American Funds decries the practice as aiding the enemy and bans lending.

"American Funds decries the practice as aiding the enemy and bans lending."
Wow props to AF (Indiana based?)
http://www.reuters.com/article/2012/04/12/us-funds-lending-idUSBRE83B1LK20120412

China allows margin financing, stock lending for brokerages

http://www.globaltimes.cn/NEWS/tabid/99/ID/730120/730120.aspx

Sadly, it appears China has fallen for the same trap that USA investors have.. FUBAR.

Lending is not managing

http://www.efinancialnews.com/story/2012-06-11/lending-is-not-managing

Securities Lending: Cause Of The Next Financial Crisis?

Securities Lending: Cause Of The Next Financial Crisis?

Read more: http://www.investopedia.com/articles/stocks/09/securities-lending-concern.asp#ixzz25WzwcPLl

suffice it to say Jason Zweig was wrong ...your fund should NOT lend out your securities

https://institutional.vanguard.com/iam/pdf/ICRSL.pdf?cbdForceDomain=true

Extremely important document outlining Vanguards intentions to loan out the most scarce stocks to borrow that yield the highest "negative rebate" ... in other words the very stocks that short sellers think are most likely to go down Vanguard is the most eager to lend out ... in other words the higher the bribe the more likely Vanguard will consent to the assassination of your stock. Seriously? Yes really... if its just any old stock they may ignore it... but the more short sellers want it ... the more likely they lend it out... what didn't they mention...the risk that the short seller that borrowed your Apple in exchange for the highest negative rebate are hell bent on eating as much of your Apple as they can before returning it... and they paid your mutual fund manager a bribe to look the other way... To get Vanguard to look the other way you'll have to pay up... so essentially Vanguard is holding out for the highest bribe among other funds who may settle for less earlier... wow thanks! So that makes Vanguard the greediest of all the accomplices to murdering our stock.. that makes them so much more ethical ... NOT. So they are the most conservative among a den of thieves still makes them a thief for handing the crooks our capital... IMHO they still violate our trust and breach prudent man rules regarding fiduciary duty to their investors. Investors should demand an end to Securities Lending at any negative rebate. This should not be left to some manager to decide if the "risks" justify the negative rebate. They are socializing the loses(of the stock going down in aggregate after funds flood short sellers with supply to short ) and privatizing the gains... by the negative rebates. So happens that Vanguard by holding out for the highest negative rebates are good and maximizing the private gains but they are not stopping the socializing of the losses... If the short sellers succeed in taking out the stock to the woodshed high negative rebates will NOT be enough to compensate for the loss. Say you own 1000 stocks each worth 10$ and short sellers offer to pay you $2 to borrow 100 of them they think will go down in value... I presume Vanguards assumption is that all of the stocks they agree to the bribe will not go down at the same time... such that the amount they get for the ones that don't go down will offset the fact they let the short sellers have a field day with the ones that did go down... of course we all know what happens in black swan market crashes they all go down at the same time... and that negative rebate they collected will in no way be enough to compensate for the fact the short sellers cleaned house by V selling your stock down the river for a song (but they only sell the most expensive songs)...
notice they don't give us a histogram of the range of income across the stocks they lend...
just how high on average is this so called maximized negative rebate...
Are they willing to tell shareholders..
Hats of to V for trying to be ethical in regards to safe collateral and all the other strategies but at the end of the day they still lent the stock out to Charles Hayes of Pacific Heights hell bent on destroying the stock I don't care how much they bribe you stop lending out our stock!

How an apple can explain short-selling

one of the best analogies yet
How an apple can explain short-selling

http://www.bbc.co.uk/news/business-14510946


The small fee is no where near enough to compensate for the damage done by short sellers. The Securities Lending industry is a crock built on pittance bribes and deception/lack of transparency to shareholders whose managers have sold their customers assets down the river for a song. The regulations permit funds to lend out 30% of the fund to short sellers. Unfortunately, due to the nature of relative performance comparisons by Rating agencies like Morningstar, the managers are caught in a prisoner's dilemma of privatizing the gains and socializing the losses and most accept this as industry best practice. Is it any wonder the market has trouble going up over the long run now with the huge overhang of recursively short sold stock without an uptick rule in place to stop or at least significantly slow the process as more and more 120/20 or short ETF's come on board. Well gee at least we got rid of the FTD naked shorts only to see them hide behind ever increasingly sophisticated option trades that create synthetic short positions expanding the stock supply. Charles Hayes of Pacific Heights is winning the battle for control of your assets.

