Updated from Feb. 23
From the Wall Street research scandals that took place during the tech/telecom boom of the 1990s to the current mortgage/credit crisis, many banks and brokers have gone out of business or have been acquired. (Don't miss "
"). But you probably already knew that.
So with the financial services industry being reshaped (via legislation, natural evolution or both), what will this world of banks, brokers, mortgage companies, insurers, hedge funds and credit card companies look like on the other side of this crisis?
Here's the first of a two-part look at how things might change (here's
Whether or not Bernie Madoff (
) or Robert Stanford (
) operated as hedge funds is not the issue. The focus will be on how we can best regulate investment vehicles and protect investor interest.
In general, investors have money managed in three types of investment vehicles:
, separate accounts (I manage separate accounts through my company LakeView Asset Management) and
I expect that mutual funds, which were in somewhat of a decline since the dot-com bubble burst, will begin a second life, despite the
. The reason: Mutual funds are registered vehicles that must file regularly with the
and those filings are publically available for anyone to view. By extension, I think that the burgeoning exchange-traded fund (ETF) industry will continue to expand and diversify its offerings.
Hedge funds are in real trouble. A prior attempt to regulate this industry failed. However, given the recent scandals and a new administration in Washington, I believe that significant changes are coming.
It's probable that the funds and their managers will be required to register with a regulatory agency and submit quarterly audited reports just like mutual funds. I envision a repeal of the regulations that allow a hedge fund manager to earn performance fees. Eliminating the performance fee would no longer limit the funds to accepting
. If that does not occur, then at the very least, expect a change in the tax law, which currently treats performance fees as capital items rather than ordinary income.
The unintended consequence of these actions might be that hedge funds will begin to operate more like mutual funds. In fact, I would not be surprised to see hedge funds begin to issue shares --
-- to the public.
However, these "public hedge funds" would be different than the management companies that have gone public, such as
Fortress Investment Group
Och-Ziff Capital Management
I also expect to see hedge fund money flowing down to the separate account business. However, two changes might occur. First, all registered investment advisors (RIAs) will fall under SEC regulation (the current threshold is $25 million of assets under management). Second, safeguards to avoid the glaring conflict of interests and lack of controls under which
operated will be enacted.
Banks and Broker-Dealers
The Glass-Steagall Act was too restrictive. The Gramm-Leach-Bliley Act was too loose. We need a middle ground. We need to structure lending institutions -- whether they function as banks, mortgage lenders or
-- under a single legal entity that is able to fund through a natural deposit base. I call this the European banking model.
Since my "
(September 2008)," we have seen such firms as
file to become bank holding companies. We need to continue to move in this direction and eliminate the mistakes from the Gramm-Leach-Bliley Act, which had no real system of financial control or checks and balances.
Standalone broker-dealers will only exist if they operate under a non-lending/non-trading business model (the only exception: margin lending under
). However, very few broker-dealers will continue in this form and I foresee
having greater prominence in the financial services sector.
(It is doubtful that the Johnson family would ever sell Fidelity or take it public, but don't count it out, as even the Bancroft family sold
to Rupert Murdoch's
After several years of capital destruction and tighter credit markets, new companies will be created that will require access to the capital markets. When that happens, another period of private equity investments will begin anew.
was in its infancy when the last tech bubble burst. Today, Google is one of the leading technology companies in the world and its success can be tied to great entrepreneurs coupled with timely funding. In terms of investment banking, I would expect to see a renaissance in the boutique investment advisory business.
As Wall Street comes under increasing pressure to cut compensation, talent will leave to start-up new firms. A great example of that is
Greenhill & Co.
, formed by former Morgan Stanley senior executive Robert Greenhill.
Identify financial services companies that can adapt to the changing credit and regulatory environment. (Cross-sector references: "Companies That Might Not Survive This Crisis," "How Starbucks, Qualcomm and Yahoo! Dropped the Ball" and "How Apple, Google and IBM Got It Done")
Review your investments to ensure that you are Madoff-proof. Here are a few good starting points: "Five Ways to Avoid Getting Madoffed," "Madoff Investors Missed Red Flag" and "Protect Yourself in Post-Madoff Investing World."
If you can find the time, read Blood on the Street. This is Charles Gasparino's account of the dark period on Wall Street in the 1990s. I highly recommend this book (and it is required reading for my students at Seton Hall).
Scott Rothbort's look at the future of the financial services sector continues here.
At the time of publication, Rothbort was long GOOG and GS, although positions can change at any time.
Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.
Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.
Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.
For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at
. Scott appreciates your feedback;
to send him an email.