Feds Launch Probe of Stock Loan Abuses

Federal prosecutors have launched a broad probe into price-gouging in the market for borrowed stock, targeting Wall Street firms that allegedly attach gratuitous finder's fees for arranging stock loans.

Among other things, prosecutors are probing allegations that employees of Wall Street trading desks are receiving kickbacks in return for lending stock, say lawyers familiar with the inquiry.

Stock lending has been a hot-button issue on Wall Street for a year, primarily for its role in an ongoing probe of short-selling abuses. But the finder's fee investigation is separate. It centers on a belief among regulators that some firms effectively impose a tax on small brokerages that are under intense pressure to locate and lend shares to hedge funds looking to make bearish bets.

The criminal investigation by federal prosecutors in New York is occurring in conjunction with regulatory investigations by the New York Stock Exchange and the Securities and Exchange Commission. The criminal probe is believed to be in its early stages, and no charges are imminent against any individuals, sources say.

A spokesman for Eastern District of New York U.S. Attorney Roslynn Mauskopf declined to comment. Also not commenting were spokesmen for the SEC and the NYSE.

Officials with Bear Stearns(BSC), Goldman Sachs(GS), Lehman Brothers(LEH), Merrill Lynch(MER) and Morgan Stanley(MS), all of which operate big stock lending desks, either declined to comment or said they were unaware of any criminal investigation.

The alleged improprieties that prosecutors are looking into are similar to ones outlined by the NYSE last week in a regulatory action against Van der Moolen(VDM), a Big Board specialist trading firm. The NYSE, in fining Van der Moolen $3.5 million, charged it with paying "unjustified finders' fees" to 29 friends and family members of its now-defunct stock-lending department.

Big Board regulators charged that the finders, all whom worked at other firms, did nothing to merit the fees they earned. The extra payments only served to "inappropriately" increase the cost of the transaction to the borrower of stock from Van der Moolen. The payments were often embedded in the fees paid by the borrower to the lender.