Contact your mutual/pension fund and ask them if they lend your stock to short sellers and if they do ...tell them to stop...and if they don't ... find a fund who doesn't sell your assets down the river for a song.
Sadly some of the biggest names in the mutual fund industry are also the biggest names in the securities lending industry.. Yes Mr. Bogle Enough is Enough...but your fund company is responsible for violating its fiduciary duty and my trust by doing something as imprudent as lending my stock out to trained assassins.

Securities Lending: What Fund Directors Should Consider - June 2008

http://production.mfgovern.com/content/view/78/63/

"A common concern for many is that loaning shares to be shorted may exert downward pressure on their portfolio’s positions.   However market wisdom would hold that securities lending promotes market efficiency and liquidity, and that short sellers are critical to efficient market theory.  Given the long term hold strategy held by most mutual funds, this should not be a factor over time."

market wisdom is wrong...

short selling causes stock prices to go down...

efficiency and liquidity arguments are just deceptive ways of justifying the extortion of institutions to lend stock away from customers hands into those hell bent on destroying their capital..

www.afajof.org/afa/forthcoming/1395.pdf

The take away here is also funds of small stocks play dangerous games whereby they gamble whether the damage down by loaning out small stocks is offset by the incremental income... I highly doubt they win that game...

and quite frankly that same game's impact on the big funds retail brokerage arm has undue nasty impacts on customers in those accounts who hold those stocks directly...

if they were looking out for ALL their long customers interest they would not loan ANY stock out at ANY rate.

The Effect of Short Selling on Bubbles and Crashes in Experimental Spot Asset Markets

www.afajof.org/afa/forthcoming/1395.pdf

Great research into negating the notion that short selling is simply a price discovery mechanism

ICI on securities lending at mutual funds

Just another link about mutual funds and securities lending:
http://www.ici.org/viewpoints/view_11_securities_lending

"Doing so allows mutual funds to generate incremental income and improve total returns with a reasonable amount of additional risk. Securities lending also provides liquidity to the market by enabling brokers to cover failed trades or short positions."


Reasonable amount of additional risk? Really? By lending out the stock mutual funds socialize the losses and privatize the relative performance gains by incrementally generating income(feds fund rate .5-1%? avg?). Yet on an aggregate basis the funds increase the supply of stock driving prices down. If they overall are increasing the supply of stock by 30% the net effect is way worse than this incremental income... 
As a mutual fund investor I have to say I fee sold down the river by my fund looking for incremental income in exchange for giving my stock a new owner that is hell bent to destroy my capital.
http://en.wiktionary.org/wiki/sell_down_the_river

I also want to say why is it in the interest of a mutual fund to "provide liquidity" to a market... if your shareholder wants the value of their investments to go up... I don't want liquidity I want a shortage of stock driving up the price of a new investor has to pay to get the stock... loaning out stock keeps prices the same or lower by "providing liquidity" ... the idea that providing liquidity is in the best interest of shareholders is patently absurd.

see :
The Effect of Short Selling on Bubbles and Crashes in Experimental Spot Asset Markets



the new owner (Mr. Short seller or Naked short seller if they sold first and begged for stock later)
is by no means as friendly to my stock as the original owner the "mutual " fund... where did we lose the "mutual" concept... there is nothing mutual about a short seller owning my stock and selling , trashing it with FUD (Fear, Uncertainty, and Doubt) and then giving it back to me after its been through the ringer.
No thanks mutual funds... stop securities lending now

PS. notice how the authors even call out mutual funds complicity in getting naked short sellers off the hook by helping them cover FTDs after the fact. Mutual funds have been "captured" by thieves...
but as I've said before its a prisoner's dilemma that fund mangers who don't participate face higher banking fees for not accepting the extortion and have lower relative returns by experiencing the share declines without the incremental income.

