Prime Executions, Inc. announced last week that it has entered the research business “in an effort to better service our clients”.  Integrity Research tracks 3,738 active research firms in its database, and most likely there are half again as many providers we don’t track.  Are Prime Executions’ clients clamoring for more research providers?  Not likely.  Prime Executions is following a long list of research firms like lemmings to the sea.

Not infrequently we get calls from analysts who are thinking about setting up their own boutiques asking for advice.  Our advice: don’t.  It is an extremely tough market, and the odds are stacked against success.  Usually, however, they don’t follow our advice, convinced that they can make a go of it.

The handful of successful research boutiques, like Autonomous Research LLP, are siren calls to all the research wannabees.  In its latest financials for the fiscal year ended March 2013, Autonomous Research’s revenues were up 19.7% over the previous year, at £21.4 million (US$34 million).  Profit, net of £3.4 million (US$5.4 million) in bonuses, was £10.9 million (US$17 million).  What’s not to like about Autonomous?

Autonomous continues to innovate in the way it runs its research business.  Part of the increase in its revenues came from adding a three person credit trading team, which contributed 13% of revenues, a juicy £2.8 million (US$4.4 million) in incremental revenues.  The credit traders are generating direct fixed income trading commissions, giving clients another way to pay for research through direct trading.  Hats off to Autonomous for finding an effective new payment mechanism, adding another form of bundled trading since Lord Myners joined the firm as Chairman.

Autonomous’s new U.S. subsidiary, launched a year ago when Guy Moszkowski defected from BoA Merrill Lynch, is not as successful, adding only £.6 ($1 million) in revenues, suggesting how much tougher the market is in the U.S.  In fairness, the results are not a full 12 months, since the U.S. operation wasn’t announced until June.  Also, the contribution from the U.S. operation is likely a royalty payment with the bulk of U.S. revenues going to pay the U.S. staff.

Nearly half (47%) of Autonomous’ revenues are generated from commission sharing arrangements (CSA’s), direct equity trading represents 37% of revenues, while 13% comes from the new credit trading group and the U.S. operation is 3%.  Direct equity trading has been very successful for Autonomous, at £7.9 million (US$12.6) up from £7.3 (US$11.7) the year before.  How many brokers can point to increased equity commissions in this environment?

Contrast Autonomous with Prime Executions’ effort.  Prime has hired 2 traders, a strategist who was previously at Bay Crest Partners and an energy analyst previously with Phoenix Partners.  Not the top ranked analysts who started Autonomous.  Nevertheless, optimism prevails:  “The team will be a tremendous asset to our firm and will position us for future expansion,” says Andrew Silverman, President and CEO of Prime Executions, Inc.  Good luck with that.

New York, NY – Last week, the SEC reached a tentative settlement in New York Federal Court over an alleged civil insider trading case involving two technology companies with hedge fund executives Anthony Chiasson and Todd Newman.  Newman and Chiasson were criminally convicted in December and sentenced in May for insider trading.  However, most surprising about this case was a recent article in Forbes magazine arguing that Newman’s conviction could spell trouble for all hedge fund managers.

SEC Settlement

In May, Anthony Chiasson, a founder of Level Global Investors, and Todd Newman, portfolio manager with Diamondback Capital Management, were found guilty of criminal insider trading charges with respect to Dell Inc. and Nvidia Corp.  In May the two were sentenced to 78 months and 54 months in prison, respectively.

The SEC filed parallel civil charges against the two for insider trading in these two stocks.  Last Monday, the SEC informed U.S. District Judge Harold Baer that it had reached “partial settlements in principal” with the two defendants.

These settlements would bar Chiasson and Newman from further violating federal securities laws and from associating with investment advisers, broker-dealers and other entities registered with the SEC, according to the letter by SEC senior counsel Daniel R. Marcus.

The settlements are only partial because they do not contain disgorgement or civil penalties. Those issues would be deferred while Chiasson and Newman appeal their sentences in the criminal matter, Marcus said.

Newman Case

While the sentencing of the two is not particularly interesting, an article published last week in Forbes magazine about the Newman case is more compelling (click on the following link for the complete article http://www.forbes.com/sites/walterpavlo/2013/06/14/todd-newmans-insider-trading-conviction-hedge-funds-take-heed/#).

