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Schwab Clears Bear's Path

The firms link up in a mutual fund trade-execution deal.

Bear Stearns


may be huge in the back-office business of clearing stocks, but it's looking to

Charles Schwab

(SCHW) - Get Charles Schwab Corporation (The) Report

for some help when it comes to processing mutual fund trades.

In a surprising move, Bear Stearns -- long a Wall Street titan in the arcane business of clearing trades -- recently inked a deal with Schwab to clear and execute most of its mutual fund trading, sources say. In recent years, Schwab has become a leader in providing mutual fund clearing services to other investment firms and asset managers.

The outsourcing arrangement means that the hundreds of small brokerages and hedge funds that currently clear stock trades through Bear Stearns now will have their mutual fund buy or sell orders processed by Schwab. The terms of the arrangement are unknown, but it's believed the outsourcing deal is scheduled to last for several years.

The deal, which has been in the works for months, comes nine months after Bear Stearns reached a $250 million settlement with securities regulators over allegations arising from the long-running mutual fund trading scandal. The penalty was one of the largest imposed on a brokerage firm, in an investigation that has collected nearly $4 billion in fines and restitution.

In settling with Bear Stearns, officials with the

Securities and Exchange Commission

painted an ugly portrait of the firm's clearing division, calling it a full-service facilitator and "hub" for abusive traders.

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Regulators charged that Bear Stearns' mutual fund trading hub generated "hundreds of millions of dollars in profits" for itself and its hedge fund clients. A number of current and former top executives in Bear Stearns' clearing operation are still facing possible regulatory action for giving the green light to the abusive hedge fund trading, which regulators contend hurt long-term mutual fund investors.

People familiar with the investigation say regulators didn't push Bear Stearns into the outsourcing arrangement.

Bear Stearns, meanwhile, said the deal makes sense because Schwab is a big player in clearing mutual fund trades and has relationships with more fund families.

"This allows us to leverage Schwab's relationships and infrastructure in the mutual fund space," says Bear Stearns spokesman Russell Sherman. "In looking at our business, we concluded that this would improve our efficiency and increase our product offering."

The spokesman declined to say how much in cost savings Bear Stearns would reap from the outsourcing deal. A person familiar with the arrangement says the firm will save money because it won't have to upgrade its technology for executing mutual fund trades.

Others suggested that without the revenue generated from the abusive trading activities, mutual fund clearing wasn't a particularly profitable line of work for Bear Stearns.

Sondra Harris, a Schwab spokeswoman, would not confirm that the San Francisco-based broker had signed an outsourcing deal with Bear Stearns. But she says Schwab has "a robust fund clearing service for third parties." Harris says the firm has been clearing mutual fund trades for other investment firms since 1997.

Clearing is the arcane but crucial service on Wall Street in which a firm such as Bear Stearns acts as a middleman for small brokerages that lack the financial resources and back-office muscle to make sure big sales of securities go off smoothly. Bear Stearns provides clearing services to more than 300 small brokerages, or correspondent firms.

At Bear Stearns, the clearing business is wrapped up with the firm's hedge fund prime brokerage business. Over the years, the clearing operation has been a significant contributor to the firm's revenue.

In the fourth quarter, Bear Stearns' clearing business generated $281 million in net revenue, up 7% from a year ago. For the full year, the clearing operation's $1.1 billion in net revenue accounted for about 12% of the firm's overall net revenue. A year ago, the clearing and prime brokerage business accounted for about 13% of the investment firm's total revenue.

Overall, the fourth quarter was another solid one for Bear Stearns. Earnings at Bear Stearns rose 38% to $563 million, or $4 a share, compared with earnings of $407 million, or $2.90 a share, in the year-ago period. Net revenue rose 28% to $2.41 billion.

In its earnings announcement Thursday, Bear Stearns called the fourth quarter its "best ever quarter." Shares of Bear Stearns rose $4.07, or 2.6%, to $159.96.