U.S. Regulators Probe Wall Street Firms for Block Trades – Report

U.S. regulators are probing big Wall Street firms for their probable involvement in the business of block trading, Wall Street Journal said.

Both the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) are investigating big banks, like Morgan Stanley (MS), Goldman Sachs (GS), along with big hedge funds to check if the banks sent out information secretly to their clients before any such block trades transpired.

Shares of the best bank stocks MS closed at $103.43 and GS closed at $363.94 on February 15.

The banks are even being investigated to see if they passed on confidential information about such trades to their clients before such information became public. If a fund knows about such a trade in advance, the fund can benefit from short-selling the stock. Short selling happens when an investor sells borrowed shares, with the intent of buying the shares back at lower prices when the stock price reacts to such trades, thereby benefiting from the difference.

When a block of shares is suspected to flow into the market, the share price of such shares falls due to the increase in supply. The stock price reaction typically occurs in the hours before the block is sold, which raises doubts about insider information being passed on before the trade.

Regulators are questioning whether the banks and Wall Street firms involved in the block trades are taking advantage of the timing of information, and are probing whether such information sharing and its timing is illegal.

The SEC has even sent out subpoenas to the banks and hedge funds to probe their trading records, and their communications with clients and investors. The SEC started the probe back in 2019 with Morgan Stanley, who are one of the biggest beneficiaries of the block trades. The subpoenas do not mean that the firms being probed are guilty or will be charged.

What is a Block Trade?

A block trade occurs when a company or a majority shareholder plans to sell a large chunk of his holdings at one go. If the stock sale is to go through a normal sale on the stock exchange by the company or individual, it will take days or weeks to complete the sale and will also impact the stock price significantly. Block trades are also seen in cases following an initial public offering (IPO), when the lock-up period for insider trades expires.

Hence, in such cases, a block trade takes place when the seller asks banks to bid for the full block and these bids are normally below the current market prices. Once a bank wins the bid, it then offers the block to its clients like hedge funds and high net worth individuals (HNIs) at a marginal premium, thereby earning a profit.

Block Trade Boom

The block trade business has exploded in the past couple of years due to the accelerated volumes of IPOs and a rise in secondary offerings, wherein companies are taking advantage of the boom in the stock market. Companies typically resort to block trading as the mechanism is relatively simpler, more efficient, and impacts the share prices less than the traditional approach.

According to Dealogic, in 2021 alone, the U.S. recorded $70 billion in block trades, marking a five-year high, and during that time MS was the most active banker. In 2021, MS earned at least $300 million in fees from such transactions and headed almost a quarter of the block trades by value in the year, Dealogic said. GS is the second biggest player in the segment.

MS Stock Prediction

The Wall Street community has a Moderate Buy consensus rating on the MS stock based on 8 Buys and 6 Holds. The average Morgan Stanley price target of $115.27 implies 11.5% upside potential to current levels.

GS stock Prediction

The GS stock has a Moderate Buy consensus rating based on 9 Buys and 5 Holds. The average Goldman Sachs price target of $463.17 implies 27.3% upside potential to current levels.

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