In this article, the author, Walter Pavlo, presents Newman as a recipient of illegal information collected by one of his analysts – Jesse Tortora.  Tortora was previously convicted of insider trading, and has been identified as being part of a group of four analysts who worked for four different funds who each admitted to having obtained, handled and distributed material nonpublic information from publicly traded companies.

However, the article suggests that Newman was not part of any conspiracy to commit insider trading.  Rather he was a portfolio manager who, in addition to doing his own research, relied on the research of one of his firm’s analysts – Tortora.  Tortora used the inside information he received from his and his group’s contacts to inform his analysis and estimates, which he provided to Newman as a regular part of his job.

Pavlo makes the following arguments about the case:

“First, Newman fired Tortora (Tortora said he quit with one day’s notice and no job to go to …. you decide) in April 2010.  Why would a person fire someone from a multimillion dollar job when they are supposed to be part of a criminal enterprise?  If I were Tortora at the time, I would have run to the feds and been part of some whistle-blower settlement rather than waiting for the FBI to show up.

Second, according to testimony from Tortora and others, there were numerous challenges presented by Newman and other portfolio managers on every piece of information used in trading decisions.  There was never an instance where Tortora said, “Here are the earnings, go buy/sell as much as you can?”.  If anything, Newman would question information, information that according to Tortora was confidential, over and over again.  If someone knew the information was truly confidential, why not just run with it?

Third, all of Newman’s email communications with Tortora used the company email address … no stealth gmail or Yahoo account.  Tortora’s Fight Club all used emails outside of their work email to communicate about their information.  Emails for Diamondback were all retained as part of a company policy … and that was the only email Newman used.

Fourth, Newman sends out “Good Call on Dell” in an email to Tortora after the quarter ends with results that were very much in line with what Tortora thought they would be.  Why would you congratulate a guy about an earnings call if, as Preet Bharara said, you “are trading on tomorrow’s news today”?

Fifth, after Tortora left Diamondback, he continued communicating with the “Fight Club”.  In fact, at trial Tortora said of his continued contact, “I was looking for a job so I felt like I should stay in touch with those in the industry so that I wasn’t too far out of the loop.”  Consider yourself lucky he didn’t come work for you!”

Everyone Guilty of Insider Trading?

Pavlo effectively argues that Newman was found guilty of insider trading because his former analyst at Diamondback, Jesse Tortora, knowingly provided him with inside information in an effort to get ahead at Diamondback.  Unfortunately, Newman did not know that Tortora was giving him anything other than good research.  In an effort to save himself, Tortora gave Newman up to the Feds to lessen his own sentence.

The interesting point made in the article is that if Todd Newman could be found guilty of insider trading, then most hedge fund managers could as well, whether or not they intentionally try and obtain and trade on material nonpublic information.  It all comes down to what their analysts do regardless of whether they were asked to do it, and even if the portfolio manager is unaware of the analysts’ activities.

Of course, Pavlo’s assertions have yet to be proven one way or the other.  However, it will be interesting to see how Newman tries to defend himself in the appeal of his criminal conviction.  Until that occurs, one good question to ask yourself if you are a hedge fund manager is, “How much do you trust your analysts?”

Direct Access Partners (DAP), an institutional brokerage firm, closed after the SEC accused two employees of bribing a Venezuelan official for bond business. Separately, the firm was building a distribution platform for third party research.

In early May, the SEC accused 2 DAP employees of generating $66 million in transaction fees on riskless principal trades in Venezuelan sovereign or state-sponsored bonds for Banco de Desarrollo Económico y Social de Venezuela (BANDES), a state-owned bank. A portion of this revenue was illicitly paid to an official at BANDES who authorized the fraudulent trades.

Tomas Clarke, an Executive Vice President at DAP, was hired by DAP in October 2008, along with two other fixed income traders from Lighthouse Financial, which subsequently shut its doors in 2010.  Clarke and the other two executives formed a subsidiary, DAP Global, which received 60% of profits generated by the group, and shared by Clarke and the other two former Lighthouse traders.

Prior to hiring Clarke, DAP was an equity brokerage, generating $15 million in revenues in 2007 and $27 million in 2008, according to the SEC complaint. After hiring the fixed income trading team from Lighthouse, DAP’s revenues soared to $75 million in 2009. According the SEC complaint, the increase was entirely caused by the fraudulent BANDES trading.

