Two law firms, Cohen Milstein Sellers & Toll and Quinn Emanuel Urquhart & Sullivan, filed suit in the Southern District Court of New York in August alleging collusion among six of the world’s largest investment banks to prevent modernisation of the securities lending market. Plaintiffs, including the Iowa Public Employees' Retirement System (IPERS), the Orange County Employees Retirement System and the Sonoma County Employees' Retirement Association, allege that Bank of America, Credit Suisse, Goldman Sachs, JP Morgan, Morgan Stanley and UBS conspired to overcharge investors and maintain the power they hold over the industry, obstructing multiple efforts to create competitive electronic exchanges that would benefit both stock lenders and borrowers.

The suit alleges that, in order to protect their profits, these large investment banks have been conspiring since at least 2009 through EquiLend, which they control, to prevent participants from accessing marketplaces where they could benefit from direct, all-to-all trading and thereby secure themselves the best prices. Specifically, the plaintiffs allege that the banks named as defendants routinely took steps together to block the development of competitive exchange platforms like AQS in the United States (now owned by EquiLend and named EquiLend Clearing Services) and SL-x in Europe.

A significant amount of insider information (valid or not) is referenced in the filing, and many notable industry participants are specifically named. EquiLend and the six defendant banks have so far declined to comment.  A spokesperson for IPERS said the following: “IPERS is proud of its role in leading this lawsuit and its efforts to get compensation for investors damaged by the lack of competition and transparency in the stock lending market.”

Ken Bertsch, executive director of the Council of Institutional Investors (CII), says many of CII’s, members, which include two of the plaintiffs, engage in stock lending. “The efficient operation of that market is important for plan returns and therefore to plan beneficiaries.  Efficient central clearing mechanisms in this and other areas are of critical importance.  IPERS and the other plaintiffs clearly took this action because they are concerned that stock lending markets have not evolved to reflect efficiency and transparency that can be afforded by modern technology."

Global Investor understands that multiple agent lenders are getting calls from clients for their perspectives on the lawsuit. Hedge funds are also looking at joining the class action. Defendants specifically named in the filing will, no doubt, each have prepared ‘talking points’ to respond to inquiries. To some extent it’s a case of unstoppable forces (pension funds) vs immovable objects (prime brokers). Plaintiffs will try to prove collusion and harm to savers while the defendants will highlight the standardization and efficiencies created by EquiLend for the benefit of lenders and borrowers alike.

“Say what you want about the major prime brokers, without their actions there wouldn’t much in the way of automated mechanisms for beneficial owner stock to match up with demand,” a New York-based securities finance executive, who wished to remain anonymous, told Global Investor. “EquiLend has automated the entire general collateral (GC) flow - that benefits asset owners. I would say, however, that a lower-tier prime broker is at a significant disadvantage. Realistically, they have to join EquiLend and conform if they wished to be successful. That costs money and you’re still a long way down the pecking order. Goldman and Morgan drive the bus, which is really not the way an efficient market should work. There are various markets where big players dictate terms such pricing and coverage but the extent to which this is done in the securities lending market is grotesque.”

Josh Galper, managing principle at securities finance consultancy Finadium, says that at several points, the lawsuit presents a vision of the securities lending market without bank credit intermediation. "However, unless beneficial owner credit departments decide that lending via CCPs or hedge funds without a CCP is acceptable, and this is all operationally and legally plausible, then the transparent, all to all markets envisioned in the lawsuit could not come to pass. We estimate that not more than 15% of today’s beneficial owner volume would continue to participate in the securities lending market without prime broker credit intermediation.”

Virginie O'Shea, research director, Aite Group, says the lawsuit highlights the vested interests in the securities financing space that have long been bemoaned by pension funds and asset managers alike.  “It is a brave move on the part of the buy-side and could potentially result in some regulatory actions to compel clearing activity and increased transparency in the US – perhaps in the same vein as Europe’s Securities Finance Transactions Regulation (SFTR).” Given the global regulatory push to tackle antitrust activities post-crisis, O’Shea assumes this case will garner some attention, but how much direct action is taken in the current environment is tough to say. “The current US administration’s focus on deregulation might impact the overall direction taken. I’d also say that lawsuit could be an opening for fintechs to seek regulatory approval to tackle the inefficiencies in securities lending highlighted by the buy-side.”

Ed Blount, executive director at the Center for the Study of Financial Market Evolution in Washington DC has testified as an expert in more than a dozen cases involving securities finance matters. He reckons it is a case with the potential to reshape the securities finance marketplace. "This is not the first challenge to the conventional fee structure, nor is it the first putative class action,” he says. “However, it is the first I have seen to rely on the antitrust statutes and the first to target the borrowers as a group. No doubt, attorneys for the defendants will move for summary dismissal in the next few weeks. If that motion fails, the defense will present arguments to prevent certification of the class." If the case survives summary judgement and the class does get certified, Blount suggests that it could still be years before attorneys for the borrowers get a chance to argue the case on its merits.

“Similar cases have been settled after the judge's decision on class certification, but this is an attack on one of the industry's revenue bedrocks so it may well end up in court,” he adds. “But it will be years before that happens, if ever." The discovery process alone, where the plaintiffs demand copies of emails, reports, and other internal documents, then take depositions from fact witnesses and experts, will produce a mountain of evidence that consultants for both sides will organise to support legal theories pro and con. “The original complaint may well be revised as plaintiffs learn more about the inner workings of the prime brokers and agent banks,” Blount adds. “Of course, defense counsel will object at every stage of the interrogatory process. At this point, only one thing is certain: this case will be followed very closely by professionals in every segment of the securities finance markets.”