Envied by rivals for its share of the hedge fund prime brokerage market, Morgan Stanley was an early and successful entrant in the business. Alongside Goldman, Sachs & Co. and now-defunct Bear Stearns Cos., it dominated for 20 years or more. But Morgan’s stature dropped not long after Lehman Brothers Holdings filed for bankruptcy on September 15 (the same day Merrill Lynch, in a preemptive move, sold out to Bank of America Corp.). Spooked by the crumbling markets, clients began to reduce their holdings at Morgan — whose stock price by mid-December was down 75 percent from its 52-week high — and some even pulled out entirely. The firm lost more than 30 percent of its balance sheet over the course of a few weeks this past fall. Banner clients that cut assets or made for the exits included New York–based, $13.6 billion Millennium Partners.
John Mack, Morgan’s hard-nosed CEO, reminded people of why his nickname is Mack the Knife when he issued a memo on September 17 in which he took short-sellers to task for the bank’s troubles. His was one of the loudest voices on Wall Street calling for a rule against short-selling on certain securities (including his firm’s stock). This irked many a hedge fund manager: They were Morgan customers, after all — cash cows for the bank — and Mack was threatening the lifeblood of their industry.
“You had the most proficient prime brokerage platform in the marketplace being compromised by its leader,” explains Keith McCullough, a former portfolio manager at Evanston, Illinois–based, $9 billion Magnetar Capital and now CEO and CIO of Research Edge, an independent investment boutique in New Haven, Connecticut. “He tried to ban short-selling!” In the ensuing weeks, Mack made clear that his firm was dialing back its prime brokerage and — like many big brokerages — began culling smaller clients especially, a further affront to hedge funds.
James Zurlo, head of prime brokerage sales at broker-dealer Gar Wood Securities in New York, estimates that a fund must now manage $150 million to get in the door of a major prime brokerage.
Morgan may have done more than other investment banks to alienate hedge fund managers, but the prime brokerage business has slowed everywhere. As hedge fund wealth has evaporated in the current downturn, a lot of the traditional warmth between brokers and funds has cooled. Things change, of course, and springtime may bring a thaw.
