Inside the $499 million lawsuit settlement exposing 'opaque' world of securities lending

Some of America's billion-dollar pension funds have agreed to a proposed settlement in a lawsuit against Wall Street banks, in a long-running case that cracked open the hidden world of securities lending.

In securities lending, pension funds and retirement plans lend out their portfolio shares to hedge funds and other investors, using Wall Street brokers that charge a fee. By some estimates, stock lending totals $1.75 trillion in market value.

But the business was so tightly controlled that it effectively functioned as a cartel, according to the pension funds' class-action lawsuit. Their partial settlement was filed in court Aug. 23.

The secrecy behind securities lending may be changing: the group of pension funds led by the $40.1 billion Iowa Public Employees' Retirement System, Des Moines, reached a $499 million partial settlement in the antitrust lawsuit alleging that Morgan Stanley, Goldman Sachs, UBS, J.P. Morgan Chase & Co., Credit Suisse, and Bank of America ran a price-fixing scheme using their own joint venture called EquiLend.

In effect, the banks hurt pension funds by keeping fees paid artificially low. That prevented asset owners from earning more revenues when they lent out stock, according to the complaint filed in the U.S. District Court in Southern District of New York.

Other pension funds that are lead members of the class-action suit include the $73.6 billion Los Angeles County Employees Retirement Association, Pasadena, Calif.; the $21 billion Orange County Employees Retirement System, Santa Ana, Calif.; and the $3.4 billion Sonoma County Employees' Retirement Association, Santa Rosa, Calif.

The proposed agreement could end up benefiting many investors far beyond the pension fund world.

"This is a class settlement, so it should achieve results for everyone. Every single borrower and lender of stock is affected," said Michael Eisenkraft, a New York-based partner with Cohen Milstein Sellers & Toll, which represented the plaintiffs.

As part of the settlement agreement, EquiLend agreed to undertake reforms over the next five years, among them: limiting the number of board seats held by each bank, appointing and rotating outside antitrust counsel, and creating an "Antitrust Code of Conduct" designed to "prevent collusion and inappropriate sharing of information."

Shawna Lode, spokeswoman for the Iowa pension fund, said in an email, "IPERS is unable to comment on ongoing litigation." The other pension funds also declined to comment.

The banks, for their part, denied any and all wrongdoing and, according to the Aug. 23 settlement filing, "maintain that their conduct was at all times proper and in compliance with all applicable provisions of law."

They also deny "each and all of the claims and contentions of wrongful conduct," as described in the complaint, and said they are settling the case to avoid further risk and litigation costs. Credit Suisse had already settled, and litigation against Bank of America continues.

Little is known about EquiLend, except that the banks' joint venture went live in 2002 as a way for them to act as middlemen for securities lending. At the time, stock trading was revolutionized by the internet and online firms such as TD Ameritrade, Charles Schwab and E-Trade.

But securities lending never was: EquiLend stood in the way, according to the pension funds' lawsuit.

EquiLend quashed startup competitors by either buying or outright shuttering them.

Two startup companies – AQS and SL-x – were victims of the cartel, according to the complaint.

First, the banks agreed to a "boycott:" Bank of New York began using AQS for stock loans, until Goldman Sachs threatened to never do business with the bank again; Bank of New York promptly abandoned its plan, the complaint alleged. The banks also warned hedge funds including SAC Capital, Renaissance Technologies, D.E. Shaw Group and others not to connect to AQS, according to the complaint.

When SL-x met with two Goldman executives to introduce its product, Brad Levy, then global head of Goldman's Principal Strategic Investments Group, said: "You ain't going to get this done," the complaint said.

In the end, EquiLend purchased AQS in the U.S. and SL-x in Europe and then mothballed both businesses in the 2010s.

EquiLend was a "vehicle for their conspiracy" to keep the stock lending market "inefficient, antiquated, and opaque," the pension funds alleged. By keeping the market shrouded in secrecy, banks took a huge cut of the revenues — amounting to approximately $9 billion annually.

In 2016, for example, the banks named in the lawsuit collected 65% of that.

EquiLend was launched not to provide transparent pricing, but as a "convenient excuse for meeting and coordinating their conduct in the stock loan market," according to the complaint.

After EquiLend purchased SL-x, the startup filed its own suit in 2018 alleging EquiLend forced the company out of the stock lending market.

SL-x was warned by a Credit Suisse executive that "EquiLend was like 'the mafia run by five crime families,'" said the pension funds' complaint. SL-x's case was dismissed by the court.

Through EquiLend, which the banks "effectively controlled" via board seats, according to lawyers for the plaintiffs, a modern and transparent system of stock lending never materialized.

"Each fell victim to a cartel" that "conspired to boycott these companies, shut them down, and eliminate them as threats," the complaint said.

As part of the settlement, EquiLend and the banks agreed to reforms.

"Better transparency will really work to the benefit of the owners of the shares. The people who want to lend their shares out will be able to get better prices," said James Angel, professor at Georgetown University, and academic director of the FINRA Certified Regulatory and Compliance Professional Program.

"Of course this also means trouble for the intermediaries who profit off the inefficiencies in the market. And that's one of the reasons why they've been fighting transparency as long as they have. We saw this in the NASDAQ marketplace in the '90s. We've seen it in the bond market for the last 20 years," he said.

In the case of securities lending, he added, "obviously they don't want a level playing field."

For the pension funds, however, the outcome of $499 million in damages and reforms was a long-awaited victory, their attorneys said. The settlement must still be approved by the court, and comes a year after another defendant, Credit Suisse, agreed to an $81 million settlement, bringing the total monetary recovery to $580 million.

Reforms mandated as part of the settlement may bring the first bit of transparency to stock lending.

Yet, data about the current value of the stock lending market remain extremely hard to come by: Many of the case documents that contain information about the financial aspects, including expert witness reports, have been placed under seal by the judge in the case.

Regulators also are closely watching the stock lending business.

The Securities and Exchange Commission in 2021 proposed Exchange Act Rule 10c-1, which would require lenders of securities to provide terms of their transactions to regulators. Anyone that loans stocks, including pension funds and banks, would be subject to the new rule.

"When there's more price transparency, we're gonna see a whole lot less of a dispersion in the prices actually charged" for lending securities, Mr. Angel said. "So if somebody wants to lend some shares, and they see that their prime broker is charging the 20%, and they can go tap, tap, tap and see what other people are charging 4%, they're going to go to their prime broker and use all their most popular four-letter words."

The case is Iowa Public Employees Retirement System et al. vs. Bank of America Corp. et al, Case No. 1:17-cv-06221, U.S. District Court, Southern District of New York. The case documents and settlement agreement are available online on the law firm's website.

Arleen Jacobius and Rob Kozlowski contributed to this story.