Facebook banks under fire after helping bet against float

Anger at Goldman Sachs and JP Morgan loaning shares to hedge funds wanting to short the stock

Simon English
Friday 25 May 2012 22:59 BST
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Anger over what critics see as the botched flotation of Facebook moved to Goldman Sachs and JP Morgan yesterday, after it emerged that the giant Wall Street banks had been aiding hedge funds to bet that the shares would fall.

With shares in the $104bn (£66bn) internet giant way below the float price and investors seething, the revelation that the two most powerful US banks lent shares so that they could be "shorted" again opened up controversy about conflicts of interest on Wall Street.

The issue could increase pressure on regulators and politicians to push for a break-up of the biggest banks, which critics say routinely bet against their own clients.

The banks robustly defend such arguments, pointing out that it is the clients, rather than the banks, that have competing interests.

Morgan Stanley – the lead banker on Facebook's flotation – was already accused of mishandling the process amid accusations that only favoured investors got proper information about the company's growth prospects.

It strongly denies this claim, saying: "Morgan Stanley followed the same procedures for the Facebook offering that it follows for all IPOs (initial public offerings). These procedures are in compliance with all applicable regulations."

It now turns out that both Goldman Sachs and JP Morgan lent stock to hedge funds wanting to short it – that is, sell the shares in the expectation they could buy them back later at a cheaper price – making a profit in the process.

The banks earn a fee from the hedge funds for the loan of the shares. To banking insiders this is regarded as entirely normal, but it adds to the growing feeling that Wall Street operates in ways that hurt ordinary investors.

There have been calls for the US regulator, the Securities & Exchange Commission, to rewrite the rules on IPOs.

Morgan Stanley has faced particular criticism since the plunge in Facebook's share price. It is able to intervene and support the shares as part of the normal IPO process but seems to have faced such a wave of selling that its attempts failed.

It has a policy of not lending stock to hedge funds if it is the lead bank on a flotation.

None of the banks involved were willing to comment on the controversy, citing client confidentiality rules.

But defenders of Wall Street say shorting shares is entirely normal and that it is simply not possible to arrange the flotation of anything if investors are only allowed to buy.

Said one analyst: "If you don't have a long and a short, you don't have a market. Are you suggesting it should only be possible to buy a house, but not sell it?"

Another observer said: "They are banks. If someone wants to buy or sell something, they allow them to do it. Why is a hedge fund selling a stock short, different from someone buying a share in the IPO and then selling it?"

Defenders of the banks say they are just the middle men.

"They are hired by Facebook, but they have other clients too," one banker said.

Daylian Cain, a Yale School of Management professor of business ethics at Yale School of Management told the Wall Street Journal: "Wall Street has conflicts of interest and conflicts of interest are profitable."

Facebook shares opened at $38 last Friday. They had fallen to $33.03 by close of play on Thursday.

Yesterday they were down $1.12 at $31.91 in late afternoon trade.

Analysts note that Facebook floated in the midst of extreme market turmoil given events in Greece and elsewhere and that this could be the biggest reason for the fall in the shares.

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