According to the SEC’s complaint, Clarke’s share of DAP Global’s profits was $3.8 million between January 2009 and June 2010. 90% of this amount, or $3.4 million, was purportedly linked to fraudulent BANDES trading. In addition, $20 million was paid by DAP to a relative of Clarke’s in “foreign finder’s fees” and “foreign associate fees”. $6 million was channeled through payments to a DAP employee who was an unregistered “back office” employee, and another $8 million was paid to the DAP employee’s wife in “foreign finder’s fees”.  A portion of these fees was paid to the BANDES official authorizing the fraudulent trades.

As part of the scheme, DAP Global would mark up the sovereign bonds transacted on behalf of BANDES in riskless trades by as much as 8%, according to the SEC complaint. DAP Global also apparently purchased bonds from BANDES and sold them back the same day. In one example cited by the SEC, DAP purchased $132 million of Electricidad de Caracas (ELECAR) from BANDES at $66 and then immediately sold them back at $70. On the following day, DAP bought $131 million of the same bonds at $66 and sold them back at $70. The total markup on the two transactions was over $10.5 million.

The SEC also claimed that Clarke and his associates regularly cheated the bent Venezuelan official. The original deal was to pay the official 50-70% of the fraudulent markups, but in reality she received only around 10% of the markups, according to the SEC.

The only evidence of compliance supervision in the SEC complaint was a query from the compliance department of one of the clearing brokers, asking for a biography for one of the individuals receiving foreign finder’s fees. The finder’s fees were apparently raising questions with clearing brokers, but not with DAP’s own internal compliance department.

DAP’s meltdown results in one less distributor of independent research. DAP was building an independent research distribution platform, and had announced a distribution arrangement with Merchant Forecast.  Given the difficulty in marketing research in the current environment, DAP’s demise is unfortunate for independent providers looking for assistance in expanding their client base.

New York, NY – Last week a Pasadena California-based wealth management company and its former fund manager, agreed to settle an SEC insider trading case involving three public technology company’s shares.

Background of the Case

The portfolio manager, Victor Dosti, and his employer, wealth management firm Whittier Trust, was charged by the SEC with engaging in insider trading over a three-year period in shares of Dell Computer, Nvidia and Wind Systems.

The SEC said Dosti used nonpublic information from Dell and Nvidia employees to trade ahead of five earnings announcements between 2008 and 2010, and from an Intel Corp employee about the chipmaker’s talks to buy Wind River in 2009.

According to the SEC complaint, in 2008 a Dell employee passed information on upcoming quarterly earnings announcements through a New York-based investment adviser who had worked at Dell. The investment adviser passed the information on to an analyst at Diamondback Capital Management LLC.  From there, the information was provided to Danny Kuo, a Whittier Trust fund manager who worked under Mr. Dosti.  Mr. Kuo passed on the illicit information to Mr. Dosti.

“Time and again, Dosti received what he knew was inside information from Kuo and traded on it to generate illicit gains,” Sanjay Wadhwa, senior associate director of the S.E.C.’s regional office in New York, said in a statement.

Settlement Terms

In its complaint, the SEC said that Dosti generated illicit profits or avoided losses for Whittier in excess of $724,000 as a result of the insider trading in these three technology companies. As a result, Dosti and Whittier agree to pay $1.682 mln to settle the charges with the SEC.

Whittier agreed to payments totaling $1.523 mln, comprised of:

• Disgorge profits of $724,052
• Pay interest of $75,296 on ill-gotten gains
• Penalty of $724,052 equal to the amount of illicit profits.

Similarly, Dosti agreed to payments totaling $158,751, comprised of:

• Disgorge profits of $77,900
• Pay interest of $2,951 on ill-gotten gains
• Penalty of $77,900 equal to the amount of illicit profits.

In neither case did the defendants admit nor deny wrongdoing.  The case is SEC v. Dosti et al, U.S. District Court, Southern District of New York, No. 13-03897.

Other’s Involved in the Scheme

Mr. Dosti is the latest person to settle insider trading allegations with the SEC who were purportedly part of an insider-trading ring involving junior-level analysts at a number of different investment funds.

The alleged insider-trading ring also included Todd Newman, a former portfolio manager with Diamondback, who was convicted and sentenced to 54 months in prison.  It also included Anthony Chiasson, a former hedge-fund manager at Level Global Investors who was convicted and sentenced to 78 months in prison, and Jon Horvath, a technology analyst with SAC who pleaded guilty and is cooperating with the investigators.