How to stop it?
Shareholder proposals? New regs? Morningstar shame rating  perhaps an indicator on how much of the fund is sold down the river for incremental income...
I favor the shareholder propsoals
but also I think the IRS can take care of the whole thing with a constructive sale definition change that says if you trade X for Y plus interest that you've constructively sold since X<> Y 100%...

http://online.barrons.com/article/SB50001424052748704759704577265301221059044.html?mod=BOL_hps_mag

Getting to the naked truth

"The Wolfsons’ alleged scheme involved a thicket of complex transactions, according to the SEC. One type of trade, a “reverse conversion”, involved taking out options that appeared to offset the short position, making naked shorting look like bona fide marketmaking. Another stock-and-option combination, the “reset”, created the illusion that trades had been settled by having an entity buy the same type and quantity of shares that had been sold short. But the shares were always sold back within days, often in trades between the brothers, which the SEC claims were “sham”. The reset trades meant they could roll over naked-short positions indefinitely."


A bit more complicated than I first thought but I think the above is what the SEC refers to as "cycling".

07-22-11 The Murky World of Securities Lending - Morningstar

The Murky World of Securities Lending

Recently, Deutsche Bank published a report that highlighted how European ETF providers have been able to generate surprisingly high profit margins. The report attributes these high margins in part to relatively large returns generated in the murky world of securities lending. There’s nothing inherently wrong with the practice – in fact it can and should create wealth for investors – but certain companies are in the habit of keeping much or all of the generated profits. I’m amazed that investors and the media aren’t up in arms about this.

Securities lending refers to the practice of a fund manager (responsible for an ETF, mutual fund, or other institutional pool) loaning (to a short seller, for example) the underlying stocks or bonds in exchange for a fee. This is desirable because it is a way to generate extra income from the stocks or bonds that are just sitting around in the portfolio collecting dust. When the investment is loaned out the beneficial ownership doesn’t change hands and the fund manager can ask for the stock or bond back at anytime he or she wishes (typically when selling the position).

I’ve glossed over all sorts of intricacies for the sake of brevity, but there are two main points to keep in mind. First, when a fund manager loans out securities, there is always the risk that he or she won’t get the securities back. Second, the loaned securities belong to the fund investor, not the fund company or fund manager. Consequently, it is the investor who is on the hook for any related losses. To be fair, it’s a fairly low risk strategy, but the potential for losses does exist.

The stink of it is that numerous fund providers are keeping much or all of the profits generated from the practice. The industry argues that securities lending creates wealth for investors and that the fund manager deserves to be compensated for performing the service on investors’ behalf. Furthermore, they would argue that this fact is typically clearly disclosed in the prospectus.

But I would argue that the investor is already paying for this service via the fund’s expense ratio. If that fee isn’t enough to cover the manager’s securities lending efforts, then the fund company should simply raise the expense ratio; not keep a fat chunk of the profits that belong to the investor.

Taking a cut of the securities lending profit seems to me a thinly veiled attempt to obfuscate the fund’s true fees. By taking a cut of securities lending revenue right off the top, the fund provider can keep that cost out of the highly scrutinized expense ratio in favour of a disclaimer buried in the prospectus. There’s no question that the expense ratio is the far more logical and transparent place to charge the investor for securities lending.

The expense ratio is the fee that compensates all sorts of managers of all sorts of products (mutual funds, ETFs, hedge funds, etc.), employing all sorts of investment strategies, whether active or passive (long only, long/short, market neutral, merger arbitrage, index replication, synthetic indexing, currency hedging, and so on). But for some reason this one practice is not covered in the expense ratio. That seems exceedingly odd to me. It’s akin to a long-only fund manager keeping the profits made on the fund’s currency hedging activities. That certainly wouldn’t be deemed acceptable. So what makes securities lending so different that it should warrant such unique accounting treatment?

03.03.10 Brother, Can You Spare A Share? - Forbes

Brother, Can You Spare A Share?
Alexandra Zendrian, 03.03.10, 7:30 PM ET

High-net-worth investors are becoming bigger players in the securities lending space.

Of the $8.6 trillion worth of individually purchased equities held by U.S. retail brokerages, $3.4 trillion are stocks that aren't affiliated with a mutual fund or hedge fund according to a recent Finadium report. Josh Galper, managing principal, Finadium, estimates that there is $1.1 billion in revenue in retail securities lending and 60% of that revenue is going in the retail investor's wallet.

