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Bear Stearns Meltdown Could Force Buy-Side to Rethink Bulge Bracket Relationships

The failure of a top broker raises questions about the buy-side consolidating broker relationships as well as counterparty risk.

"In effect, you're banking your commissions to pay out later," he says. There is uncertainty of whether any unallocated commissions from the buy-side clients can be recovered from Bear Stearns, he adds. "I think it would be difficult to go back to Bear Stearns now and say, I had X millions of dollars of commission sitting in your research platform that I never allocated. I want to allocate it now. I'm not sure how Bear is going to respond to that," says Tabb.

However, Tabb doesn't think buy-side firms should panic and pull the plug on their bulge-bracket relationships. Tabb says all buy-side firms and hedge funds should periodically examine who they do business with and see if that mix is right. "It's going to be very hard to justify to anyone if all of a sudden you cut out all the bulge bracket brokers and only execute with the small research brokers," says Tabb.

Even though the bulge-bracket made having some financial difficulties, Tabb points to their extensive infrastructure and the fact that the problems they had were more on the fixed income desk than in equities. "I think every (buy-side) firm has to look at who they trade with and what they trade and take a look at how much risk they want to take," says Tabb.

However, Wetherington says the buy-side should diversify its trading partners by considering regional and middle market firms. "My firm is polar opposite of what is happening because we're agency only and because we don't invest in proprietary trading or speculate," says the CEO. "We have no debt and everything is paid out of operating capital and we're hiring people," she says, noting that her firm will benefit from the layoffs in the Wall Street firms. "As far as best execution is concerned, we've proven that over and over again in equities, fixed income, options and international securities," she says.

But Tabb says its more likely that a small brokerage firm with a boutique trading desk would go out of business than a multi-billion dollar capitalized top-10 broker. "If you take out of consideration the Bear issue, it's more likely that the small firm will go out of business than the big one. But every firm needs to take a look at those credit issues and counterparty issues," he says.

Still, Wetherington argues, "Two weeks ago you never would have thought the mighty could fall just because we've been in a market where firms could operate in a highly leveraged model. Apparently, we're entering a different phase. It may cause the buy-side to rethink their broker diversification and their broker-selection model," says Wetherington.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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