(February 4, 2013) — Securities lending is rife with conflicts of interest and its profits are skewed towards the agent, two US pension funds have claimed in a lawsuit against BlackRock subsidiary iShares.
The Laborers’ Local 265 Pension Fund and Plumbers and Pipefitters Local No. 572 Pension Fund, both of which are shareholders in iShares, filed a lawsuit against the world’s largest fund manager last month, newswires initially reported.
According to suit documents, filed at the District Court of the Middle District of Tennessee, the pensions plans “seek to recover funds rightfully owed to them as iShares shareholders, which were improperly spent by iShares’s management on grossly excessive compensation to securities lending agents affiliated with iShares and certain of their affiliates.”
The claim states that the set-up within in the iShares securities lending business saw several BlackRock affiliates overly compensated for the part they played.
iShares is the largest operator of exchange-traded funds in the world. It was bought from banking group Barclays in 2009, as part of BlackRock’s purchase of Barclays Global Investors. At the end of December, iShares had over $752 billion in assets under management and earned fees of $660 million in the fourth quarter of the year, equivalent to a third of BlackRock’s base fee revenue, according to the company’s latest earnings announcement.
The pension funds’ claim, “recent academic research confirms that when mutual fund companies like iShares use affiliated agents to manage security lending transactions, the agents work against the interests of mutual fund investors by siphoning off securities lending profits for the benefit of mutual fund managers. Here, defendants engaged in just such a scheme, arranging for affiliates of iShares to take at least 40% of securities lending revenues for themselves at the expense of investors – a fee entirely disproportionate to the performance of those affiliates.”
A spokeswoman for BlackRock said the company considered the lawsuit to be without merit, and it would be contesting the claim vigorously. “Our securities lending program has delivered above average returns to our ETF shareholders over time. To achieve this, we run the program ourselves while bearing all the costs, rather than outsourcing to third parties as others do. iShares has a long record of delivering the returns our ETF investors expect, and securities lending is one of the tools we use to help ensure our funds efficiently track the performance of their underlying indices.”
The lawsuit criticised the practice of lending securities to third parties more generally and the mechanism by which revenue is distributed.
“Securities lending by any mutual fund involves an inherent conflict of interest because it facilitates short sellers who are trying to drive down the price of the very shares that funds are lending,” the claim stated.
“Because no transparent market exists to determine the ‘price’ that a borrower pays to short a stock,” the claimed added, “the transactions associated with the short-selling of a security (premium or rebate, amount of premium or rebate, indemnification, etc.) are rife with potential for abuse of conflicts of interest.”
The filing claimed that the agents carrying out the broking with the market on behalf of iShares received a disproportionate level of compensation for their part in the system.
“BTC (BlackRock Institutional Trust Company, N.A.) is the affiliated lending agent retained by BlackRock Fund Advisors (BFA), BTC’s wholly owned subsidiary, to manage securities lending transactions for the Funds. BTC’s contract with iShares has proven to be highly profitable for BTC, but not for the pension plans and other investors, the very persons for whose benefit iShares operates.”
To read the entire court filing, click here.