That's significant since this business of lending out securities to short-sellers has traditionally been one for institutional investors like hedge funds, endowments, insurance companies and pension funds. Securities lending can produce annualized returns between 3% and 20%. Galper notes that investors receive higher premiums for lending out "hard to borrow" securities, particularly small- and mid-cap stocks.

High-net-worth retail investors are getting more interested as a result of increasing transparency, Galper says, noting that many brokerages are making it easier to lend securities. Indeed, brokerage firms are sitting up and taking note of increased retail securities lending. Fidelity, Morgan Stanley, Bank of America Merrill Lynch, Charles Schwab, UBS, Pershing and E*Trade are noted in the Finadium report as having lending programs for fully paid securities. Wells Fargo, TD Ameritrade and Raymond James do not have a securities lending program, according to the report.

In the flap over short-selling during the bear market, securities lending got a bad rap, Galper says. Investors shouldn’t be leery about lending out their stocks because the data show that there’s no direct relationship between a retail investor lending out stock and that stock’s price performance.

05-21-07 How Small Investors Lend Shares To Hard-pressed Short Sellers Source iStockAnalyst

WEEKEND EDITION: How Small Investors Lend Shares To Hard-pressed Short Sellers

Monday, May 21, 2007 12:14 AM

SAN FRANCISCO (Dow Jones) -- The hedge fund boom rarely presents new money- making opportunities for individual investors.

Now, however, increasing competition in one corner of the business is giving retail shareholders the chance to generate extra cash from the assets in their brokerage accounts.

Short selling, in which traders bet against stocks, has become more competitive in recent years as hedge fund assets soar and managers proliferate. Short sellers borrow a stock, betting its price will fall. When they return the shares to the lender at the original price, they profit from the difference.

Usually, institutions with big, long-term stakes in companies earn interest in exchange for lending their stock to Wall Street firms. Those investment banks then lend the securities on again toshort sellers at a higher rate. But with more hedge fund managers searching for profitable short trades, some stocks have become much more difficult to borrow.

The trend has encouraged brokerage firms to offer to pay retail investors to lend their shares too.

Charles Schwab (NASDAQ-NMS:SCHW) (SCHW) , the largest discount broker, runs a service in which it offers to pay customers interest on any loans of hard-to-borrow stocks from their brokerage accounts. The rate varies, depending on how much demand there is to borrow the stock.

Schwab rivals E-Trade Financial (ETFC) and TD Ameritrade (NASDAQ-NMS:AMTD) (AMTD) say they too are considering similar services of their own.

"If there's a small available supply of stock to borrow, people will look for any new source," said Joe Weinhoffer, chief executive of Quadriserv Inc., a New York-based firm that specializes in helping hedge funds and other traders to borrow stock.

'Hard-to-resist'

Schwab, which launched its Securities Lending Fully Paid Program in 2004, markets the service to investors and financial advisers, summing it up in a brochure entitled "Hard-to-find stocks. Hard-to-resist opportunities."

The firm also draws up a list of dozens of hard-to-borrow stocks. A recent copy of the list obtained by MarketWatch contains 76 stocks.

Biotech and medical equipment companies including Dendreon Corp. (NASDAQ-NMS:DNDN) (DNDN) , Northfield Labs (NFLD) and Neurometrix Inc. (NASDAQ-NMS:NURO) (NURO) , are most heavily represented.

Homebuilders such as KB Home (NYSE:KBH) (KBH) , Brookfield Homes (NYSE:BHS) (BHS) and Dominion Homes (NASDAQ-NMS:DHOM) (DHOM) are also on the list, along with mortgage lenders like IndyMac Bancorp (NYSE:IMB) ( IMB) , Delta Financial (NASDAQ-NMS:DFC) (DFC) and American Home Mortgage (NYSE:AHM) (AHM) .

Ethanol producers and other renewable energy and environmental companies like Xethanol Corp. (XTHN) , Medis Technologies (NASDAQ-NMS:MDTL) (MDTL) and Trina Solar (NYSE:TSL) (TSL) , also make an appearance.

Other big companies on the list include drinks giant Diageo (NYSE:DEO) , department store company J.C. Penny (JCP) and luxury goods maker Gucci Group (GUCG) .

