17 November 2008

Goldman Sachs Target of Naked Short-Selling and Price Manipulation Complaints in High Yield Loan Markets

The charge is that as an agent bank Goldman Sachs has access to private information that gives it an advantage in the opaque market of high risk debt, and they have been using that information to target certain portions of the market with naked short selling to drive down prices and reap large profits for themselves at the expense of their clients and other market participants.

This is the template for potential market fraud that we described previously on several occasions. The banks have privileged information and access to funds that precludes a level playing field with other market participants. The uneven enforcement of the rules by the SEC and CFTC and lack of transparency in other markets is another significant factor.

We should note that the fails in this end of the markets are relative small change when compared to the fails in the Treasuries markets as we have previously shown, overseen by the Fed.

Now that Goldman is trading with public funds from the Treasury granted without oversight or restrictions by their former chairman the situation becomes even more outrageous, almost incredible.

Perhaps there is no explicitly legal wrong-doing. And we are only using this allegation against Goldman Sachs as an example. But even a simple top down examination of the market structures shows the weakness of our regulatory process, and the failure of crony capitalism and laissez-faire self-regulation to create markets that are transparent and worthy of trust and confidence for all participants. They more closely resemble dishonest poker games.

Until the financial system is reformed there can be no sustainable recovery.

Bring back Glass-Steagall and honest, responsive, and transparent regulation of the markets.

Goldman Targeted by Investor Complaints of Naked Short-Selling
By Pierre Paulden and Caroline Salas

Nov. 17 (Bloomberg) -- Investors in the $591 billion high- yield, high-risk loan market are accusing Goldman Sachs Group Inc. of naked short selling to profit from record price declines.

At least two fund managers complained verbally to officials of the Loan Syndications and Trading Association, saying they believe Goldman helped drive down prices by using the technique, according to people with knowledge of the objections. New York- based Goldman is acting against its clients by trying to profit at their expense, the investors said.

A $171 billion drop in the value of the loans in the past year is pitting banks against investing clients on assets once considered so safe they typically traded at par. The drop exposed flaws in an unregulated market where trades can take from several days to months to settle and banks may have information unavailable to investors. In a naked-short transaction, a firm would sell debt it didn’t already own, betting the price will fall before it purchases the loan and delivers it to the buyer.

“The LSTA is closely monitoring issues of naked short selling,” Alicia Sansone, head of communications, marketing and education at the New York-based industry association, said in an e-mail.

The group, comprising banks and money management firms that trade the debt, plans to tighten rules to ensure transactions are settled more quickly and prices reported accurately, Sansone said. She wouldn’t elaborate or discuss the claims against Goldman....

Most Aggressive

The bank was seen as the most aggressive in recent months in selling loans at prices below other dealers’ offers and taking longer than the LSTA’s recommended seven days to settle the deals, according to the investors complaining to the trade group.

There’s no rule preventing naked short selling of loans. The U.S. Securities and Exchange Commission this year banned the practice for 19 stocks including Lehman Brothers Holdings Inc. and Fannie Mae and Freddie Mac from July 21 to Aug. 12 as share prices plunged. New York-based Lehman, once the fourth-biggest securities firm, eventually went bankrupt and Fannie and Freddie, the two largest mortgage-finance providers, were brought under government conservatorship. (Excuse us but isn't naked short selling of stocks illegal in the US? The SEC just does not enforce the law and the list of 19 was just a declaration of vigilant enforcement for a select group of 'special companies.' - Jesse)/em>

The slump in loan prices during the global seizure in credit markets is causing particular disruption in the loan market because the debt typically trades close to 100 cents on the dollar. Prices never were below 90 cents until February this year. By October they had fallen to a record low of 71 cents, according to data compiled by Standard & Poor’s. The decline, which S&P said equated to losses of about $171 billion, helped drive the complaints from fund managers.


“Investors are shell-shocked” by the decline, said Christopher Garman, chief executive officer of debt-research firm Garman Research LLC in Orinda, California. “In many ways they’re all but wiped out.”

Because prices were so stable, short sales of loans were unheard of until now, Elliot Ganz, general counsel of the LSTA, said at the group’s annual conference in New York last month.

“No one ever shorted loans,” Ganz said. “Prices never went down.”

High-yield, or leveraged, loans are given to companies with below-investment grade ratings, or less than Baa3 at Moody’s Investors Service and under BBB- at S&P. Banks typically form a group to arrange the financing. They then find other investors to take pieces of the debt, helping spread the risk.

Those loan parts can trade through private negotiations between banks and hedge funds or mutual funds. One of the lenders involved in the initial deal remains the so-called agent bank, which keeps track of who owns what piece. Unlike bonds and stocks, the debt doesn’t trade on an exchange and has no central clearinghouse.

Agent Banks

When a loan changes hands, the agent bank must sign off on the transaction, meaning it knows exactly who is buying and who is selling. The rest of the market is in the dark. Getting an agent to sign off, also can delay settlement.

An agent will have a bird’s-eye view of who owns what and when,” said John Jay, a senior analyst at Aite Group LLC, a research firm that specializes in technology and regulatory issues in Boston. “They have information that no one else has....”

Three Days

In the bond market, the standard settlement time is three days following the trade. In a bond short sale, a trader acquires debt by borrowing the security in a deal known as a repurchase contract. The two sides specify how long the bond will be borrowed with the right to renew the pact. Because loans can’t be borrowed through such agreements, any short seller would have to go naked.

While the LSTA doesn’t track the amount of loans currently unsettled, at least 700 trades made by Lehman Brothers Holdings Inc. before it filed for bankruptcy hadn’t cleared, Ganz told last month’s conference....