The nearly $3 million FINRA award to a Merrill Lynch subsidiary and two other major broker-dealers highlights the risks, speculative and tricky strategies that advisors and investors face when shorting a company’s stock.
The Arbitration Board of financial industry regulators attacked ODS Capital, a Jupiter, Fla., hedge fund on March 24. Over $2.8 million in damages and fees Claims filed by hedge funds against Merrill Lynch Professional Clearing, Bank of New York Mellon’s Pershing Securities subsidiary, and Celadon Financial Group.
According to a summary of the lawsuit, ODS Capital alleges that the brokerage firm breached fiduciary duty, breached contract and committed fraud when it withdrew funds from hedge fund accounts in response to a short sale of shares of agricultural giant Dole. claimed to have committed Previously, ODS Capital filed a similar allegation against Merrill Lynch Professional Clearing, the securities arm of Merrill Lynch, regarding short sales transactions conducted by Lions Gate Entertainment and investment firm Calamos Asset Management.
Shorting is betting that the stock price will fall.
Here’s how it works: An investor borrows a security from a brokerage firm that they think will fall in price and sells it. The goal is to buy back the same shares later at a lower price than you sold them, and pocket the difference after paying back the brokerage firm for the shares you borrowed. If things go pear-shaped and the stock goes up in value, the borrower will see a loss.
Douglas Schultz, president of Invest Securities Consulting and a longtime FINRA arbitrator, said shorting stocks is always a risky proposition. This is especially true if the company you are betting on is about to merge or go private.
Schultz said anyone taking a short position during such a time could suffer big losses, as this type of trading usually drives up stock prices.
“In the event of a merger or acquisition, there is technically no limit to how the share price can go up,” he said. “If it’s $20 today, it could go up to $50. If you’re short, you’ve lost more than double your investment.”
At some point before Dole went private in 2013 — the exact date was not disclosed in the FINRA decision — ODS Capital took a short position in Dole for an amount also unreported by FINRA. I approached Celadon to do so. Celadon, on the other hand, used both Merrill and Pershing to “settle” these trades. In other words, we handled the behind-the-scenes work required for such a deal.
Short positions blew up in ODS Capital’s face when Dole’s privatization boosted the company’s share price. Subsequent lawsuits surrounding that transaction required the hedge fund to settle due to shareholders. ODS tried to claim that he was unfairly forced to pay FINRA.
Of the approximately $3 million in fees owed by ODS Capital, Merrill Lynch Professional Clearing will receive approximately $1.8 million. Pershing and Celadon will receive $892,512 and $75,385, respectively, in attorney fees. The hedge fund will also have to pay more than $28,500 to cover the costs of the FINRA Arbitration Board hearings.
A FINRA panel, a self-regulatory body for the broker-dealer industry, rejected the hedge fund’s claims and did not give reasons why it ordered it to pay a hefty fine.
FINRA arbitrations often lack a formal explanation. Attempts to contact her ODS Capital in Tampa, Florida and her attorney in her FINRA case, Jo Ann Palchak, were unsuccessful.
A person familiar with the case, who asked not to be identified because he wasn’t authorized to speak for the record, said it stemmed from a $1.6 billion deal that Doll Food struck to take it private in 2013. , ODS Capital took a short position in Dole through Morristown, New Jersey-based introducing broker Celadon Financial Group. The short sale was settled through subsidiaries of Pershing and Merrill Lynch, brokers that perform the behind-the-scenes work necessary for such transactions.
The short position in ODS came into question as a class action lawsuit was filed over Dole’s privatization deal. In 2015, the Delaware Enclave and the Delaware state court later found that Dole’s former CEO David Murdoch and former president and chief attorney Michael Carter failed to provide anticipated costs and ordered them to pay. rice field. $189.8 million in a pair of settlements with shareholders.
ODS Capital had not liquidated its short position in Dole when the privatization deal was finalized, according to a person familiar with the matter. As such, ODS Capital was financially responsible for paying the brokerage firm a class action settlement for each share it sold short.
Sources said that ODS Capital denied any obligation to do so when filing its request for arbitration.ODS Capital made similar arguments in its dispute with Merrill Lynch Professional Clearing over a merger transaction involving Lions Gate Entertainment and Calamos Asset Management, sources said. pay $92.5 million to settle charges Entertainment company Starz alleged that when it bought the cable television network for $4.4 billion, it unfairly paid some of the company’s shareholders a lower premium for their shares. Calamos Asset Management agreed to pay $22 million in 2019. Resolve shareholder complaints Became a private company on the way
Hedge funds use short selling and other sophisticated investment strategies to reduce market risk. Because the funds are opaque, they are often limited to institutions, companies, and “qualified” individuals with total net worth over $1 million and annual income over $200,000.
ODS Capital has a history of participating in shareholder lawsuits. In 2018, a hedge fund filed a class action lawsuit against Chinese renewable energy company JA Solar Holdings over allegations that it misled shareholders about a deal that would take the company private.
the complaint is dismissed by a federal district court In Manhattan in 2020, ODS Capital filed an appeal later in the same year. The case was eventually remanded to district court in 2021 after Chinese regulators found aspects of the privatization deal questionable. The lawsuit is still pending.
ODS Capital filed a similar lawsuit in 2019, initiating a class action lawsuit against Chinese tech company Quihoo 360.