This type of service gives retail-focused brokers an entrée into the lucrative securities-lending business, said Joshua Galper, managing principal of Vodia Group, a financial-services consulting group that focuses on securities lending.
It's a business dominated by investment banks such as Goldman Sachs (NYSE:GS) (GS) , Morgan Stanley (NYSE:MS) (MS) and Bear Stearns (NYSE:BSC) (BSC) . Wall Street firms generate more than $5 billion in annual revenue from providing so-called prime brokerage services, such as securities lending, to hedge funds.
Schwab's service targets wealthier customers who own a lot of shares in companies that are in demand among short sellers. It doesn't apply to stock held in a margin account.
"We're responding to demand in the marketplace and providing something that's appealing to some individual investors," said Glen Mathison, a Schwab spokesman. "As a result of growth in the number of hedge funds and the fact that most hedge funds employ some sort of short strategy, there's growing demand and a finite number of shares to borrow."
Lending Imergent (AMEX:IIG)
In one example from March 28, Schwab wrote to a customer who held 6,000 shares of Imergent Inc. (AMEX:IIG) (IIG) , an online service provider that's battled accounting problems and is heavily shorted. The customer held the stock in a Roth conversion IRA account.
Schwab agreed to pay the customer an interest rate of 7% for lending the 6,000 Imergent (AMEX:IIG) shares, based on a share price of $19.34. The deal generated $677 a month for the customer, according to a copy of the letter sent by Schwab, which was obtained by MarketWatch. Imergent (AMEX:IIG) stock is up more than 10% since March 28.
If Schwab is willing to pay 7% to borrow a stock from its retail clients, the company is probably able to lend it back out at 9% or more, which illustrates the potential profitability of the business, Vodia's Galper said.
Developing such a service is very beneficial to brokers such as Schwab, because they can build up an ever larger network of wealthy clients to contact if they need to satisfy demand to borrow certain stocks in future, Quadriserv's Weinhoffer explained.
Weinhoffer joined Merrill Lynch (NYSE:MER) (MER) in 1992 and helped develop one of the first third-party securities lending businesses. In 1993, he said he tried to develop a retail version, but "internal bureaucracy" got in the way.
"It was something that could be done from time to time, but to set up a system for it to work regularly was more difficult," Weinhoffer said.
Eric Hendrickson, a Merrill Lynch (NYSE:MER) spokesman, declined to comment on whether the firm offers such a service to its retail clients now.
Retail stock lending programs are still a drop in the bucket compared to the institutional business, which accounts for most of the $717 billion of equities on loan in the U.S., Galper noted.

Schwab's Mathison called its program a "niche service" for the firm.Still, Galper suspects "everyone" will be offering the service within the next two years.
Extra income
While brokers make money on the transaction, Galper and others say it can still be an attractive way for individual, long-term investors to generate income from their stock holdings.
"It's an absolutely fair and justified thing to do and a fairly low-risk way of generating income" Galper said.
The main risk is that the broker could lend customers' stock to someone who defaults. That would leave retail investors fighting with the defaulted entity or their broker to get their shares back, he explained.
Schwab's Mathison said the program fully discloses the potential risks, lets customers get their stock back any time and ensures that positions are collateralized.
"We make sure people know how it works," he added. "Some people aren't comfortable with it."
Chris Cordaro, chief investment officer at Regent Atlantic Capital LLC, a wealth-management firm that oversees more than $1.5 billion for roughly 750 clients, said he's never come across such a service. But he said he's very interested.
"Why would I pass up a chance to generate more returns for clients from positions they're going to be in over the long term anyway?" Cordaro said.
"Hedge funds are going to sell it short, but who knows if they're going to be right?" he added. "In the meantime, my clients can get more income."
NovaStar stock loan
Stock lent by retail investors may well be borrowed by a hedge fund in a short sale. That could pressure the stock in the short term, and if the hedge fund manager's bet turns out to be correct, more losses could follow.
In a December article, Forbes magazine featured an individual investor called Roger Metzlerwho owned 32,000 shares of NovaStar Financial (NYSE:NFI) (NFI) , a subprime mortgage originator that's heavily shorted.
By lending the stock out through his account with Smith Barney, the broker paid him a 13% interest rate. That generated income of $129,000 a year, according to Forbes.
However, NovaStar's shares have slumped so far in 2007 as a shakeout in the subprime mortgage market hit the company hard.
In mid-December, Metzler's 32,000 NovaStar shares were worth roughly $928,000. If the investor still holds the position, it's now worth $198,400. That $729,600 loss is more than the annual income he reportedly generated from lending the stock.
But for consultant Joshua Galper, situations like that merely highlight the usual market risk that investors take on when they buy stocks. Even retail investors who don't lend stock could see their company's shares shorted and falling, he noted, adding: "The real question is: are you maximizing the value of your assets?"

