Selling one share of stock can be simple: It generally goes for whatever price other shares of the same company are trading for at the moment. Selling large numbers of shares can be complicated, since the very act of selling can drive down the price — especially if others get wind of a big stake being sold.
The US Securities and Exchange Commission (SEC) and Justice Department are digging into how such “block trades” work, specifically into how bankers work with hedge funds to privately carry out such deals, which have been booming in recent years. A similar case in Japan has already resulted in charges of market manipulation.
1. What are block trades?
Stock sales big enough to send market prices tumbling. Highly secretive, market moving and potentially treacherous — block trading has been one of Wall Street’s most delicate arts since it emerged as a major business line more than a half century ago. Legendary Goldman Sachs deal maker Gus Levy pioneered the business in the 1960s, helping position his firm to become the trading powerhouse that it is today. Block trading is one of few Wall Street businesses where relationships still drive the flow of deals.
2. Why potentially treacherous?
Things can go wrong both for the seller and for the bank or broker who’s helping. The seller wants to move quickly to get the benefit of an existing price before the sale of the block of stock can drive it down. Banks win that business in part by offering to buy the block themselves — which leaves them with the problem of how to dispose of it without losing money in the process.
3. How do they do that?
Banks typically agree to acquire a slug of stock at a discount from an investor — such as a company founder, venture capital firm, private equity investor or hedge fund — and then split the block up into smaller chunks that are sold discreetly to other large investors. The aim is to sell the pieces at a slight discount to the stock’s last closing price, and to avoid sending the price into a dive before the transaction is done. A number of hedge funds have set up their own equity capital markets desks to catch pieces of block trades, selling them onward for their own gains, too.
4. What’s been happening?
Block trades have been popular on Wall Street since 2005, when the SEC revised registration processes for so-called well known seasoned issuers. This gave sellers the ability to liquidate shares quickly, sometimes within 24 hours, compared to the alternative of waiting about a week for the SEC to review a filling ahead of the sale.
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But the market has swelled in recent years; banks managed more than US$70 billion ($94 billion) of block trades in the US in 2021, according to data from financial markets platform Dealogic. Block trading has grown increasingly competitive, and it’s all the more difficult when markets sell off. Price declines make current shareholders disinclined to unload slugs of stocks, leaving fewer opportunities for banks and the enthusiastic buyers who covet the offerings.
5. What’s changed?
More companies are staying private longer. Rather than going public while still small, so-called unicorns grow into multi-billion dollar firms before offering stock for sale. That means that every time a large start-up goes public, there’s a long list of Silicon Valley entrepreneurs, venture capital firms and other early investors left with big stakes that they can unload once so-called lockup periods expire.
6. What’s the problem?
Many fund managers grouse that they may be missing out on stock allocations in popular initial public offerings because bankers are more focused on cultivating relationships with longer term investors or with other clients willing to buy into block trades. Sellers have long complained about block trades that seemed to be preceded by stock drops, hurting their proceeds when they cash out. They have pointed to practices that have been seen as existing in a legal grey area. Some private equity firms have developed a number of strategies to try to minimise any such “fade.”
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7. Like what?
To gauge demand from buyers and potentially gin up interest from sellers, bankers send out lists of shares with upcoming lock-up expirations, according to market participants. It’s essentially an invitation to hedge funds and family offices to express interest in buying, even if banks don’t have a mandate yet. The practice is considered legal. Sometimes, bankers also engage in hypothetical conversations with buyers before they have a mandate. Asking prospective buyers whether they might be interested in certain stocks is one thing. But if there are indeed plans afoot for block sales, such conversations, even phrased hypothetically, can tip off savvy money managers who can move to sell the stock.
While there is technically no transfer of material non-public information — the usual line for running afoul of US laws — the practice has drawn criticism, and now, regulatory scrutiny. It’s possible that some deals have confidentiality agreements between the block’s seller and the banks and between the banks and the block’s buyers not to trade on information about potential deals.
8. What are US investigators looking at?
The activities of a slate of money managers that dealt with Morgan Stanley and at least one other competitor, Goldman Sachs Group. The SEC began investigating block trading in 2018. It ramped up its investigation after the blow up at Archegos Capital Management, the family office of Bill Hwang. When his holdings tanked in March 2021, the banks he’d been working with unloaded tens of billions of dollars of stocks through a spree of huge sales. The Department of Justice is conducting a parallel investigation. One concern is whether investors are betting against stocks before block trades, causing prices to slump. Authorities haven’t accused anyone of wrongdoing.
9. Does this happen elsewhere?
In an unrelated situation in Japan, authorities have accused financial firms of improperly seeking to prop stocks up, rather than setting off declines. Tokyo prosecutors in March indicted the brokerage arm of Sumitomo Mitsui Financial Group, SMBC Nikko Securities and five employees. They are alleged to have used SMBC Nikko’s proprietary trading desk to put in large buy orders for certain stocks before the market closed in Tokyo. The alleged aim was to prop up prices before the brokerage sold large chunks of those companies’ shares outside the open market for clients in the block offers. According to prosecutors, such actions amount to market manipulation. SMBC Nikko CEO Yuichiro Kondo has expressed remorse and said the brokerage was cooperating with the authorities. At least four of the five individuals indicted have denied the allegations, according to local media. — Bloomberg Quicktake
Photo by Chenyu Guan on Unsplash
