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November 11, 2008

Lehman Bankruptcy Hits Clients

By Peter Chapman

Also in this article

  • Lehman Bankruptcy Hits Clients

With money managers' commission-sharing balances frozen at Lehman Brothers' European unit, the industry is rethinking the critical payment mechanism.

"This is an absolute wake-up call for folks in terms of whom they have their CSAs with," Ray Tierney, global director of equity trading at Morgan Stanley Investment Management, said at a conference last month. "I think there will be a push toward a consortium with some type of insurance wrapper."

Lehman Brothers International, the European division of Lehman Brothers Holdings, is under the administration of accountants PricewaterhouseCoopers, as per U.K. bankruptcy law. Any balances in LBI's commission-sharing-arrangement accounts are frozen, and the account holders are being treated as unsecured creditors. It is uncertain how long this will remain the case. The unraveling of the large unit is expected to last until 2018. Nomura Holdings did acquire Lehman's European and Middle Eastern investment banking and equities operations. Sources opine Nomura will accept those CSA balances as its own.

In the U.S., some money managers tried to transfer their client-commission-arrangement balances out of Lehman, but were unsuccessful. In at least one case, a bulge bracket operator of CCAs, refused to accept the transfer of the balances, citing legal prohibitions.

Because of the problems, U.S. trading executives on both the buyside and the sellside are exploring ways to safeguard credit balances of client commission arrangements, the U.S. equivalent of the CSA. These are the monies held by brokers for eventual payment to the money managers' research providers. Legally speaking, the accounts are the property of the broker-dealers, not the money managers.

Client commission arrangements account for about $2 billion of the total $12 billion commission pool, according to estimates by Greenwich Associates. Balances in individual CCA accounts held for the larger money managers can range from single-digit millions of dollars to double-digit millions. Funds come in after trades and go out when it comes time to pay research providers.

"The machinations around how CSAs are conducted and paid and where those balances are held will change," Tom Wright, head trader at Sanford Bernstein, said at last month's Traders Magazine conference.

One old idea being dusted off is that of a consortium. Rather than maintain CCA accounts at several different brokers, money managers would maintain an account at one entity that would deal with all the brokers.

The idea has been around for a while, but has never taken hold. Proponents say a single pooled account is easier for the buyside to manage than multiple CCA balances. Opponents say it results in a loss of control that could lead to information leakage.

Some aggregation already exists. In the U.K., both Goldman Sachs and UBS run their own CSA programs and pool other brokers' accounts, as well. In the U.S., the idea of an independent operator of a centralized escrow or trust vehicle has also been tossed around. Cogent Consulting, which offers a software product to the buyside that consolidates their various balances into one virtual account, is sometimes mentioned in this regard.