Goldman Sachs, Morgan Stanley and other investment banks could face new legal claims running into hundreds of millions of dollars, amid allegations that some brokerages overcharged their biggest hedge fund clients.
Some of Wall Street's most prolific "short sellers" are set to mount a class action lawsuit, in a move that casts the shadowy hedge fund industry in the unusual position of victim.
The lawsuit will throw an uncomfortable spotlight on the world of "prime brokerage", the business of executing trades on behalf of hedge funds, which has grown into one of the most lucrative parts of investment banking business.
There are concerns that it could once again attract the attention of state prosecutors and regulators, just as Wall Street firms finish paying almost $4bn (£2.3bn) in fines over the "market timing" mutual funds trading scandal.
The aggressive law firm Milberg Weiss said it had been contacted by a number of hedge funds alleging they had been overcharged or ill-served by their broking firms, and had been gathering information on so-called "naked short-selling". A class action lawsuit could be launched in the next few weeks.
Short selling is a way of profiting from a fall in a company's share price. The practice has made hedge funds notorious, accused of deliberately spreading negative stories to undermine a company.
Steven Schulman, a Milberg Weiss partner, said: "This is not about the evils of short-selling, which is part of an efficient market. We think that the short-sellers themselves are suffering injury. The market may not be operating in the way that participants assume and pay for."
Short sellers sell shares they do not own in the expectation that they can buy them more cheaply in time for delivery to the buyer. Usually, they borrow stock for the period, for security's sake. When this is not done, the practice is called naked short selling.
At issue are claims that brokers failed to borrow stock despite being paid to do so, and that this frequently caused market distortions that leave the hedge funds out of pocket.
Fees from prime brokerage are estimated to total more than $10bn per year, and the business is dominated by Goldman Sachs and Morgan Stanley. Bear Stearns is also a significant player and many other investment banks - notably UBS, Merrill Lynch and Bank of America - have been battling to win market share.
It is not yet clear which particular firms will be targeted by the Milberg Weiss suit, and nor is it clear which hedge funds would initially attach themselves as plaintiffs.Reuse content