Horvath said he shared the information about Dell and Nvidia with Michael Steinberg, a longtime SAC trader.  Mr. Steinberg has pleaded not guilty and is scheduled to stand trial on Nov. 18.

Frost Consulting and Quark Software have jointly published a white paper which examines recent research trends and the pressures on brokerage research: unbundling of research commissions is increasing competition for research allocations, even as commissions have declined and the banks’ cost of capital has increased. Despite the pressures, the paper suggests that asset managers are likely to continue to rely on investment banks for research, partly because it is in their financial interest.

As we have reported in the past, Frost Consulting, a UK based consulting firm specializing in global equity commission unbundling and related market structure/regulatory change, estimates that global institutional equity commissions were $33 billion in 2011. Of this 33% were allocated to execution and the remaining $22.1 billion to advisory services, primarily research.

In its latest paper, “Optimizing Research ROI in an Environment of Structural Change”, Frost estimates that 70% of equity commission volume traded in the UK is being paid through Commission Sharing Arrangements (CSAs), which allow asset managers to pay separately for research and execution services. Frost estimates that 50% of commission volume in Europe (ex-UK) is traded through CSAs and 40% in the U.S.

Compounding the pressures from unbundling, equity commissions have declined significantly since the financial crisis. Frost points out that the decline is worse outside the U.S., where commissions are calculated as a percent of the share price. Frost estimates that 2012 equity commissions were down 48% from their peak in Asia and down 58% in Europe (and a mere 29% in the U.S.)

Despite unbundling and cuts in brokerage research product, asset managers remain highly dependent on brokerage research, especially in Europe. In a survey Frost conducted in 2012, investment banking research represented over 80% of the external research utilized by three quarters of the European CIOs surveyed.

Frost calculates that if the estimated $5 billion of brokerage research costs were shifted to the buy side, asset managers’ 20% profit margins would be cut in half. Frost estimates that brokerage research costs have already shrunk by 42% from their $8 billion peak in 2007, and this rationalization process is likely to continue further.

Reflecting Quark’s sponsorship, the paper outlines how a digital publishing platform such as Quark’s can provide savings and productivity improvements.

We are less bullish than Frost Consulting on unbundling. Regulators are unlikely to force the issue. The predecessor to the UK’s Financial Conduct Authority declared victory on commission transparency in 2009 and, for staffers at the U.S. Securities and Exchange Commission, commission transparency is a dim memory at best.

Nevertheless, the inexorable decline in commissions is proving as powerful a force as regulatory mandates. Unfortunately, this is a cruel process for all research providers, large and small. We believe the end result will be a more open market structure, for those firms which can endure the process.

New York, NY – The ongoing insider trading investigation at $15 bln Stamford CT-based hedge fund SAC Capital, is expected to have a huge impact on 2^nd Quarter investor redemptions, with some estimating that $3.5 bln in redemption requests will be submitted.  This follows $1.7 bln in redemption requests in the 1^st qtr.

Redemptions Mount

According to executives at SAC Capital, withdrawal requests are expected to reach $3.5 bln in the second quarter as firms like Blackstone, Magnitude Capital, and Ironwood Capital have already asked to withdraw capital from the fund.  Blackstone, the largest outside investor in SAC, has decided to redeem a significant portion of its roughly $550 million allocation from the hedge fund, while Ironwood has submitted a request to withdraw $100 mln in capital.

At the beginning of 2013, outside investors in SAC Capital accounted for roughly $6.75 billion of the $15 billion in assets managed by the hedge fund.  In the first quarter, outside investors submitted requests to withdraw about $1.7 billion of that $6.75 billion by the end of the year.  If redemption requests hit $3.5 bln in the second quarter as feared, SAC would be left managing less than $1.5 bln in assets for outside investors.

Waning Investor Confidence

The spate of redemption requests in the last two quarters at SAC is a direct result of waning investor confidence resulting from the government’s ongoing insider trading investigation at the hedge fund.  In March, SAC Capital reached a $616 million agreement with the U.S. Securities and Exchange Commission to settle allegations that the hedge fund’s employees had engaged in insider trading in four stocks.

