers have inappropriately worked together and structured the marketplace so that investors cannot clearly and efficiently find out who has different stock available for lending purposes and where the demand for borrowing specific stocks exists. Plaintiffs say they are also effectively prevented from being able to determine the prospective prices of these stock exchanges, given the influence of the providers named.

According to the plaintiffs, the large banks have created and fostered the opacity of the marketplace in order to prevent borrowers and lenders from working together directly and to thereby protect/maximize their own interests as a broker of securities lending arrangements. In doing this they have allegedly worked together behind the scenes to fend off previous attempts by clients and competitors to make the market more efficient. One example of how the defendants have done this, according to the complaint, was by forming a joint project called EquiLend LLC, through which the banks allegedly purchased and shelved key intellectual property of potential competition.

As is noted in the complaint, today there is approximately $1.72 trillion worth of securities on loan, and this has become a very important part of the wider financial marketplace. Simply put, there are many hedge funds that want to borrow stock and a lot of pension funds that want to loan their stock, but there is no real way for these groups to match themselves up without having to use the big banks as a conduit.

It should be noted that hedge funds often have their own interest in maintaining confidentiality, so it is far from clear that it would be as easy a matter to create more transparency in the securities lending marketplace as the plaintiffs seem to suggest. Hedge funds, many of them, will be loath to publicly broadcast their desired holdings even if they did not have to use the big banks as a go-between. 

Beyond this, the plaintiffs might also have trouble establishing the class action standing they are seeking. In the federal court system, to prove that a complaint can succeed as a class action, plaintiffs must prove numerosity, commonalty and typicality. Because these stock lending transactions are all structured and papered somewhat differently, it will be particularly challenging for the plaintiffs to prove typicality.

The full text of the complaint is here.