I blogged yesterday on the lawsuit filed by the AFTRA Retirement Plan over the loss of millions of dollars invested in a Cayman Islands tax haven through the bank JPMorganChase.
While AFTRA may have a valid concern about the fiduciary duty it was owed by JPMorgan I also pointed out that the AFTRA plan has a fiduciary duty to actors whose precious retirement assets were invested in the Morgan scheme.
The Hollywood Reporter (“THR”) picked up on the story and quoted an anonymous source who defended the decision by the AFTRA fund to invest in what was simply described as a safe “securities lending” vehicle.
But the source apparently did not explain to THR what securities lending is all about.
Here is how the AFTRA deal worked from what I have been able to piece together from public sources. As I learn more about this situation I will try to update it. As you read it, ask yourself, would you risk your grandmother’s retirement assets in such a transaction?
1) AFTRA invests millions of dollars in the stock market. As such, it owns shares in hundreds of publicly traded corporations.
2) Some Wall Street speculators engage in a very risky and controversial practice known as “short sales” – which are in essence bets that the price of companies will go down. To make their bets short sellers borrow other people’s shares in the companies they are targeting and then sell them at the current market price. They then wait and see if the price does indeed go down and if it does they then repurchase shares in the open market at the new lower price and give them back to the original shareholder. They keep the difference between the original higher sales price and the lower new purchase price. In other words, short sellers are happy if the value of public companies falls dramatically.
3) The risk, of course, is that the share price can go higher not lower. If it does the short seller is “squeezed” and must put up additional funds as collateral to the brokerage house that arranged the loan.
4) The short seller also pays a fee to the brokerage house on behalf of the actual owner of the loaned shares. This is the “securities lending” process in which the AFTRA fund was engaged. The fees can add up to millions in such a short selling program.
5) In turn, the lender of the shares, in this case AFTRA, can reinvest the fees and the collateral posted by the short sellers somewhere else. Apparently upon the recommendation of Morgan, AFTRA agreed to reinvest the fees it generated from lending to the speculators in a fund called Sigma that Morgan was closely involved with. In fact, JPMorgan was lending Sigma large sums of money that was well protected by collateral. AFTRA’s money was invested in less well protected medium term notes. This is the transaction at the heart of AFTRA’s suit against JPMorgan. JPMorgan contends that its lending business (which made the loans to Sigma) is separated internally from its asset management business (which advised AFTRA to lend money to Sigma).
6) Sigma in turn invested the money it was receiving from JPMorgan, AFTRA and other lenders into the inflated credit and mortgage markets. While the THR source says the investment was “not particularly risky,” apparently JPMorgan was well aware of the problems building up at structured investment vehicles like Sigma. Ordinarily a fund like Sigma would have been able to secure enough money for its investment plans from the short term commercial paper market. It only issued the medium term notes like those sold to AFTRA by JPMorgan because it was under financial pressure. Sure enough Sigma collapsed and JPMorgan seized its collateral leaving next to nothing for investors in the less well protected medium term notes that were sold to AFTRA.
In sum, AFTRA generated the millions it later lost by lending its securities to speculating short sellers. They then invested the money in an even more speculative off shore tax haven that was under growing financial pressure and they failed to insure that the money invested was backed by adequate collateral. Ironically, AFTRA earned the cash flow to invest in Sigma by helping speculators bet against the success of American companies. But it is now blaming JPMorgan for, in essence, having bet against the success of Sigma!
Those who play with fire sometimes get burned. JPMorgan may be partly to blame but it beggars belief to suggest that this scheme was anything other than risky.