Hedge Fund IsZo Says Jefferies 'Hijacked' Its Brokerage Account

(Bloomberg) -- Jefferies Group LLC overcharged and then “hijacked” the prime brokerage account of its client IsZo Capital Management, the activist hedge fund claimed in an arbitration filing. 

The investment bank held back $5 million of IsZo’s money, later reduced to $2.5 million, to secure seven short positions in securities that are now worthless, IsZo claimed in an arbitration claim filed this week with the Financial Industry Regulatory Authority, or Finra.

The conflict arose in June, when IsZo, which manages more than $300 million, tried to close its Jefferies account and move its cash and holdings to another prime broker. Jefferies told the hedge fund that the illiquid positions couldn’t be transferred and would have to remain open, subject to minimum net equity and collateral requirements, according to IsZo. 

It’s a problem that can arise when a short-seller is too successful -- betting against a company that goes bankrupt, while prime brokerages continue to charge fees. In the cases cited by IsZo, the market for the securities of those companies disappeared, leaving them unable to cover their position. IsZo calls it “little more than a theft.”

“While these 7 legacy short positions ‘remain open,’ Jefferies is further charging IsZo Capital money on the seized positions that do not exist and it purports to be able to borrow such funds for almost nothing,” the hedge fund said. 

In an August Zoom call, Jefferies executives told IsZo that the funds were needed to protect the firm “in case any of the stocks traded like ‘meme stocks’” -- companies favored by retail traders that have seen wild price action in their shares this year.

“Even the barest modicum of diligence would have revealed that there is no danger that any of the 7 legacy short positions could ever become a meme stock,” IsZo said in the filing. “The securities – to the extent that they even exist – have no trading market at all.”

A representative for Jefferies declined to comment.

IsZo is seeking to win the return of its $2.5 million from a Finra arbitration panel. The hedge fund also claims it was overcharged on the $28 million in fees and interest paid to Jefferies in the five years it maintained its account with the firm. It’s seeking to get some or all of it back, in addition to fees Jefferies continues to charge, according to IsZo founder Brian Sheehy.

IsZo says the seven positions include four equity shorts in companies that filed for bankruptcy protection years ago: Capital Corp. of the West, Franklin Credit Management Corp., CPI Corp. and Orleans Homebuilders Inc. Three others are positions in distressed debt from Sears Holding Corp., Massey Energy Co. and Offshore Group Investment Ltd.

The arbitration case is IsZo Capital LP v. Jefferies LLC, 21-02848, Finra Dispute Resolution Services.

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