October 9, 2009
One of the major problems in the securities lending business is that of mutual fund companies lending their investors' shares to shorts. This practice needs to be completely reformed or ended.
Large mutual fund companies lend their investors' shares to short-sellers and directly contravene their investors' primary goal: price appreciation, by lending their shares to short-sellers whose goal is to have the stocks' prices decline. This practice is inane.
Mutual Fund companies are able to make a few extra basis points, which help to boost their returns and allow them to beat various market indices by which, their performance is measured. Furthermore, many of these mutual fund companies do not share their security lending proceeds with their investors instead, they retain those profits at the management company level. Worse, many invest the cash collateral in their own money market funds in order to generate even more fee income from their investors' monies.
There was a great article on this subject, "Is Your Fund Pawning Shares at Your Expense" (WSJ, 5/30/09, Zweig) that pointed out all of the obvious flaws with this practice.
This practice also hurts individual investors, as they rarely have any control over stocks held in a margin account with their broker, and their broker, per the margin agreement, is free to lend their shares and keep any associated income.
We have proposed a market-based solution to the aforementioned problems and to many of the other problems associated with short-selling that were mentioned during the two-day roundtable dicussion.
Thank you for your consideration.