Wall Street’s B-List Firms Trade on Bigger Rivals’ Woes

by Jack Kelly on August 11, 2009

[Wall Street's Woes Boost B-List Firms]     [Wall Street's Woes Boost B-List Firms]

By Aaron Lucchetti for The Wall Street Journal August
11, 2009

Steven Schonfeld has nothing to worry about from the new
U.S. executive-pay czar. The 50-year-old owner of trading firm Schonfeld Group
Holdings LLC is living it up like the financial crisis never happened.

He says he made $200 million last year and just moved into a
mansion near the Long Island Sound with its own nine-hole golf course. He has
spent $90 million on the home, he says, and is currently erecting a poolside
cabana designed to look like the Cove Atlantis resort in the Bahamas. "I
don't think it's putting anyone's face in it," he said recently while
showing a visitor around the property. "I live in this house."

Many of Wall Street's A-list firms are retrenching, but
plenty of B-list firms like Mr. Schonfeld's are prospering and hiring. In Mr.
Schonfeld's 27 years in the business, his small, little-known firm never had
much success hiring traders from Wall Street's biggest firms — until the
financial crisis battered the industry last year. Since then, he has hired more
than 20 traders from big banks, and he wants a dozen more.

The growth push at Schonfeld Group and dozens of other small
securities firms illustrates the shifting landscape of the trading business –
the freewheeling slice of the securities industry where individual traders take
big risks and can collect enormous paychecks. For years, big Wall Street firms
hoarded much of the trading talent. Now, many of those firms are shedding
traders as they ratchet back their risk-taking, and smaller firms are stepping
up to hire them.

First New York Securities LLC, with about 225 traders, says
it has landed more than 50 traders in the past year from larger rivals such as J.P.
Morgan Chase & Co. and UBS AG. Execution LLC, a
Greenwich, Conn.-based securities firm, opened a new office in midtown
Manhattan to make room for new hires from Goldman Sachs Group Inc., Morgan
Stanley and other big firms. Also recruiting aggressively are Bright
Trading LLC, Schottenfeld Group and DRW Trading Group.

"We're a recipient of the purge," says Donald
Mottschwiller, managing partner at First New York Securities. He says he's been
looking for traders who bet lots of capital at their old firms.

Joseph Goldsmith, a recruiter at Goldsmith & Co., says
upstarts are "attracting people they did not have the ability to attract
before," positioning themselves, they hope, to take market share away from
big firms.

For now, large firms have been content to watch some of
their traders leave, especially those who took big risks in volatile bond
markets. That stance may change if big banks continue to rebound from the
losses many notched late last year.

One selling point for Schonfeld Group: As a small, privately
held company that didn't receive federal bailout money, it isn't in the cross
hairs of federal regulators intent on changing pay and business practices on
Wall Street. Treasury Department official Kenneth Feinberg is overseeing
compensation only at companies that got the biggest injections of federal
money. The Obama administration's proposed overhaul of financial regulation is
likely to result in tougher standards mainly for large firms that pose
potential "systemic risk."

Mr. Schonfeld isn't trying to rein in the
every-man-for-himself culture that churned out big profits on Wall Street
during the boom but even bigger losses at some firms during the bust. He
provides seed money for new hires and gives them freedom to decide how to
trade. Traders keep a percentage of their profits. His best ones make $5
million to $10 million a year, he says.

The firm, founded in 1988 with six employees, hasn't always
focused so heavily on trading. Over the years, it also has handled trades for
day traders and institutions, among other things. These days, it is betting
more of its own capital than it once did, just as firms such as Morgan Stanley
dump businesses that don't fit the lower risk profiles it adopted when it
converted to a bank-holding company last year.

Trader Dmitry Gekhtman, 41, who has a Ph.D. in physics, left
Bear Stearns Cos. in late 2007 and later launched Quantitative Models Capital
Management. Schonfeld is providing capital to the venture, which employs a
statistics-driven trading strategy. Mr. Gekhtman says that Wall Street firms
grew risk-averse after the financial crisis, "but someone needs to
do" the short-term trading that many banks have been abandoning.

Analysts estimate that as many as 25,000 Wall Street traders
lost their jobs in the year ended March 31, or about 10% of the
financial-services job losses reported by the federal Bureau of Labor
Statistics.

The addition of some of these traders already is having a
financial impact. Investment bank Jefferies Group Inc. in July
reported a second-quarter profit of $61.9 million, compared with a $4 million
loss a year earlier. It said the profit in part reflected the hiring of about 80
new traders, analysts and bankers from larger firms. Its biggest hire was the
former head of health-care banking at UBS.

Although firms like Schonfeld have avoided the regulatory
and political glare, some industry experts say regulators can't afford to ignore
small firms, which are no less prone to problems than big ones.

