By Peter Reap, J.D., LL.M.
Three public employee retirement systems have filed suit in the federal district court in New York City accusing several of the largest investment banks—including Bank of America, Goldman Sachs, Morgan Stanley, Credit Suisse, JP Morgan, and UBS—of conspiring to boycott trading platforms in violation of the antitrust laws in order to protect their control over the lucrative and antiquated "stock loan" market. The complaint in Iowa Public Employees’ Retirement System v. Bank of America was filed Aug. 16, 2017.
The plaintiffs, Iowa Public Employees’ Retirement System, Orange County Employees Retirement System, and Sonoma County Employees’ Retirement Association, describe stock lending as the temporary transfer of stock from one investor to another investor. It plays a vital role in maintaining the liquidity of financial markets and is the fundamental process underlying most short selling activity. Short selling without stock borrowing is referred to as "naked" short selling, which is illegal under Securities and Exchange Commission rules. By contrast, short selling coupled with stock borrowing is lawful because it strengthens markets and reduces systemic risk.
Inefficient and antiquated. However, according to the plaintiffs, unlike many other financial markets, the stock loan market remains an inefficient, antiquated, and opaque over-the-counter (OTC) trading market that is dominated by large dealer banks, principally the defendant investment banks (the Prime Broker Defendants). These banks have structured the market in such a way that they take a large cut of nearly every stock loan trade that is made.
The stock loan market has long been ready to evolve to a modern, efficient market in which stock borrowers and lenders (typically hedge funds and pension funds) could execute stock loan trades on electronic platforms at lower costs and with better returns. But the Prime Broker Defendants conspired to keep stock loan trading frozen in an inefficient and opaque OTC market in order to preserve their privileged position as intermediaries on every trade, the plaintiffs allege. The Prime Broker Defendants preserved this antiquated system by taking collective action to boycott trading platforms which sought to enter the market and which threatened to increase transparency and competition.
Central marketplace. Unlike, for example, the market for stocks themselves, there is no central marketplace for stock loan transactions. Borrowers and lenders must instead transact through intermediaries—the Prime Broker Defendants. The cut taken by the Prime Broker Defendants is massive. In 2016, for example, the Prime Broker Defendants skimmed approximately 60 percent off a pot of some $9.15 billion in total industry revenue. These profits far exceed any benefit or service provided by the Prime Broker Defendants, who take virtually no risk in brokering these transactions, the plaintiffs contend.
The Prime Broker Defendants have long known that, left to evolve naturally, the stock loan market would become more efficient and transparent and eventually move to "all-to-all" electronic trading like most major financial markets have. "All-to-all" electronic trading provides greater price transparency, expands the number and type of potential counterparties, and does not involve a "middleman." Perceiving this threat, the Prime Broker Defendants organized themselves into a working cartel. In 2001, several of them did, together with a handful of other market participants, by forming a company called EquiLend. Having formed EquiLend, the Prime Broker Defendants made it clear to market participants that all new entrants into the market would need to go through EquiLend and they subsequently conspired and took concerted action to boycott and block new trading platforms from access to the stock loan market. The plaintiffs allege that the Prime Broker Defendants also took steps to block offerings that improved price transparency, recognizing that increased transparency would itself present a threat to their inflated profits.
Furthermore, by 2016, the Prime Broker Defendants came under tremendous pressure to begin clearing all of their stock loan trades in light of federal regulatory measures. They recognized, however, that the advent of central clearing would increase the risk of a central electronic marketplace developing.
Project to control. Project Gateway was created through one-on-one discussions at restaurants between senior executives at Morgan Stanley and Goldman Sachs, along with their counterparts at the other Prime Broker Defendants, to take a controlling ownership stake in AQS (an electronic trading platform that would allow borrowers and lenders to transact anonymously in the stock loan market) in late 2016 in order to ensure that they would control all commercially viable paths to central clearing. Absent their joint action as part of Project Gateway, the stock loan market would be much more like the modern, electronic, U.S. stock market, the complaint states.
"Major investment banks are conspiring to preserve their profits at the expense of everyday investors," said Michael B. Eisenkraft, plaintiffs’ attorney and a Partner at Cohen Milstein Sellers & Toll. "Through various improper means, the likes of Goldman Sachs and Morgan Stanley have for years colluded to maintain their power over this little-known-but-lucrative corner of Wall Street. In doing so, they deprive investors of money that should flow to retirees, families and other hard-working Americans."
Julie G. Reiser, plaintiffs’ attorney and Partner at Cohen Milstein Sellers & Toll, noted "This case is potentially of historic importance as it offers a chance to reform an entire area of the financial markets."
The plaintiffs contend that the actions of the defendants amount to a naked, per se violation of the federal antitrust laws and amount to an unreasonable and unlawful restraint of trade that lacks any countervailing procompetitive rationale. The plaintiffs seek treble damages and the award of their reasonable attorney fees and costs.
This is Case No. 1:17-cv-06221.
Attorneys: Michael B. Eisenkraft and Julie G. Reiser (Cohen Milstein Sellers & Toll PLLC) and Daniel L. Brockett (Quinn Emanuel Urquhart & Sullivan LLP) for Iowa Public Employees’ Retirement System.
Companies: Bank of America Corporation; The Goldman Sachs Group, Inc.; Morgan Stanley; Credit Suisse AG; J.P. Morgan Securities, LLC; UBS Group AG; Iowa Public Employees’ Retirement System; Orange County Employees Retirement System; Sonoma County Employees’ Retirement Assn
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