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Short-Selling Sparks RICO Suit Against Financial Giants


Stun-gun maker Taser and shareholders claim that Morgan Stanley, Goldman Sachs, Merrill Lynch and others illegally manipulated stock price

Greg Land
Fulton County Daily Report
May 15, 2009
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Trooping into the courtroom of Fulton County, Ga., State Court Judge Patsy Y. Porter, a phalanx of lawyers representing the cream of global finance -- to be sure, a thinner cream since last year's financial collapse -- sought to short-circuit a suit claiming a conspiracy to reap tens of millions of dollars in unearned fees and force down the value of stock in stun-gun manufacturer TASER International Inc.

Robert F. Wise Jr. of New York's Davis Polk & Wardwell, representing Morgan Stanley and one of three lawyers who would argue for the defendants, opened up the hearing succinctly.

"In short," he said, "what we'd like is a dismissal."

For nearly two and a half hours, they and opposing counsel sparred over a suit, originally filed by dozens of TASER shareholders and later joined by the company itself. It accuses Morgan Stanley, Goldman Sachs, Merrill Lynch, Deutsche Bank Securities, Credit Suisse, Banc of America Securities and three remnants of Bears Stearns of engaging "abusive naked short sales" of TASER stock that have devalued stock and created millions of shares of "counterfeit" or "phantom" shares.

The complaint (pdf), filed nearly a year ago by Bondurant, Mixson & Elmore partners John E. Floyd and Steven J. Rosenwasser and Houston's James W. Christian and John M. O'Quinn, accuses the companies of violating the Georgia Securities Act, the state's Racketeer Influenced and Corrupt Organizations Act and the Georgia Computer Systems Protection Act. A fourth count, added later, also alleges conversion.
COMMISSIONS AND 'PHANTOM SHARES'

In the case of TASER stock, says the suit, the companies deliberately engaged in a pattern of naked short-selling designed to generate commissions and fees for nonexistent stock transactions and interest on borrowed shares that were never loaned. They also manipulated the sales in order to drive down the value of TASER stock, it says, because the companies routinely short-sold the stock in their own proprietary accounts, "giving them a financial interest in lowering the stock's price."

"The SEC has repeatedly found that naked short sales can depress stock prices," said Rosenwasser, arguing in support of his case. "That's what happened with TASER."

In 2005, he said, TASER stock suffered a stunning 77 percent decline largely because of the defendant companies' manipulation.

"Why would they do that?" he asked. "Because they make a wealth of money. ... They make hundreds of millions of dollars in fees and commissions from short-selling," he said, asserting that the companies' second-largest source of revenue came from such transactions.

The suit includes figures purporting to show that, on a given day, the number of TASER shares the DTCC recorded as being held by the defendant companies could be vastly lower than the number the company itself claimed to control. For instance, on May 22, Morgan Stanley claimed "beneficial ownership" of 11.7 million shares; the same day, DTCC records showed the company holding 2.6 million.

The so-called "phantom shares" also dramatically increased the number of TASER shares reportedly held by stockholders, the suit says.

"Objective shareholder voting data demonstrates that the defendants' unlawful selling of unregistered and unissued TASER shares flooded the market with counterfeit shares," it says. "For example, at the time of TASER's 2005 annual vote, TASER had approximately 61.1 million shares outstanding. Yet, approximately 82 million shares voted, an additional over-vote of approximately 20 million shares."

That figure is "particularly compelling," said the complaint, because the day of the vote there were roughly 17.2 million shorted shares of TASER stock. Thus, "[e]ven if all of the TASER shares that were sold short were able to vote ... there were at least 3.7 million shares that were undoubtedly counterfeit."

The suit, which now has 42 shareholder plaintiffs as well as TASER, does not enumerate the financial loss suffered by those bringing it, demanding only compensatory and punitive damages, along with attorney fees and court costs.