Wall St. Banks Help Hedge Funds Recruit

Date: Tuesday, October 11, 2011
Author: Susanne Craig and Azam Ahmed, DealBook

Wall Street banks often boast that they hire the best and the brightest. Now, scrambling to bolster profits, they have become full-time headhunters for some of their biggest hedge fund clients, a role that is rife with potential conflicts.

Big banks have long provided extra benefits to hedge funds, including finding office space for firms and raising money for new portfolios. They have even acted like informal recruiters for their premier clients by passing along résumés or making introductions to industry professionals.

But those once-ancillary placement services have become established practices as Wall Street struggles to make up for profit centers that have been lost to new regulations and a weak economy. Since the financial crisis, Goldman Sachs, Morgan Stanley, Deutsche Bank, Bank of America and others have become powerful recruiting forces for hedge funds. In an effort to secure lucrative brokerage and trading business, the banks scout finance executives, accountants and receptionists free. Goldman calls the practice “talent introduction.”

Without the necessary disclosures and appropriate restrictions, the staffing services could prove controversial.

For one, Wall Street firms risk provoking the ire of a client if they poach hedge fund talent or compete for the same potential employees. It also raises a question of loyalty; hedge fund executives may be swayed to direct business to the Wall Street firm that hired them rather than the bank that makes the best sense for investors.

“We get put in this situation every day,” said Stuart Hendel, global head of prime brokerage at Bank of America Merrill Lynch, which offers recruiting as part of its hedge fund services. The banks, he said, have “to walk a tight rope.”

Banks say they have strict rules to prevent conflicts. Bank of America says it will not poach active employees of a current client.

“All we’re doing is providing a clearinghouse for managers to meet prospective employees,” Mr. Hendel said. “We don’t go looking for people, people seem to find us. And we make it very clear we’re not providing recommendations.”

Goldman said it disclosed its consulting services to clients and had “robust policies and procedures” to prevent conflicts of interest. “We are not in the headhunting business,” a spokeswoman for the firm, Andrea Raphael, said. “We do not solicit employees of one client to work at another client.”

Deutsche Bank and Morgan Stanley declined to comment.

The practice renews concerns about how hedge funds indirectly pay for such secondary services. Government regulators have cracked down on these “soft dollar” arrangements — where a money manager steers business to a bank in exchange for perks. The deals can come at the expense of investors, who may be unaware of the relationship.

Several years ago, Massachusetts’s chief financial regulator, William Galvin, took aim at so-called hedge fund hotels. At the time, Wall Street firms provided office space to up-and-coming money managers at below market rates in return for their trading business. As part of a settlement with UBS, investment advisers that leased real estate from the bank in the state had to provide written disclosure to current and prospective clients about the arrangement.

It is unclear if hedge funds report their use of Wall Street staffing services. Mr. Galvin said that the money managers should disclose the value of the services they receive from big banks and the employees placed by banks.

“It’s the type of relationship investors should know about, or simply shouldn’t exist,” Mr. Galvin said.

As the industry has grown in size and stature, hedge funds have become an increasingly important source of revenue for Wall Street banks. Hedge funds, for example, account for an estimated 35 percent of trading commissions, according to Brad Hintz, an analyst at Sanford C. Bernstein & Company.

To distinguish themselves in the highly competitive business, banks — which provide credit and execute transactions for the big investors through their prime brokerage and trading divisions — have built out their suite of services.

Recruiting was a natural extension. Wall Street firms, through their prime brokerage units, are involved in the daily operations of thousands of hedge funds, giving them a good sense of the industry turnover.

After acting as informal recruiters for years, many banks formalized the process in recent years. The Wall Street firms have created rich databases that track hedge fund openings and potential candidates, with a small staff dedicated to the service.

It is appealing for hedge funds. Traditional recruiters take as much as 25 percent of the hire’s first-year compensation. But Wall Street doesn’t charge anything. Richard Scardina, co-founder of the Atlantic Group, a professional search firm, said the banks were his biggest rivals.

“It’s competition, but they are not going to put me out of business,” he said. “We specialize in recruitment day in and day out, and that is an edge that is hard to compete with.”

Mostly, the banks’ staffing efforts focus on back-office and accounting functions, although the banks occasionally place investment professionals and research analysts. Glazer Capital Management, a New York-based hedge fund with roughly $500 million, recently tapped Goldman to hire a staff member in its accounting division, according to a person with knowledge of the matter.

The potential landmines for banks are significant. The majority of people in Goldman’s database are out of work, according to executives at three hedge funds who have used the service. But the list, the people said, does include a small number of hedge fund employees looking to leave their jobs, because they’re unhappy or are looking to move to another part of the world.

In such instances, banks could run the risk of poaching staff from their hedge fund clients, said Dick Del Bello, a senior partner at Conifer Securities, a independent firm that provides administrative support to hedge funds. “The one thing they have to be careful of is, you don’t want to raid the henhouse,” he said. “You don’t want to go to client A and take someone actively there and send them to client B.”

The practice could also have unwanted consequences for hedge funds. If the Wall Street bank knows a top executive wants to leave a firm, the departure could raise red flags about the health of the hedge fund, Mr. Del Bello said. The bank, in response, might decide to withdraw the fund’s credit, potentially forcing it to sell assets.

Ms. Raphael of Goldman said that if the firm discovered something material, it “would discuss the matter and its implications with the client.”

To Mr. Galvin, it comes down to disclosure. “If you are an investor, you want to know the manager is acting in your interest without an ulterior motive.”