Despite this, the SEC continues to investigate the firm for additional insider-trading issues.  Earlier this month federal authorities issued grand jury subpoenas seeking testimony from SAC founder Steve Cohen and four other executives at the hedge fund, including portfolio manager   Anthony Vaccarino, president Tom Conheeney, chief operating officer Solomon Kumin, compliance head Steve Kessler, and director of trading Phillipp Villhauer.

Plans to Return Outside Capital Possible

Some say that SAC Capital Advisors is preparing plans to return capital to outside investors and become a family office.  A decision on this plan could some within a few weeks.  The reason Cohen might do this is because US prosecutors are considering racketeering charges against SAC as a criminal enterprise. To avoid these or any other charges, Cohen could offer shutting down the firm to outside investors, as part of a negotiated settlement to prosecutors.

The second quarter redemption deadline for SAC is Monday, June 3^rd, 2013.

Scott Mushkin, an Institutional Investor ranked retail analyst, has left Jefferies & Company to join Wolfe Research along with two of his team members.  Mushkin had been a Managing Director at Jefferies since 2008, and previously with Bank of America and Lehman.  He will be covering discount retailers, supermarkets and drugstores, with a secondary focus on the burgeoning healthy lifestyle industry.

Recruiting Mushkin helps Wolfe in two ways.  First, it boosts the firm after the recent defection of François Trahan to Nancy Lazar’s new Cornerstone Macro LP.  Second, it represents a significant step in expanding Wolfe’s coverage beyond his core transportation-related sectors.

Wolfe and his immediate team cover Airfreight & Surface Transportation, Airlines, Auto and Truck O.E.M. & Suppliers.  Steven Fleishman, another II-ranked analyst, covers Electric Utilities.  Fleishman joined Wolfe from Bank of America, where he had worked with Scott Mushkin prior to Mushkin’s move to Jefferies in 2008.  In the latest Institutional Investor poll, Wolfe Research (#12) edged out Jefferies (#13) in the firm rankings, and Mushkin’s defection is likely to increase the gap between the firms.

Chris Senyek was promoted to Chief Investment Strategist and Lead Quantitative Analyst after Trahan’s departure, in addition to his previous coverage of Accounting & Tax Policy.

In Institutional Investor’s 2012 poll, its most recent, Mushkin was named to the All-America Research Team, ranking third in Consumer – Retailing/Food & Drug Chains. In the same year, he was also named to the Financial Times’ StarMine Analyst Awards, ranking 1st and 3rd for the “Top Stock Pickers” and “Top Earnings Estimators” lists, respectively, for Food & Staples Retailing. Additionally in 2012, The Wall Street Journal named Mushkin to “The Master Stock Pickers” list, ranking him 2nd in Retailers: Food & Drug.

Mike Otway and Brian Cullinane, also left Jefferies as part of Mushkin’s retail team.

New York, NY – Earlier this month, Craig Moffett, a former top ranked telecommunications analyst at Sanford C. Bernstein, announced the opening of his own independent equity research firm, Moffett Research, LLC.  Three of his Bernstein colleagues will join Moffett as partners.

Background

Craig Moffett, left Sanford C. Bernstein, in January of this year after more than 10 years at the firm.  Moffett had been ranked No. 1 among U.S. cable and satellite analysts for seven consecutive years by Institutional Investor magazine. Prior to working for Bernstein, Moffett served as president of Sothebys.com, and previously he spent 11 years at the Boston Consulting Group, where he led the firm’s global telecommunications practice.

Former Bernstein colleagues Patrick O’Connell, Ethan Steinberg and John Towers, have joined Moffett as partners in the new independent research firm.  David Cielusniak, an attorney, formerly at New York-based Conquest Capital Group, LLC will also join the firm as a partner and will serve as general counsel, chief compliance officer and chief operating officer.

Moffett Research is planning to initiate coverage in the cable and satellite sector in June, before the National Cable and Telecommunication Association’s annual conference starts on June 10^th. The firm expects to add other coverage areas, including telecommunications, later that month.

In Good Company

Moffett is just the latest in a string of star Wall Street analysts over the past decade who decided to leave prominent sell-side investment banks in order to set up their own independent research firms.

Over the past few years, some of the highly ranked sell-side analysts who have successfully made the switch to offering independent research include Michelle Applebaum, Dana Telsey, Ed Wolfe, Ivy Zelman, Bill Pecoriello, Stuart Graham, Meredith Whitney, Jeffrey Sprague, and Jeff DeGraaf.