Mr. Schonfeld's track record, in fact, contains blemishes.
Last year, he was suspended by New York Stock Exchange regulators from
supervising a brokerage firm for three months. The regulators cited improper
"prearranged" trades between Schonfeld affiliates and unreported
deficiencies in net-capital levels. Since 1996, the NYSE, Financial Industry
Regulatory Authority and other regulators have taken regulatory action against
his brokerage firm 16 times.

A Schonfeld spokesman says the firm's regulatory history
compares well with larger Wall Street companies, and issues that led to the
suspension were quickly resolved. Mr. Schonfeld says the NYSE's claims had
"zero validity," and "zero of what we did hurt anyone." An
NYSE spokesman says the $1.1 million in fines levied against Mr. Schonfeld and
his brokerage firm "clearly demonstrates that the conduct was not trivial
or irrelevant."

After his suspension, several of Mr. Schonfeld's trading
partners and lenders spoke with Schonfeld officials to express their concern,
says Andrew Fishman, Schonfeld's president. Mr. Schonfeld says the company
plans to get out of the brokerage business by selling the unit to a former
executive, and to focus on trading, which is less regulated.

Last year, Mr. Schonfeld's trading strategies — some are
based on short-term market moves — generated 35% of the firm's profits, says
Mr. Fishman. Schonfeld Group expects revenues of $250 million to $350 million
this year, down from $590 million in 2008, when volatile markets generated
better trading opportunities. Mr. Schonfeld says he expects profit growth to
bounce back as the firm's newly hired traders get established.

Mr. Schonfeld got his start on Wall Street in 1982 as a
broker at Blinder, Robinson & Co., which got into trouble over its sales
practices for penny stocks. He says he steered clear of those securities. In
1987, he left for Prudential-Bache Securities Inc. and began trading, but soon
quit to trade his own money full time.

In the 1990s, he built a business around training day traders.
When the Internet bubble burst, he acquired several struggling rivals. In 2006,
he sold a majority stake in the day-trading business, but held onto the traders
who were operating with the firm's capital.

Mr. Schonfeld developed a reputation for obsessing about
statistical probabilities and making rapid-fire decisions. He sleeps just four
or five hours a night, and often emails trading ideas to lieutenants between 3
a.m. and 5 a.m. At one dinner with traders, he said that anyone who looked at
the menu for more than 90 seconds was in the wrong business.

In mid-2007, Mr. Schonfeld noticed that many traders using
math-based strategies were notching losses. Figuring such losses wouldn't
persist for long, he began trying to lure such traders away from big firms, an
effort that gathered steam as Wall Street's troubles deepened last year.

In January, Ashwin Kapur, 33, left a Barclays PLC trading
desk in New York to join Schonfeld. A veteran also of J.P. Morgan, Credit
Suisse Group and Royal Bank of Scotland Group PLC, he is working on a trading
system to exploit discrepancies between prices in stocks and derivative
contracts such as futures and stock options. Schonfeld executives say they plan
to bankroll the venture, called Systematic Trading LLC, with as much as $250
million in capital, and will split any profits with Mr. Kapur. If there are
losses, the firm will have to bear them.

Mr. Kapur initially will have less capital to trade with
than he did at Barclays. But he says he could earn more money because his
compensation won't be affected by Barclays's various nontrading businesses.
Working at Schonfeld "directly ties my take-home to my performance,"
he says. His contract entitles him to a few million dollars in bonuses if he
generates consistently positive returns.

Mr. Schonfeld is rarely seen in the firm's Manhattan office.
He runs his own trading strategies from the company's headquarters in Jericho,
N.Y., near his mansion in Old Westbury.

Three or more times a week he keeps right on wagering at the
gin-rummy table after the markets close. Playing cards, he said, is a lot like
playing the markets. He doesn't like to play games where he doesn't have an
"edge," he explained one recent afternoon as he stepped into a
card-playing room in his home to sit down with five other players.

Wearing a gray sweater, faded jeans and white Nike sneakers,
he settled into a chair embroidered with playing cards. Michael Sall, author of
the book "Gin Rummy: A Predator's Guide," says Mr. Schonfeld can
match up with the best gin-rummy players in the U.S., sometimes walking away
with six-figure winnings.

The game broke up for dinner, and Mr. Schonfeld's chef
served veal medallions and halibut. (At high-end restaurants, Mr. Schonfeld has
been known to order one of everything on the menu, with his party leaving much
of the food uneaten.) Over dinner, Mr. Schonfeld mused about, among other
things, the odds of getting the same two gin partners twice in a row in a
six-person game (10%, he says), and the chances that the Dow Jones Industrial
Average will rally after a sharp decline (55%, he says).

Mr. Schonfeld has also become an avid golfer. No one is
allowed to use his golf course if Mr. Schonfeld, a nine-handicap player, isn't
at home. "It's not a private golf course," he explains. "It's a
personal golf course."

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