Goldman Sachs Wins Dismissal of "Short Sale" Lawsuit by Overstock
January 11, 2012
Editors: Peter Blumberg, Michael Hytha

Goldman Sachs Group Inc. persuaded a judge to dismiss Inc.'s lawsuit alleging the investment bank manipulated short sales of the online retailer's stock from 2005 to 2007, causing the shares to fall.

State court judge John Munter in San Francisco threw out the complaint in a ruling yesterday. The decision comes almost five years after accused Wall Street brokerages of using a practice known as naked short selling to deliberately drive down its shares to allegedly reap security lending fees and appease hedge fund clients who were shorting

Munter agreed with the defendants, which included Merrill Lynch & Co., that the lawsuit couldn't go forward because hadn't shown that any of the conduct it sued over happened in California.

“Plaintiffs have failed to raise a triable issue of material fact supportive of a finding that any act by any defendant foundational to liability, causation or damages occurred in California,” Munter said in the ruling.

Patrick Byrne, chief executive officer of Salt Lake City- based Overstock, has accused investment banks and hedge funds of working together to destroy market value of small-cap companies.

In short selling, investors sell shares they have borrowed in anticipation of making a profit by paying for the stock after its price has fallen. In naked short selling, traders never borrow the stock and can drive down prices by flooding the market with orders to sell shares they don't have, alleges in court filings.

Naked Shorting

Overstock claims large portions of its shares were the subject of naked shorting, leading to instances where the short position in its stock has exceeded the entire supply of outstanding shares. Its shares fell from more than $70 in early 2005 to less than $20 in late 2006, according to court filings.

The clearing operations at Goldman Sachs and Merrill Lynch, the brokerage acquired by Bank of America Corp. in 2009, intentionally failed to locate and deliver borrowed shares for clients, allowing the firms to earn fees and interest on phantom securities transactions, lawyers for Overstock said in court filings. Overstock sought millions of dollars in damages against Goldman Sachs and Merrill Lynch.

Clients shorting the stock benefited because the oversupply of shares depressed the shares, the company alleges. The conduct violated California's unfair business practices and securities laws, according to the complaint.

Jonathan Johnson, Overstock's president, said he hadn't seen yesterday's ruling yet and couldn't comment. He said in an e-mail that Overstock expects to file a racketeering lawsuit on the same allegations in New Jersey tomorrow.

Michael DuVally, a spokesman for New York-based Goldman Sachs, declined to comment on the ruling in a telephone interview. Lawrence Grayson, a spokesman for Charlotte, North Carolina-based Bank of America, and Andrew Frackman, an attorney who represented the Merrill Lynch units in the case, didn't immediately respond yesterday to e-mail messages seeking comment on the ruling after hours.

‘Phantom Shares'

Lawyers for Goldman Sachs and Merrill Lynch said the case had to be dismissed because the alleged manipulative conduct at issue didn't occur in California and there's no evidence that failing to deliver stock creates “phantom shares” or depressed Overstock's shares. Clearing operations for Goldman Sachs and Merrill Lynch are based in New York, they said.

“There's no evidence in the record that the defendants' fails-to-deliver, regardless of what short sales we might have caused as a result of that, caused Overstock to be in the top 1 percent of all shorted companies,” Andrew Frackman, an attorney for Merrill Lynch, said at a Jan. 5 hearing in San Francisco. “Their prime broker, their settling departments that were engaged in this are located in New York and New Jersey.”

“We do believe very strongly that the conduct at issue here, wherever it occurred, was entirely lawful and was not prohibited under any laws against market manipulation,” Joseph Floren, a lawyer for Goldman Sachs, said at the hearing.

California Brokers

Lawyers for Overstock told Munter that the company sold shares in California and the defendants were licensed California brokers that affected the national market for Overstock shares.

They also pointed to certain trades the defendants executed on the San Francisco-based Pacific Stock Exchange for clients who were based in Northern California and conduct at a San Francisco-based Merrill Lynch office that allegedly accommodated manipulative trading schemes.

“In looking at the California conduct, you have to look at it from soup to nuts,” Theodore Griffinger, Overstock's lawyer, said at the hearing. “You have to look at it from the initiation of the relationship.”

The company originally sued more than 10 brokerage firms in its 2007 lawsuit. Claims against all but Goldman Sachs and Merrill Lynch were dismissed previously.

The case is v. Morgan Stanley, CGC-07-460147, Superior Court of California, San Francisco.

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