More Illegal Activity on Wall Street
Short-Selling Inquiry Is Widened
To Cover Stock-Lending Business
By RANDALL SMITH
July 18, 2006; Page C3
Federal prosecutors and civil regulators have opened a new front in their probes of the mechanics of short selling, according to people familiar with the case.
The Justice Department's U.S. attorney for the Eastern District of New York in Brooklyn is investigating possible overcharging in the stock-lending business, including the use of bogus "finder's fees," the same people said. The prosecutors are working with regulators at the Securities and Exchange Commission and the New York Stock Exchange, a unit of NYSE Group Inc.
Stock lending is an important part of short selling, in which investors sell borrowed stock in hopes of buying it back at a lower price. The improper finder's fees came to light last week in an NYSE regulatory action against one of the NYSE's major "specialist firms" that direct trading on the floor, the specialist unit of Van der Moolen Holding NV, based in the Netherlands.
The NYSE regulators fined Van der Moolen $3.5 million for allegedly overcharging customers with finder's fees and interest rates that were as much as 13 percentage points above market. Van der Moolen consented to the charges without admitting or denying wrongdoing. (On Friday, two former NYSE specialist traders at Van der Moolen Specialists USA were each convicted of securities fraud.)
The prosecutors and regulators are focusing not only on individuals involved in the Van der Moolen case but also on a few other firms that engage in stock lending, according to the people familiar with the case. The probe by the prosecutors was earlier reported by TheStreet.com Inc.
The latest probe follows separate civil lawsuits and regulatory investigations of the influence of short selling on independent research, and how short selling may have contributed to the steep decline of the price of Vonage Holdings Corp. after its initial public offering in May.
Biovail Corp., a specialty pharmaceuticals company that has tangled with short sellers, filed a civil lawsuit in February alleging that a hedge fund conspired with an independent research firm to drive down Biovail's stock price. And last month the NYSE asked Wall Street firms for information about procedures they used to facilitate borrowing in shares of Vonage when it first began trading.
Prime brokers that provide stock-lending services to hedge funds are allowed to facilitate such sales if they have "reasonable grounds" to believe the stock can be borrowed. But a recent civil lawsuit against the largest prime brokers alleged that sometimes such brokers charge fees for such loans without actually borrowing the stock.
As the Van der Moolen case suggests, market rates for such transactions may not be widely known. Indeed, a former consultant at Morgan Stanley, one of the largest prime brokerage firms, was arrested Friday and charged with conspiracy for allegedly improperly emailing rates charged to specific customers for prime brokerage services.
The consultant, Ira Chilowitz, along with an unnamed co-conspirator who formerly worked as a Morgan Stanley prime brokerage salesman, planned to use the data to help customers of Morgan Stanley and other firms negotiate better rates, according to a Federal Bureau of Investigation complaint and affidavit.
Morgan Stanley said in a statement that it sought the action by Manhattan federal prosecutors to safeguard its confidential customer information. A lawyer for Mr. Chilowitz, Peter Batalla Jr., said his client is "innocent and will defend the charges against him."
