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Criminal Charges Near
In Stock-Lending Cases
By KARA SCANNELL
August 15, 2007; Page C3
WASHINGTON -- Federal authorities are preparing to file criminal charges against nearly a dozen individuals in connection to a years-long investigation into improper stock lending, people familiar with the matter said.
Federal prosecutors in Brooklyn, N.Y., and the Securities and Exchange Commission are investigating whether current or former employees at Janney Montgomery Scott LLC, Morgan Stanley and other financial institutions committed fraud by taking kickbacks or engaging in self-dealing while arranging stock-lending agreements, the people said.
The investigation has centered on conduct involving mostly lower-level employees across Wall Street, the people said. The cases involve "finders" or firms that act as intermediaries and assist borrowers and lenders in locating stock to borrow, they said.
The stock-lending market was once a backwater of Wall Street, but has grown into a $10 billion industry, fueled by the increased use of short-selling. For years, this market had been under the radar, which authorities believe created holes in compliance and an opportunity for fraud.
In short selling, stock is borrowed and sold on the bet that its price will drop. Then when the share price drops, the stock is purchased at the lower price and returned to the lender. The borrower pockets the difference.
Problems have occurred when stock borrowers pay finders to help locate shares when such services aren't needed, people familiar with the situation said. That can in some cases result in finders' siphoning off investor fees that should go to the brokerage house. Ultimately, the practice could make borrowing more expensive.
The charges could come in the next few weeks, and some of the individuals have pleaded guilty in sealed court papers, the people familiar with the matter said. One Morgan Stanley employee has resigned in connection with the investigation, they said.
The types of schemes that authorities are investigating vary from individuals' diverting money to family members at finder shops, to cases in which loans were being passed through several firms or intermediaries without any purpose other than to drive up the price of borrowing the stock, these people said.
Yesterday, Janney agreed to pay $2.5 million to settle with New York Stock Exchange regulators over allegations that it failed to supervise its stock-loan desk in connection with improper stock-loan transactions. In connection with this case, the NYSE reached settlements with Van der Moolen Specialists USA LLC and CIBC World Markets Corp. within the past year.
The companies settled without admitting or denying wrongdoing. Janney suspended the stock-loan department manager, the stock-loan desk manager and a trader, who all later resigned. The NYSE's investigations are continuing.
The NYSE found that from January 2004 to December 2004, Janney employees engaged in a series of transactions that fed money to finder firms that had the effect of driving up the cost of borrowing. Janney paid 24 finders about $1.4 million in connection with the stock loans, according to the settlement, without any written agreements or invoices that showed the finder performed any services.
Write to Kara Scannell at kara.scannell@wsj.com
