ADAM KLASFELD, 06 May 2016
Merrill Lynch and other brokerage firms must face a state court case that says illegal naked short sales cost investors more than $800 million, the U.S. Supreme Court ruled Monday. The shareholders brought their case four years ago in New Jersey over the Fortune 500 memorabilia company Spectrum Group International, then known as Escala Group. One of the investors, Greg Manning, said “naked short selling” sent his more than 2 million Escala shares into a nosedive. In typical short sales, investors speculate that the price of a stock will decline and purchase securities that they do not currently own in order to profit from the fall. Securities laws and regulations mandate that a short seller borrow the stock it sold and deliver it within four days of sale.
A so-called “naked” short sale is illegal because it disregards such regulations. “If the short seller never borrows or otherwise obtains the stock it sold short, the short seller cannot convey or deliver authorized or legitimate stock to the purchase,” the investors’ original complaint states. In addition to Merrill Lynch, Manning’s lawsuit took aim at Pierce, Fenner & Smith, UBS Securities and E-Trade Capital Markets. It said the brokerages’ use of this practice — in May and December 2006 — diluted and artificially depressed the shares’ value so that the defendants could repurchase them for cheap, return them to the lender, and profit on the difference. Since its filing, the case has languished over jurisdictional issues. Merrill Lynch and the other companies removed the case to federal court on the basis of the federal securities laws in play.