And while each of these firms have been able to attract healthy demand from the buy side, most of these analysts will admit that it was more difficult than they originally expected to get customers to pay them what they felt their research was worth.

Difficult Market Environment

One of the major reasons for this is the fact that the market environment for research in general has been extremely difficult in the past few years.   Part of this has been a result of sharp drop in equity commissions over the past 5 or 6 years.  Many Wall Street veterans say that the equity commission pool has fallen 30% to 50% since the peak in 2007.

Another reason the market environment has been so challenging for independent research firms has been the fear that unregulated independent research firms might pass along MNPI or confidential company information to buy-side clients.  Consequently many asset managers stopped adding new independent research firms in the past few years until this concern was addressed.

This fear has prompted many buy-side firms to design and implement extensive compliance due diligence procedures to ensure that their third-party research firms have the compliance infrastructure in place to protect them from risky information.

Turnaround in the Offing?

However, a number of asset managers have started adding new independent research providers over the past four or five months.  This trend has been consistent with a turnaround in equity commission volume, and reduced anxiety about the compliance issues associated with third-party research as firms have implemented their own controls.

This may also explain why analysts like Nancy Lazar (formerly of ISI), Dane Mott (formerly of JP Morgan), and now Craig Moffett have all decided to start new independent research firms since the turn of the New Year.

The real question is whether this trend will continue into the second half of 2013.  Certainly, a large number of independent research firms are hoping this turnaround is the start of a prolonged uptrend, including Craig Moffett and his team at Moffett Research.  We will just have to wait and see.

ITG is a bellwether for commissions and, with its acquisition of Majestic Research and subsequent purchase of Ross Smith Energy Group, it is a publicly traded example of an agency broker seeking to profit from higher commissions generated through research. Unfortunately, while the commission environment seems to be improving, all does not seem well with ITG’s research operation.

Improved Environment

ITG’s first quarter revenues increased 9% over the fourth quarter results. As in its 4^th quarter call, ITG was cautiously optimistic on the commission environment. This quarter it cited improving inflows into equity assets, a hopeful sign for commissions:

“For the first time in 10 quarters, we witnessed positive domestic equity inflows with active equity managers experiencing an estimated $20 billion in domestic equity fund inflows… While these flows in and of themselves did not amount to a great rotation back in equities, they are improvement over the heavy outflows we’ve seen over the past few years.”

Business Line Results

This quarter marked the first time ITG released financial results for its lines of business, including research. ITG’s 9% revenue increase was driven by a 19% increase in electronic brokerage revenues from $58.3 million in the fourth quarter to $69.6 million in the first quarter. Research revenues, however, were down 7% from $27.4 to $25.4 million.  For details, follow this link: http://investor.itg.com/files/doc_presentations/2013/ITG_1Q13_EarningsPresentation_02May13_FINAL.pdf

The official explanation of the decline in research revenues was bad timing: “Revenues from research sales and trading declined due in part to a decline in project based work and the timing of payment from research accounts that pay on a discretionary or voting basis.”

Product allocations are notoriously difficult for brokerages. If an asset manager directs more commissions to ITG, how much of that is attributable to increased volume and how much to the research product? ITG’s electronic brokerage group, its flagship operation, will believe that any increase will be due to its capabilities and relationships.  And now that internal resource allocations are on the line, the passion gets even stronger.

A Zero Sum Game?

As we noted when ITG first announced its product profitability review in February, business line analysis is typically not flattering to research. Now that ITG has decided run its business based on product profitability, the existing culture will tend to favor electronic brokerage rather than research. The risk is that the win/win of trading and research turns into a zero sum game where trading will prosper at the expense of research.

When asked by an analyst about the decline in research, ITG CEO Bob Gasser suggested that some of the benefit from research was being booked with electronic brokerage: “I think the overall dynamic – some of that [revenues] shifted into the brokerage world, in some cases the electronic brokerage world has benefited from a higher rate card, if that’s the client’s preference in terms of how they want to interact with us, and pay for the various products and services they consume.”  In other words, some of the benefit of ITG’s research is showing up in the electronic brokerage revenues.

