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Big Banks Bleed Best and Brightest to Hedge Funds

NEW YORK ( TheStreet) -- While the Volcker Rule hasn't yet been implemented, buy-side analysts, traders and investment managers are already leaving the big banks to strike out on their own.

The major banks continue to battle regulators over the implementation of the Volcker Rule -- part of the Dodd Frank Wall Street Reform and Consumer Protection Act -- and its confusing ban on most proprietary trading, but the writing is on the wall.
Paul Volcker

On Sunday, the Financial Times reported that Mike Stewart, JPMorgan Chase's (JPM - Get Report) global head of proprietary trading, was planning to leave the firm to start his own investment fund while taking several JPMorgan employees with him.

The Financial Times also said that Deepak Gulati, who was slated to move into JPMorgan's asset management division, was also considering exiting the company to start his own fund, based on Zurich. The FT cited unnamed sources.

Another new investment fund.

Douglas Ormond -- former JPMorgan Chase executive director and portfolio manager for proprietary trading -- and Michael Schwartz -- former star principal and head of research at Normandy Hill Capital -- plan to launch Otlet Capital Management, during the second quarter, according to people familiar with the situation.

The New York-based special situations and capital structure arbitrage fund is named after Paul Otlet, an early twentieth century researcher considered the "father" of information science, sources said.

Volcker Rule's affect is still uncertain, but there's hope.

According to a transcript provided by Thomson Reuters, JPMorgan CEO James Dimon expressed concerns that the Volcker Rule might overly curb banks' market-making activities, during the company's earnings conference call in January. "If you lose liquidity, you lose market makers, you are going to -- it is going to cost retirees, pensioners, firemen, retired military, more money to invest their money," adding that "we've got to be very careful we don't destroy that," along with the ban on proprietary trading.

In its 10-K report for 2011, JPMorgan said that until the Volcker Rule is finalized by the Federal Reserve, its effect on the firm's market making and risk-mitigation activities is uncertain, but the company also said in its 2011 10-K filing last Wednesday that "with respect to certain of the Firm's investments in illiquid private equity funds, should regulators not exercise their authority to permit the Firm to hold such investments beyond the minimum statutory divestment period, the Firm could incur substantial losses when it disposes of such investments."

JPMorgan Chase declined to comment for this article, but in its comment letter to the Federal Reseve, the company said that "banking entities are by far the largest providers of market-making services," which provide liquidity that is "essential to create secondary market support for investments like corporate and municipal bonds," adding that the Volcker Rule "has created considerable uncertainty about the market-making-related services that these entities can continue to provide."

In its 10-K filing last Tuesday, Goldman Sachs (GS - Get Report) also said that the Volcker Rule's overall effect was still uncertain, but that the company prepared for the proprietary trading ban by liquidation "substantially all of our Principal Strategies and global macro proprietary trading positions."

The proposed Volcker Rule limits a bank holding company's investments in hedge funds and private equity funds, to 3% of Tier 1 capital. Goldman said that "from 1999 through 2011, the firm's aggregate net revenues from its investments in hedge funds and private equity funds were not material to the firm's aggregate total net revenues over the same period.

Morgan Stanley (MS - Get Report) said in its 10-K filing last Monday that it would "dispose of its in-house proprietary quantitative trading unit, Process-Driven Trading ('PDT'), by the end of 2012," which had previously been announced, and that the unit "did not have a material impact on the Company's financial condition, results of operations and liquidity," during 2011.

Morgan Stanley added that it had "previously exited other standalone proprietary trading businesses (defined as those businesses dedicated solely to investing the Company's capital), and the Company is continuing to liquidate legacy positions related to those businesses."

Bank of America (BAC - Get Report) said in its 10-K filing on Feb. 23 that although its Global Banking & Markets segment "exited its stand-alone proprietary trading business as of June 30, 2011 in anticipation of the Volcker Rule and to further our initiative to optimize our balance sheet, the ultimate impact of the Volcker Rule on us remains uncertain," as "it is possible that the implementation of the Volcker Rule could limit or restrict our remaining trading activities," and that Volcker "could also limit or restrict our ability to sponsor and hold ownership interests in hedge funds, private equity funds and other subsidiary operations."

Bank of America also said the rule "could increase our operational and compliance costs and reduce our trading revenues, and adversely affect our results of operations."

The company's Global Banking & Market's segment reported trading account profits of $6.6 billion in 2011, declining from $9.7 billion in 2010.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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