Toomre Capital Markets LLC

On April 16^th 2008, the International Swaps and Derivatives Association, Inc. ("ISDA") released the results of its Year-End 2007 Market Survey of privately negotiated derivatives. In that report, IDSA reports "The notional amount outstanding of credit default swaps (CDS) grew 37 percent to $62.2 trillion in the second half of 2007 from $45.5 trillion at mid-year. Further CDS notional growth for the whole of 2007 was 81 percent from $34.5 trillion at year-end 2006. The survey monitors credit default swaps on single names and obligations, baskets and portfolios of credits and index trades." [Emphasis added]

Holy crap! No wonder there was so much concern about counter-party risk a month ago when a "run on the bank" which led to the acquisition of Bear Stearns by JPMorgan. Toomre Capital Markets LLC ("TCM") now even more appreciates the efforts of the President of New York Federal Reserve, Timothy Geithner, to clean up the credit default swap middle and back office operational issues. With growth this explosive, the major investment and global banks are particularly interconnected. From a moral hazard perspective, due to their derivatives exposures, are not all of these banks "too big to fail"? Or does this explosive growth suggest that the Capital Markets finally needs a global clearing mechanism so that there is more price transparency on what specific derivatives are worth and that there is less counter-party risk in the financial system?

In recent days, what Toomre Capital Markets LLC ("TCM") considers to be two of the most challenging Chief Risk Officer ("CRO") roles in the financial services sector have been filled. Both JP Morgan Chase with its considerable Credit Default Swap ("CDS"), leveraged loan and other large derivative exposures and Citigroup with its kitchen-sink collection of issues have named new CROs.

On Monday November 26th 2007, JPMorgan Chase announced that former Goldman Sachs managing director and chief administrative officer, Mr. Barry Zubrow, had been hired as its Chief Risk Officer. Starting December 1st, Mr. Zubrow will be reporting directly to CEO Jamie Dimon and will be a member of JP Morgan's Operating Committee. Earlier in his career, Mr. Zubrow was Chief Credit Officer and co-head of the Goldman Sachs risk committee that oversaw that investment bank's strong risk culture which is credited with helping Goldman Sachs steer clear of much of the losses associated with this year's subprime meltdown.

Apparently, CEO JPMorgan Jamie Dimon had been fulfilling this role for the bank since former CRO Don Wilson retired at the end of 2006. JPMorgan's recent performance during the credit market turmoil suggests that, unlike former Merrill Lynch CEO Stan O'Neal who apparently was off playing golf on many business days during the summer seizures, Jamie DImon was very much hands on (like Goldman Sachs CEO Lloyd Blankfein and Lehman Brothers CEO Dick Fuld were widely reported to be). Is it any wonder then that JPMorgan, Goldman Sachs and Lehman Brothers have fared relatively well during the mortgage credit crunch, especially when compared to Citigroup, Merrill Lynch, and Bear Stearns?

In response to yesterday's post Event Driven Architecture - Event Processing Moving Forward?, several other sources of information on Event Driven Architecture have been highlighted. One is a new blog by the leaders of the Apama team over at Progress Software. Another is the web site of the Aite Group.

Another reader suggested that Toomre Capital Markets LLC ("TCM") also highlight the other major vendors of software for an Event Driven Architecture. In addition to Streambase Systems (whom we mentioned is a client of TCM), other significant players in the event processing space include: TIBCO BusinessEvents, Progress Apama, Coral8, Aptsoft, Aleri, Kaskad, KX and Vhayu.

At present, the two largest vendors in the financial services vertical are probably TIBCO and Progress Apama. However, one must always take vendor reports of number of customers with a grain of salt in the financial services space since so many financial firms request anonymity as a condition of their contractual arrangements.

No doubt there are pluses and minuses to each one of these respective vendors. However, Toomre Capital Markets LLC would like to reemphasize that leading financial firms need consider the competitive advantage that Event Driven Architecture provides in the move to real-time (and continuous) trading, near real-time Enterprise Risk Management, and near real-time compliance applications.

