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November 1, 2004

Lehman Succeed Stock Trading?

By Peter Chapman

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A few years from now will anyone recognize Lehman Brothers? The venera-

ble fixed-income house is getting a makeover. "There's no doubt in my mind," says Pat Whalen, Lehman's global head of equity trading, "that in the next two or three years, people will have a completely different view of Lehman Brothers' equities division. We will be in the top three."

Whalen is at the epicenter of a huge transformation at Lehman Brothers. This is a shop that is best known for bonds. Yet it has embarked on a comprehensive plan to raise its profile in equities trading. Lehman is betting that by expanding its services and shouldering more risk revenues from equity trading will eventually rival those of its prodigious fixed-income businesses.

This comes as Lehman is also taking pains to build its investment banking business, a business that is dominated on Wall Street by Goldman Sachs.

At Lehman's cavernous trading floor in Times Square in New York City, Whalen, a managing director, supervises a team of dozens of trading professionals. The firm did not disclose the exact number or break them out. However, on the Nasdaq and OTC side, it listed a dozen market makers and 11 sales traders in a Traders Magazine survey published in May.

Execution Options

Whalen, who reports to Robert Shafir and Roger Nagioff, co-heads of the global equities division, joined Lehman last year from Morgan Stanley. At the time, large competitors like Goldman Sachs, Morgan Stanley and Credit Suisse First Boston had begun to offer institutional clients a variety of execution options. In contrast, Lehman remained a classic block-trading house where sales traders worked orders for customers at standard rates. Under Whalen's direction, that has begun to change.

At Morgan Stanley, Whalen was head of North American equity trading. He spent 12 years with the huge investment bank in both London and New York, mostly running its derivatives operations.

His derivatives background - Whalen began his Wall Street career as an options market maker - was a critical factor in his hire. Lehman Brothers, like most of its rivals, is looking to inject more risk into its cash equities operations. That's because stocks have become a more difficult business over the last few years.

With decimalization and the reduction of the minimum trading tick, spreads have withered along with traders' profits. Brokers have either abandoned the business altogether or changed their approaches.

Those remaining in the game of block trading are reengineering their processes and technology so that they can risk more of their capital. Offsetting equity positions with derivative instruments, for instance, is a key tactic.

At the same time, top firms such as Morgan Stanley, Goldman, CSFB and UBS are investing heavily in technology and slashing payrolls in order to offer customers a full range of trading services.

From high-touch worked orders at five cents per share to no-touch computer-managed trades at one cent, the most sophisticated shops are striving to meet the needs of increasingly demanding money managers. And for those who can keep finicky managers happy, success will come, according to one market observer.