Friday, December 21, 2007

An Intriguing Lawsuit Dismissed

I've always been a bit intrigued by the lawsuit that was filed against Wall Street brokerages last year by Electronic Trading Group LLC. This suit was dismissed yesterday, which is a shame.

Unlike most of the suits that have been filed in the general realm of naked short selling -- mostly by companies seeking to shift blame for their own failures -- this suit alleged behavior that was actually quite plausible. ETG claimed, in essence, that it engaged in trading that it thought was ordinary shorting, but that the firms actually didn't borrow the stocks--but charged borrowing-related fees anyway. It also said that the firms conspired to fix the rates they could charge short sellers for borrowing stock.

That's a far cry from the nutty conspiracy theories and "stock counterfeiting" nonsense that is usually alleged in naked shorting suits, such as the junk lawsuit filed by Overstock.com's telegenic CEO Patrick Byrne (left).

The ETG suit says that the big firms were engaged in a bit of back-office chicanery, and that happens to be an area that has been troublesome for years. At their worst, some prime brokers gave financial backing to some of the cruddiest penny stock firms of the 1990s, a phenomenon that was never fully dealt with by law enforcement and Arthur Levitt's SEC. (Note the piddling fine imposed on Bear Stearns in this very serious case.)

The judge's reasoning was also a bit weird:

"The threat of a 'nonexpert jury' mistaking lawful conduct under the securities laws as evidence of a conspiracy under the antitrust laws and exacerbated by the prospect of trebled damages, would place immense pressure on defendants to curtail the open exchange of information," the judge said. "Such antitrust suits would likely chill a broad range of activities that the securities laws permit and encourage, and would likely inhibit the short selling activity that provides market liquidity and pricing efficiency."
I think that's a pretty strange reason for not letting the case go forward. Prime brokers are notoriously underrregulated by the SEC, and this kind of litigation is necessary to let the truth come out. Juries aren't that dumb. I think they can tell the difference between baloney and the real thing, even if some CEOs can't make that distinction.

© 2007 Gary Weiss. All rights reserved.

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Wall Street Versus America was published by Penguin USA on April 6.
Click here for its Amazon.com listing and here for more information on the book, from my web site, gary-weiss.com.

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