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
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.
The defense attacked the action on several fronts, asserting in filings and during the hearing that federal law pre-empted the action; that the plaintiffs could not prove any actual harm; that the majority of the plaintiffs lived outside of Georgia and could not sue in a Georgia court; and that -- regardless of their other points -- the financial giants were not liable of any wrongdoing.
SELLING SHORT
The practice of short-selling involves selling stock one does not own and, as detailed in court filings and during Tuesday's hearing, the practice is itself a long-standing and perfectly legal activity. A buyer who thinks a stock will lose value borrows some of that stock from a willing lender, sells it on the open market at the current price and then buys replacement shares and returns it to the lender.
If the stock price has fallen, then the short-seller makes money on the transaction because he sold the borrowed stock for more than he paid for the replacement. If the price remains stable or rises, the short-seller loses money by having to pay more for the replacement than he received for selling the borrowed stock.
In both cases, the short-seller is on the hook for any fees and commissions related to the sale and interest charged by the share lender.
In transactions like those cited in the TASER case, the short-sellers are generally hedge funds that borrow the shares either from their prime brokers -- the defendant companies -- or from a central clearinghouse established to hold and oversee such loans, the Depository Trust & Clearing Corp. (DTCC).
Under Securities and Exchange Commission rules, the seller of stock generally has three days to deliver the shares to a purchaser, or "settle," although in these days of computer transactions, no actual paper shares are transferred; rather, an electronic confirmation of the sale is sent to the purchaser.
Naked short sales, according to the SEC's Web site, are those in which "the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period. As a result, the seller fails to deliver securities to the buyer when delivery is due (known as a 'failure to deliver' or 'fail')."
According to the suit, the defendant companies routinely failed to locate, borrow and deliver the TASER stocks to the DTCC for transmission to the buyer, but the DTCC nonetheless credited the buyer with the purchase.
"If the short seller fails to deliver the stock it owes to the DTCC," says the complaint, "the short seller has, in effect, created and conveyed a new, counterfeit share of stock to the buyer. That is, the DTCC credits the buyer with owning shares that did not previously exist. The newly created shares are counterfeit shares because they were not authorized or issued by the company or registered by the company ... . Rather, they were created electronically by the short seller through an illegal short sale of a stock that the short seller did not own, deliver and/or intend on possessing for the settlement of the short sale."
Contrary to the initial complaint, which bluntly says naked short-selling is illegal, the SEC does not say all such sales are improper.
"Indeed," says its Web site, "in certain circumstances, naked short selling contributes to market liquidity. For example, broker-dealers that make a market in a security generally stand ready to buy and sell the security on a regular and continuous basis at a publicly quoted price, even when there are no other buyers or sellers. Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market."
But the agency adds that intentionally engaging in naked short sales to manipulate or drive down a stock's value is illegal.
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.
DEFENSE: CLAIMS ARE TOO VAGUE
The lack of any detail of actual harm suffered by the plaintiffs was one of many points attorneys for the financial companies pounced on Tuesday. That team included Wise; Rogers & Hardin partner Richard H. Sinkfield; and Gregory A. Markel of New York's Cadwalader, Wickersham & Taft, closely watched by a contingent of their legal brethren and support staff from behind the rail.
Wise argued that the case should be dismissed because the conduct at issue is permitted under SEC regulations and that any state claims were subordinate to those rules.
"If there is an actual conflict between state and federal law," he said, "federal law pre-empts" any challenge.
The plaintiffs "do not allege a single trade or transaction" to show fraud, manipulation or other abusive short-selling. "Instead," said Wise, "they rely on generalities ... it's all very unspecific, it's all very vague."
At "key periods" when shorted shares have been sold but not located or borrowed by the defendant companies, he said, there may indeed appear to be more shares than actually exist. But the discrepancy is resolved through the settlement process, even if it takes longer than the three days recommended by the SEC, and "the buyer receives what they're supposed to," he said.
"There is nothing 'counterfeit' about this," said Wise. "This is an attack on the system, not on a particular trade."
Rosenwasser responded, "This is not an attack of the system, or on short-selling or the SEC rules."
"It is about breaking those rules," and "engaging in an illegal transaction to manipulate the stock," he added.
"A lawful short sale involves actually finding stock to borrow," said Rosenwasser. But in the "abusive short sales" alleged in the suit, "the prime broker has no intention of locating the shares or borrowing them."
As to pre-emption, federal law explicitly allows states to enact their own securities regulations, he said; the FEC rules are in accord with Georgia's.
"There is no conflict," said Rosenwasser.
After haggling at length over the techniques and intricacies of naked short-selling, complete with flow charts, graphs and PowerPoint presentations, the attorneys wrangled over jurisdiction, with Sinkfield arguing that the Superior Court, not Porter's State Court, should be the venue for such a case, and Markel demanding to know why none of the plaintiffs had disclosed how much he or she had actually lost through the alleged scheme.
"It must be the case that they have to show damages," he said.
Floyd responded that his clients would be happy to provide that information at the proper time.
"The answer," he said, "is do discovery."
As the clock neared 5:30 p.m., the final salvos were exchanged, and Porter -- who had listened patiently, with few comments -- finally weighed in. Noting the "army of trees" already slaughtered for the copious filings she had reviewed, the judge urged the lawyers to keep in mind that she had but one staff attorney and to refrain from unduly complicating a case that, while complex, was not as intractable as their presentations seemed to indicate.
"All I'm saying is, be reasonable," said Porter. "It's not the easiest case to decide, but it's not nearly as complicated as it's been made out to be."
The suit had been filed almost a year earlier, she noted, and "it needs to be moved."
"This case is going to sit on the corner of Patsy Porter's desk," she said. "That means it's always on my mind."
The case is TASER International v. Morgan Stanley, No. 2008-EV-004739-B.
Nessun commento:
Posta un commento