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September 30, 2000

Putting Up for Customers: Dealers Must Risk More to Make More

By Laura Santini üInvestment Dealers' Digest

It's a risky play. But several Wall Street dealers say they are coming through for their institutional clients, even in the face of abysmally low trading volume.

They are putting up the capital required by clients to get block trades done.

Committing capital means that, rather than look for a buyer of the customer's stock, a dealer buys the stock itself.

Usually, the firm steps in, because there is a glut of sellers in the market. A buyer at an acceptable price cannot be found.

So the firm offers the customer a better price than it could fetch in the market, often taking a loss for doing so.

The reason for doing this, explained Scott Saber, executive director of equities at UBS Warburg, is to preserve the relationship with the customer.

Important Clients

In fact, one of the criteria in determining whether a firm will put up its own money for a trade is how important the client is to the firm, whether it is a mutual fund or a pension fund.

Saber said that capital commitment has increased at many Wall Street firms, even though their risk tolerance for doing so may differ.

Jon Olesky, head of block trading at Morgan Stanley Dean Witter, says the great capital commitment trend has increased this year.

"The business has naturally evolved to a higher level of capital commitment," he said.

While trading volume has been low in recent weeks, overall stock market volume is up 25 percent to 35 percent in the past year, Olesky explained. Trade sizes and share volume have increased.

One trading house executive cautioned that risking more capital in the current volatile market conditions is foolish.

Peter DaPuzzo, co-president of institutional equity sales and trading at Cantor Fitzgerald, said his firm will always put up capital when it is required to get a trade started.

But sometimes it is better to make more calls in search of the other side. "The losses per share [from putting up too much capital] are severe if you are wrong," he said. "The volatility can hurt."

Traders said that Wall Street's big selling point, in a field of upstart trading systems and electronic brokerages, is that its pockets are deep enough to put up cash for a customer when the entire market is against the trade.

Mutual fund traders note a movement toward using small independent trading firms more frequently than ever before, as a way of cloaking their trading strategies.

Mutual funds complain that some trades placed with Wall Street's bulge-bracket firms receive inferior prices, because information is leaked to the general marketplace.

To prevent this, some mutual funds try to conceal orders through low-profile trading shops, some of which also execute orders for hedge funds or extremely wealthy individuals.

To this end, Jamie Atwell, head of trading at Nicholas-Applegate Capital Management, said he works with at least one such trading shop. He declined to name the firm.

Olesky declined to comment on specific instances of capital commitment. John Peluso, head of block trading at Lehman Brothers, also declined to comment-as did an official at Goldman Sachs-citing the sensitive nature of information about the firm's risk portfolios.

Jim Toes, a director of Nasdaq trading at Merrill Lynch, said the firm is always competitive. "As far as any changes go, our customers are always demanding capital," he said.

Reducing Broker List

Meanwhile, there has been a steady move on the buyside toward paring the number of brokers it uses, to ensure better service from fewer firms.

Buy-side traders claim they are doing this mainly so that they can rely on capital commitment at critical times.

By keeping their roster of brokerages small, buy-side traders can send more commission dollars to the firms with which they opt to work. with staff reports