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The FBI is going after corruption in a little-known part of Wall Street. It's a place where investors borrow and lend stocks instead of buying and selling them. So far, the bureau has arrested or indicted two dozen people for taking part in a scheme to win millions of dollars in kickbacks. Stock lending has exploded over the past decade with the growth of hedge funds.
AS NPR's Dina Temple-Raston reports, it's still a business that relies on personal relationships and family connections.
DINA TEMPLE-RASTON: Stock lending is a back office operation, part of Wall Street's vast plumbing system. Absolutely necessary but little known. It's run by a relatively small group of people whose only job is to locate stocks needed to cover short sales. Investors sometimes short stocks when they believe the price of that stock is going to go down. Of course if the price goes up, they loose. But that's another story.
Now, in order to carry out a short sale, the investor has to acquire some of the stock. And that's where the stock lenders come in. John Tabacco is CEO of Matador, a new electronic stock lending company. He describes a typical stock lender's morning.
Mr. JOHN TABACCO (LocateStock.com): When a securities lending department comes into work today, they get a list of stocks that they need to borrow.
TEMPLE-RASTON: Then they pick up the phone. Sometimes it's easy to borrow a stock. A friend at another brokerage house will offer to lend it for a small fee. Sometimes with hard-to-get or popular stocks, it isn't so easy. When that happens, stock lending departments will often hire a finder.
Mr. TABACCO: A finder really goes out and find securities, maybe in unlikely places, maybe from accounts that a particular broker or dealer doesn't the relationship with. As we've seen, the flow of brokers and the market timing, they're always bad actors who go out there and try to find some way to gain the system.
TEMPLE-RASTON: A three-year FBI investigation uncovered a number of investments firms who are hiring finders as middle men, but they weren't really finding stocks at all. Instead, they were friends or relatives just picking up the fees and providing kickbacks. Miklos Kallo was the managing director of a major Wall Street firm in charge of their stock lending operations. He felt the latest crackdown coming years ago.
Mr. MIKLOS KALLO (Managing Director, Berkeley International): It was clear in the middle to late '90s that many of these middle men were not adding any value and were in fact, apparently, set up to really just either make profits for themselves or be engaged in the business in a way that didn't add any obvious economic value.
TENPLE-RASTON: Stock lending is a little market all to itself, and it's very different from the big market it serves. On the stock exchange, it's easy to know what you should pay for a stock. The price is right there. That's not the case with this other market where people are borrowing and lending stock. That's part of the reason Tabacco says the stock lending business is a family affair. Lenders all seem to know each other or are related to each other or grew up in the same neighborhoods. Tabacco says that's been good for business.
Mr. TABACCO: And it made sense that you would want to deal with someone because everything was done over the phone and verbally, you would want to do a deal with someone who you had trust, who you believed in, who you could believe when they hung up the phone, they were going to really deliver shares.
TEMPLE-RASTON: Greg DePetris is the founder of Qaudriserv, another securities lending business. To him, the surprising thing is how long it has taken the FBI to discover the abuse. Still, he says, not everybody in the business is corrupt.
Mr. GREG DePETRIS (Founder, Quadriserv): Ninety-five plus percent of them are all really good guys doing a good job and making a living. The five percent of guys who aren't, they're really doing some bad stuff. And, you know, when - I think unfortunately for the industry, the only time you've ever heard of securities lending, you know, before this was never, you know? And now, there's just a bunch of people getting hold off in handcuffs.
TEMPLE-RASTON: So far, Morgan Stanley, JPMorgan Chase, and Jenny Montgomery Scott have been the highest profile Wall Street firms to be caught up in the scandal. Eighteen people have pleaded guilty and seven additional people are under indictment. The FBI says this is just the beginning. More arrests are in the works.
Dina Temple-Raston, NPR News, New York. Transcript provided by NPR, Copyright NPR.