If the reader has any questions, please feel free to contact Toomre Capital Markets LLC as indicated below. Reader comments and thoughts are welcome.

On Thursday March 1st 2007, the United States federal regulators filed civil (and unspecified criminal) charges against 11 individuals and three entities in connection with two insider-trading schemes in which insiders (employees) at UBS Securities LLC and Morgan Stanley allegedly provided inside (non-public) information that helped hedge funds, brokers and others make at least $15 million in illicit profits. According to Reuters, "eight Wall Street professionals, two broker dealers, a day-trading firm, and three hedge funds are accused of participating in a scheme that used information stolen from UBS and Morgan Stanley."

[Update: The SEC has now released a press release entitled SEC Charges 14 in Wall Street Insider Trading Ring; Defendants Include Hedge Funds, Lawyers and Professionals at UBS, Bear Stearns, and Morgan Stanley with more information on the participants. Those charged include: Mitchel S. Guttenberg; Erik R. Franklin; David S. Tavdy; Mark E. Lenowitz; Robert D. Babcock; Andrew A. Srebnik; Ken Okada; David A. Glass; Randi E. Collotta; Christopher K. Collotta; Marc R. Jurman; Q Capital Investment Partners, LP; DSJ International Resources Ltd., which does business as Chelsey Capital; and Jasper Capital LLC.]

According to The Wall Street Journal, "The Securities and Exchange Commission said that in one scheme, which was ongoing since 2001, a UBS executive director, Mitchel Guttenberg, illegally tipped off at least two traders to information about upcoming UBS analyst stock upgrades in exchange for sharing in the illicit profits. One of the traders illegally traded on the information for two hedge funds and in his and his father-in-law's personal accounts, the SEC said."

The other scheme was said to involve Randi Collota, an attorney in Morgan Stanley's global compliance department, and her husband. They apparently provided information about upcoming corporate actions to a Florida broker in exchange for sharing in the some portion of the illicit profits that resulted.

Bloomberg News is reporting on February 15th 2007 that Bear Stearns Cos. has been ordered to return at least $125.1 million to Manhattan Investment Fund Ltd., a failed hedge fund, that now is bankruptcy proceedings. This surprising court ruling likely will prompt other Wall Street firms with prime brokerage operations to scrutinize their most lucrative trading clients even more aggressively.

Burton Lifland, the U.S. judge overseeing the bankruptcy of Manhattan Investment Fund Ltd., made the ruling at a hearing in New York today. Lifland concluded last month that Bear Stearns, one of the biggest brokers to hedge funds, was trying to cover its own potential losses and didn't investigate thoroughly after learning of possible fraud at Manhattan Investment, court filings show. Bear Stearns faced returning as much as $180 million.

``Bear Stearns failed to act diligently in a timely manner,'' Lifland said in a Jan. 9 opinion, finding that the New York-based company, the fifth-largest U.S. securities firm, learned as early as December 1998 that fund manager Michael Berger may have been deceiving investors about returns.

Today's ruling adds to the pressure on securities firms to monitor hedge funds, which pay Wall Street about $10 billion annually in fees for prime-brokerage services. Federal regulators already are probing whether the securities industry sets strict enough limits when lending to hedge funds, and the U.S. Securities and Exchange Commission has said prime brokers should be a ``window'' into their dealings.

``This is going to send shock waves through many prime brokers, because they've been very careful to limit their responsibility for their customers' actions,'' Michael Missal, a former SEC lawyer and head of the regulatory practice at Kirkpatrick & Lockhart Preston Gates Ellis LLP in Washington, said before today's hearing. ``They do not want to be seen as insurers for their clients.''

Toomre Capital Markets LLC agrees whole-heartedly that securities firms do not want to be the "deep pockets" that "insure" hedge fund investors against fraud and other illegal activities that may occur at an alternative investment vehicle. The very interesting question is how much responsibility should prime brokers have for policing the activities of their hedge fund clients, especially in a world where the larger hedge funds have multiple prime broker relationships. Your thoughts on how important a ruling this is and what responsibilities prime brokers should have are most welcome.