Nobody Cares about Mike Mayo

The Journal mentions that longtime Prudential bank analyst Mike Mayo is leaving that firm to join Deutsche Bank. Mayo has quite a reputation as a hard nosed analyst who has been bearish on the banking sector over the years, particularly on JP Morgan and Citi's strategy to build financial supermarkets that would service the consumer in all their banking, mortgage, insurance and credit needs. He was, of course, right. (Do you have your mortgage, your life insurance, your credit cards all with your bank?) Mayo made quite a splash when he decided to stick with Prudential after they meekly exited the investment banking business. He appeared in print ads, touting Prudential's independence, and vowed to speak his mind, in stark contrast to other Wall Street analysts, who are beholden to the corporate finance department that pays their salaries and implicitly predetermines their investment opinions.

Well, Mike's heading back to the dark side. But now, nobody cares. Sell side investment bank research has virtually no value at all in today's world. Aside from the fact that retail customers assume that their product is tainted by the inherent conflict of interest that supports the model, the analysts face a far more sinister foe. Commission dollars, the fuel that runs the research, sales and trading model have declined precipitously, as the buy side takes advantage of alternative trading networks, direct market access tools that allow the buy side to anonymously move large blocks of stock without the information leakage inherent in using sell-side brokers. Add to that the fact that the information that the analysts once had exclusive control over is now universally accessible, and you have a quickly depreciating value proposition.

Prudential exited the corporate finance business after they bought Volpe, Brown and Whelan back in 2000. They bought that boutique at the top of the market, and quickly realized that they had a pig in a poke. To much fanfare, Prudential announced that they would forgo the high margin corporate finance piece of the investment banking model and focus on the low margin research, sales and trading portion. It took Mike Mayo 7 years to figure out that nobody gives a whit about his research reports, and the same amount of time for Prudential to realize that they weren't generating enough revenue to pay for a "big-time" analyst like Mike Mayo? And these investment bankers are the smartest guys in the room, eh?

myCFO.com redux

MyCFO was an extremely high profile start up in the personal financial services space that was backed by Silicon Valley royalty. Their basic premise was to move the entire family office into an online experience, catering to the tech-savvy dot com millionaires who were being created each hour during the tech boom of the late 90s. Since we competed around that space, I was always curious as to how their model would play out. Their vision of a personal concierge service, private jet rentals, tax advice, online brokerage, and accounting all delivered via the web seemed way ahead of its time, but the vision was so bold it bore attention.

When you read about them, their revenue and assets under management seemed compelling. I cynically assumed that the only customers and assets that they had were the founders, John Doerr, Jim Clark, Jim Barksdale. When they shut down, I assumed that it was just the exhaustion of the tech bubble bursting, an idea ahead of its time, bold but too aggressive for the time.

How wrong I was. I wasn't cynical enough. It was all a big tax dodge for the founders. It's emails like this that people should never forget:

Mr. Doerr was a booster for the firm's tax strategists. In response to Mr. Doerr's 2001 email lauding the tax team for its performance -- which he sent on Sept. 11, 31 minutes before the first plane struck the World Trade Center -- the tax team's leader reported landing $4.5 million more in fees. Five days after 9/11, Mr. Doerr replied: "This is AWESOME news, particularly during a week marred by national tragedy.... Please keep me posted."

And never far from malfeasance in the Valley is Larry Sonsini, of course. He adopts the exact same position he trotted out during the recent HP fiasco, and during the options backdating scandal here:

A spokeswoman for Mr. Sonsini said his law firm did basic legal work for myCFO that didn't include reviewing its tax offerings

Of course you didn't, Larry. The firm hired Wilson Sonsini, the most expensive white shoe law firm in the Valley to write their procedure manual. What a joke.

How banks make money, part 3,616

We had a discussion in the office today concerning brokers pushing this investment on our day traders.

Broker: Do you have a mortgage?
Customer: No.
B: You should consider tapping into that equity for this. The yield is targeted at 9-10%.
C: I don't think that I need any more exposure to the market. In order to get that yield, these guys gotta buy stock, right?
B: The market doesn't go down over the long term.

And on and on. So how does a closed end fund achieve such high yields? It must be very sophisticated, right? Covered calls, leverage, derivatives, right?

Actually, it's all in the press release:

The primary investment objective of the Fund is high current dividend income, with a secondary focus on long-term growth of capital. The Fund seeks to achieve these goals by employing a research-driven approach to identifying companies globally with the potential for dividend increases and capital appreciation.

Good old 'dividend recapture'. The fund buys companies just before they pay a dividend and sells them right after. The dividend gets passed on as yield, and the capital gains/losses, well, you'll have to live with them. As Richie Rich, our resident fund analyst said, "You could put a whole room of MBAs together and they couldn't come up with a stupider idea".

Underwritten and schlepped by Wachovia, Citi and Edwards. $4.4 B raised at 7%. That's a cool $308m in gross underwriting fees. How'd Goldman miss that one?

End of the Sell Side

The "sell side" of Wall Street continues to become less and less relevant. Prevailing trends call into question whether is value in any of their services. Eventually, the sell side will disappear.

Sell side research, while it barely survived the IPO debacle of 99-00, when it was clearly revealed to be nothing more than a shill for investment banking business, will continue towards obsolescence for two reasons. First, because the "information" that is included in those reports has become ubiquitous, available to anyone with a browser, and secondly, because there really is no way to justify the economic model that keeps the analyst on the sell side. The analyst belongs on the buy side, along side of the portfolio manager, keeping the value of the research at it's highest point, closely held and captive to the buy side firm. As soon as research is disseminated, it loses it's value. The only reason why the buy side does not pay for the research analysts today is because the sell side continues to foolishly foot the bill. That is a broken model.

Direct market access trading, dark liquidity pools, and the rise of alternative trading systems like Liquidnet and Lava Trading have made the notion of sending order flow to smaller sell side trading desks as quaint as a buggy ride in Lancaster. There will come a day when buy side trading desk employees will be fired for sending order flow anywhere but into an automated black box, and it won't be too far out in the future.

So, why does the sell side even exist? Their product set includes four things, research, liquidity and trading, M&A advice, and IPOs. My firm has worked towards finding a disruptive model to break the traditional book-building process of IPO issuance, but even we haven't gone far enough. At the end of the day, the exchanges will handle the issuance of new issues (perhaps through an auction, something with which they are intimately familiar) and lawyers and consultants will provide M&A advice. Hedge Funds and buy-out funds will line up to provide the balance sheet to finance the transactions.

Goldman just raised a $19B private equity fund. What side of the street are they on again?

Another blow to the boutique investment banking model

The WSJ reports today that Goldman got received a no-action letter from the SEC giving them broad access to using client-commission arrangements. Through these arrangements, Goldman and other large sell side investment banks will act as "commission catchers" for smaller research boutiques. Mutual funds like this because they can be sure of Goldman's top notch execution and still receive and pay for boutique firms' research. It's really just another version of soft-dollar commission payment, but one that specifically cuts out the small trading desks that most regional and boutique I-banks still maintain.

Hedge funds won't like the service much, because they'll find it tougher to mask their trading flow, and they suspect (quite rightly) that Goldman and the other bulge bracket firms are trading against their flow.

The real losers, though, are the traditional boutique investment banks that still struggle to make the old cash equity model work. The cold economic reality is that the cash equities business is going away.