(END) Dow Jones Newswires   05-21-07 0014   Copyright (c) 2007 Dow Jones & Company, Inc. 

(Source: iStockAnalyst )

Tax considerations? Just a sample question/answer link

One topic that has been bothering me a lot is the fact that there appears to be no tax implication from "owning" an IOU after a short seller has sold your stock. If the IRS were told by Congress that they should view this as a constructive sale then poof there goes your supply of stock.
http://www.linkedin.com/answers/personal-finance/personal-investing/PFI_PIN/300183-64065

05/18/07 Poor short seller, rich retail investor - MarketWatch

http://www.marketwatch.com/story/how-small-investors-lend-shares-to-hard-pressed-short-sellers

May 18, 2007, 8:14 p.m. EDT

Poor short seller, rich retail investor

Competition among hedge funds creates opportunities for ordinary folks

By Alistair Barr, MarketWatch

SAN FRANCISCO (MarketWatch) -- The hedge fund boom rarely presents new money-making opportunities for individual investors.

Now, however, increasing competition in one corner of the business is giving retail shareholders the chance to generate extra cash from the assets in their brokerage accounts.

Short selling, in which traders bet against stocks, has become more competitive in recent years as hedge fund assets soar and managers proliferate. Short sellers borrow a stock, betting its price will fall. When they return the shares to the lender at the original price, they profit from the difference.

'If there's a small available supply of stock to borrow, people will look for any new source.'

Joe Weinhoffer, Quadriserv Inc.

Usually, institutions with big, long-term stakes in companies earn interest in exchange for lending their stock to Wall Street firms. Those investment banks then lend the securities on again to short sellers at a higher rate. But with more hedge fund managers searching for profitable short trades, some stocks have become much more difficult to borrow.

The trend has encouraged brokerage firms to offer to pay retail investors to lend their shares too.

Charles Schwab (NYSE:SCHW) , the largest discount broker, runs a service in which it offers to pay customers interest on any loans of hard-to-borrow stocks from their brokerage accounts. The rate varies, depending on how much demand there is to borrow the stock.

Schwab rivals E-Trade Financial (NASDAQ:ETFC) and TD Ameritrade (NASDAQ:AMTD) say they too are considering similar services of their own.

"If there's a small available supply of stock to borrow, people will look for any new source," said Joe Weinhoffer, chief executive of Quadriserv Inc., a New York-based firm that specializes in helping hedge funds and other traders to borrow stock.

'Hard-to-resist'

Schwab, which launched its Securities Lending Fully Paid Program in 2004, markets the service to investors and financial advisers, summing it up in a brochure entitled "Hard-to-find stocks. Hard-to-resist opportunities."

The firm also draws up a list of dozens of hard-to-borrow stocks. A recent copy of the list obtained by MarketWatch contains 76 stocks.

Biotech and medical equipment companies including Dendreon Corp. (NASDAQ:DNDN) , Northfield Labs and Neurometrix Inc. (UTD:NURO) , are most heavily represented.

Homebuilders such as KB Home (NYSE:KBH) , Brookfield Homes and Dominion Homes are also on the list, along with mortgage lenders like IndyMac Bancorp , Delta Financial and American Home Mortgage .

Ethanol producers and other renewable energy and environmental companies like Xethanol Corp. , Medis Technologies (OTN:MDTL) and Trina Solar (NYSE:TSL) , also make an appearance.

Other big companies on the list include drinks giant Diageo (LSS:UK:DGE) , department store company J.C. Penny (NYSE:JCP) and luxury goods maker Gucci Group (OTN:GUCG) .

This type of service gives retail-focused brokers an entrée into the lucrative securities-lending business, said Joshua Galper, managing principal of Vodia Group, a financial-services consulting group that focuses on securities lending.