Management Turnover

Here is another clue that research is becoming a losing proposition at ITG: research management departures. Tony Berkman, who was the CEO of ITG Investment Research and previously CEO of Majestic Research, left ITG this month. According to his LinkedIn profile, Tony is now an employee at an unnamed hedge fund.

Terry Gardner, the ex-CEO of Soleil Securities, who was recruited to be the COO of ITG Investment Research after the Ross Smith acquisition, also left ITG this month. According to LinkedIn he is doing consulting.

Research operations are run by co-heads Jie Zhang (a 9-year veteran of ITG and Majestic before that) and Jim Jarrell (formerly president of Ross Smith Energy Research, which he joined in 1999).

The departures of Berkman and Gardner, both experienced research managers with track records of running large research operations, suggests that all is not well with ITG Investment Research.

New York, NY – Last week, JP Morgan Chase sent a formal letter to global market data vendor Bloomberg LP, requesting five years of internal logs verifying what data the firm’s journalists had accessed about how the bank’s employees had used the terminal. JP Morgan also sought confirmation of the controls that have been put in place to keep this from occurring again.

Background on the Issue

In a formal statement, JP Morgan Chase said, “Our legal department sent a formal request to Bloomberg to verify exactly what information reporters had access to and confirmation of their controls to prevent future breaches.”

The request by JP Morgan came last week after it became known that Bloomberg journalists had long accessed information about the usage patterns of its subscribers. This transpired because executives at Goldman Sachs had expressed concern over the practice to Bloomberg after one of the firm’s reporters shared the terminal login habits of one of Goldman’s executives to another.

This acknowledgement has sparked both concern and anger across Wall Street as traders and investment bankers have wondered what types of proprietary data Bloomberg’s journalists have had access to.

Bloomberg says that its reporters have historically had access to a user’s login history, help desk inquiries, and how many times different computer programs were accessed.

Bloomberg’s Response

Matthew Winkler, the editor-in-chief of Bloomberg News publically apologized last week, explaining that this access can be traced to long-time practices at Bloomberg News. “Our reporters should not have access to any data considered proprietary. I am sorry they did. The error is inexcusable,” Winkler wrote in an op-ed.

In an internal memo to Bloomberg employees sent last Friday, CEO Dan Doctoroff also expressed his apologies, writing: “Client trust is our highest priority and the cornerstone of our business, and we are deeply committed to ensuring the complete integrity and confidentiality of our clients’ data in all situations and at all times.”

Last week, Bloomberg also said that it had restricted its journalists from accessing any information about its terminal subscribers, including the information they had previously been able to access. In addition, Bloomberg said that it had appointed Steve Ross, a senior executive responsible for the day-to-day operations of its market data terminal business, as its first dedicated compliance chief.

As a result of this scandal, Bloomberg has been in contact with executives at a number of their large customers, including JP Morgan, Goldman Sachs and Morgan Stanley in an effort to convince them that they were addressing this issue and that their firms’ proprietary data had always been kept confidential.

The Market’s Reaction

Thomas Nides, Morgan Stanley’s vice chairman explained their firm’s interactions with Bloomberg management on this issue, saying: “They’re assuring customers this was a mistake and that they’re going to rectify that. We want to make sure we have all the facts, but right now we’re taking the company’s assurances,” that the issues with use of customer data didn’t extend to trades or instant-message conversations.

Goldman Sachs’ President Gary Cohn has also spoken extensively with Bloomberg management about this issue. Last week he told the media that the bank does not have a major concern about the issue.

Despite these expressions of confidence in Bloomberg’s response, some are not so convinced. Citigroup used this development as an excuse to move its foreign exchange traders from using the Bloomberg messaging service to their own internal chatrooms. In addition, some Wall Street traders have started discussing whether the big banks should try to form a cooperative that could compete with Bloomberg.

Integrity’s Assessment

We are not convinced that a mass exodus to an alternative market data platform is likely over the near term as the Bloomberg terminal has become deeply imbedded in the workflow of many sell-side and buy-side firms. However, we would not be surprised if some clients use this development as a reason to emphasize a competing provider like Thomson Reuters, FactSet or S&P Capital IQ.

We do believe that this scandal, on top of the news a few weeks ago that Thomson Reuters was sending out certain data earlier to specific clients, is likely to prompt market data firms and their Wall Street clients, to become much more sensitive to the potential compliance risks associated with the use of these previously “safe” information sources.