Sunday, October 22, 2006

Share lending deceit

I read an interesting editorial in the weekend edition of the Financial Times on the subject of broker share loans. In, "The story brokers don't want you to read", money manager Arne Alsin describes the process by which stock brokerages take advantage of retail investors and disrupt the shareholder voting process.

Brokers lend investor property to short sellers, often at annual yields in excess of 10 per cent, without notice to investors. After lending investor property, brokers have the gall to keep 100 per cent of the proceeds.

Broker lending of investor property generates $10bn a year for the brokerage industry. Because brokers are reluctant to share this booty, they wilfully and systematically discriminate between investors. They discriminate between those investors who have information and those who don’t have information.

Investors who know when their shares are lent (in other words, institutional investors) demand a piece of the action. And they should. Those investors deserve to be compensated when their property is lent to someone else.

Investors who do not know when their shares are lent (retail investors) are treated differently. Brokers regularly loan out the property of uninformed retail investors and keep all the proceeds. Those property owners cannot demand a piece of the action if they do not know about it in the first place.

To understand how retail investors are being shafted by "hypothecation" agreements and their own ignorance, read on at the link above.

Note: Alsin's "Turnaround Fund" at one time held shares in (OSTK), a company whose CEO famously asserted they had been besieged by a conspiracy involving naked short sellers. As of 9/30/06, OSTK remains as one of the fund's largest individual holdings.

Has this experience colored Alsin's commentary? Let us know what you think, as I'm still trying to fully understand the whole "naked shorts" debate.