It's a business dominated by investment banks such as Goldman Sachs (NYSE:GS) , Morgan Stanley (NYSE:MS) and Bear Stearns . Wall Street firms generate more than $5 billion in annual revenue from providing so-called prime brokerage services, such as securities lending, to hedge funds.

Schwab's service targets wealthier customers who own a lot of shares in companies that are in demand among short sellers. It doesn't apply to stock held in a margin account.

"We're responding to demand in the marketplace and providing something that's appealing to some individual investors," said Glen Mathison, a Schwab spokesman. "As a result of growth in the number of hedge funds and the fact that most hedge funds employ some sort of short strategy, there's growing demand and a finite number of shares to borrow."

Lending Imergent

In one example from March 28, Schwab wrote to a customer who held 6,000 shares of Imergent Inc. , an online service provider that's battled accounting problems and is heavily shorted. The customer held the stock in a Roth conversion IRA account.

Schwab agreed to pay the customer an interest rate of 7% for lending the 6,000 Imergent shares, based on a share price of $19.34. The deal generated $677 a month for the customer, according to a copy of the letter sent by Schwab, which was obtained by MarketWatch. Imergent stock is up more than 10% since March 28.

If Schwab is willing to pay 7% to borrow a stock from its retail clients, the company is probably able to lend it back out at 9% or more, which illustrates the potential profitability of the business, Vodia's Galper said.

Developing such a service is very beneficial to brokers such as Schwab, because they can build up an ever larger network of wealthy clients to contact if they need to satisfy demand to borrow certain stocks in future, Quadriserv's Weinhoffer explained.

Weinhoffer joined Merrill Lynch in 1992 and helped develop one of the first third-party securities lending businesses. In 1993, he said he tried to develop a retail version, but "internal bureaucracy" got in the way.

"It was something that could be done from time to time, but to set up a system for it to work regularly was more difficult," Weinhoffer said.

Eric Hendrickson, a Merrill Lynch spokesman, declined to comment on whether the firm offers such a service to its retail clients now.

Retail stock lending programs are still a drop in the bucket compared to the institutional business, which accounts for most of the $717 billion of equities on loan in the U.S., Galper noted. Schwab's Mathison called its program a "niche service" for the firm.

Still, Galper suspects "everyone" will be offering the service within the next two years.

Extra income

While brokers make money on the transaction, Galper and others say it can still be an attractive way for individual, long-term investors to generate income from their stock holdings.

"It's an absolutely fair and justified thing to do and a fairly low-risk way of generating income" Galper said.

The main risk is that the broker could lend customers' stock to someone who defaults. That would leave retail investors fighting with the defaulted entity or their broker to get their shares back, he explained.

Schwab's Mathison said the program fully discloses the potential risks, lets customers get their stock back any time and ensures that positions are collateralized.

"We make sure people know how it works," he added. "Some people aren't comfortable with it."

Chris Cordaro, chief investment officer at Regent Atlantic Capital LLC, a wealth-management firm that oversees more than $1.5 billion for roughly 750 clients, said he's never come across such a service. But he said he's very interested.

"Why would I pass up a chance to generate more returns for clients from positions they're going to be in over the long term anyway?" Cordaro said.

"Hedge funds are going to sell it short, but who knows if they're going to be right?" he added. "In the meantime, my clients can get more income."

NovaStar stock loan

Stock lent by retail investors may well be borrowed by a hedge fund in a short sale. That could pressure the stock in the short term, and if the hedge fund manager's bet turns out to be correct, more losses could follow.

In a December article, Forbes magazine featured an individual investor called Roger Metzler who owned 32,000 shares of NovaStar Financial , a subprime mortgage originator that's heavily shorted.

By lending the stock out through his account with Smith Barney, the broker paid him a 13% interest rate. That generated income of $129,000 a year, according to Forbes.

However, NovaStar's shares have slumped so far in 2007 as a shakeout in the subprime mortgage market hit the company hard.

In mid-December, Metzler's 32,000 NovaStar shares were worth roughly $928,000. If the investor still holds the position, it's now worth $198,400. That $729,600 loss is more than the annual income he reportedly generated from lending the stock.

But for consultant Joshua Galper, situations like that merely highlight the usual market risk that investors take on when they buy stocks. Even retail investors who don't lend stock could see their company's shares shorted and falling, he noted, adding: "The real question is: are you maximizing the value of your assets?"