Brokerage that lends my share to short seller

[worven]

What is the name of your state (only U.S. law)? Ontario, Canada

I have a brokerage account with scotia itrade and held a significant amount of shares in electronic format.

It has come to my attention that my broker is allowed to lend my shares to a short seller for a fee. How can they lend my shares for a fee wihtout my knowledge and pocket the fees.

The problem is two folds, one that they profit from my holdings with fees. But also the side effect of lending my shares for shorting may potentially decrease the value of my shares. Why is this legal?, I would be interested in a public interest litigation / class action lawsuit to return money earned by such activities back to the owner of the shares to discourage such practices by brokerages.

This looks like organised crime to me.What is the name of your state (only U.S. law)?

 

[racer72]

US law only.

 

[boberta]

Shot selling provides people who believe share prices will fall with the opportunity to borrow shares from a broker and sell them in hopes that they will be able to buy them back at a lower price to return them to the broker and profit from the difference in price.

From an economic prospective this is important because it provides a market mechanism to keep share prices in check. The stock market is essentially a predictions market; if people predict that a company will do well its share price goes up because they will buy shares which will cause demand to outstrip supply. When someone short sells a stock they increase the supply of shares which drives the price down. This is existential of the price of the stock is to be an accurate signal of the market's valuation of the underlying company. Short sellers were important in discovering accounting frauds at Enron and in limiting the size of the dot com bubble.

Because short selling is essential from an economic prospective, governments have enacted public policy to make it possible for short sellers to obtain shares to sell. With most individual brokerage accounts, and virtually all electronic brokerage accounts, you do not actually own the shares you purchase. Rather the brokerage company holds the shares that represent their individual clients holdings.

So if you buy 100 shares of XYZ corp, and 20 other clients of your broker own 100 shares each, your broker would hold in his account 2,100 shares of XYZ. 100 shares will sort of belong to you in that you have the right to order your broker to sell those shares and receive the proceeds of the sale. In another sense, these shares do not belong to you in that they are fungible, and as long as the broker keeps enough shares to meet your sale order, they can lend out the rest of the shares. This is very similar to how banks accept deposits than loan out the funds even though they have to be able to pay depositors' withdraw requests.

The brokerage charges a fee for lending out the shares because in the event that the short seller is unable to buy back shares to return to the broker, the broker would have to buy shares on the open market to return to its account to meet clients' sale orders.

Assuming you have a standard brokerage contract, the brokerage has done nothing illegal by lending out the shares it holds on your behalf.

Note that i'm not a lawyer. This should not be construed as legal advice.

 

[Hot Topic]

And remember that you're responding to a Canadian, who repeatedly ignored the warnings that the forum dealt with U.S. law ONLY. What applies to Wall Street may not necessarily apply to Canada.