January 10, 2011 / 5:17 PM / 8 years ago

UPDATE 4-Morgan Stanley to spin off prop trading unit

* Peter Muller, 60 employees to leave, form PDT Advisers

* Firm will become independent at end of 2012

* Morgan Stanley shares closed down 0.5 pct (Adds details of Morgan Stanley’s proprietary trading business, rewrites paragraphs 1-5)

By Joe Rauch

CHARLOTTE, N.C., Jan 10 (Reuters) - Morgan Stanley (MS.N) will spin off its proprietary trading business into an independent firm in 2012, joining a host of Wall Street banks moving to comply with new rules that bar them from making market bets with their own capital.

Morgan Stanley will lose control over the unit when the spin-off happens, but it will be able to buy a stake in the group. Analysts said that Morgan Stanley may also negotiate to allow wealthy brokerage clients to invest in the unit’s funds. The funds, meanwhile, may trade through Morgan Stanley, generating prime brokerage fees for the company.

“This won’t be a parent-child relationship anymore, but it might be a sibling relationship,” said Brad Hintz, analyst at Sanford C. Bernstein & Co LLC.

“Morgan Stanley’s a loser in this deal, but not a 100 percent loser,” Hintz said.

The division, known internally as process driven trading, is the last major piece of Morgan Stanley’s formerly large proprietary trading operation. The bank began scaling down its efforts to manage its own money after the 2008 financial crisis, to reduce risk-taking.

Morgan Stanley is the latest major bank to try to figure out how to handle proprietary trading, which is severely limited under the Dodd-Frank financial reform act, signed into law last year. [ID:nN04118596]

Banks could have more than five years to comply with those restrictions, but many are eager to comply with the law sooner, before their traders bolt for hedge funds.

The fund manager that Morgan Stanley spins off will be named PDT Advisers and will be run by Morgan Stanley’s proprietary trading chief, Peter Muller, the bank said on Monday.

Roughly 60 Morgan Stanley proprietary traders will move to the new firm as part of the two-year migration.

Analysts said while Morgan Stanley will lose the units’ lucrative returns, the arrangement of PDT Advisers’ spin-off will minimize the revenue loss.

Proprietary trading accounts for less than 5 percent of Morgan Stanley’s revenue, a spokesman said. That’s less than larger rival Goldman Sachs Group Inc (GS.N), which historically has generated about 10 percent of revenue from proprietary trading.

Some analysts argue that Goldman realizes much more than 10 percent of revenue from trading its own money, if proprietary trading is defined broadly.

During a two-year transition period, Morgan Stanley’s process driven trading group will continue to manage the bank’s proprietary trading and will expand its business to include third-party investors.

A bank spokesman said Morgan Stanley’s capital will be replaced by outside investors by 2012, and the bank will, in turn, reinvest that capital in other businesses.

VOLCKER RULE

The Dodd-Frank provision that limits proprietary trading is named the Volcker rule, for former Federal Reserve Chairman Paul Volcker, a key adviser to President Barack Obama. Volcker suggested banks be barred from such trading, which has generated big profits for many banks, because banks could be at risk of failure if large market bets soured.

Some traders have already left big banks to work for private equity groups and hedge funds. In other instances, the banks have reassigned them to other asset management divisions.

In October, nine traders from Goldman Sachs Group Inc jumped to private equity firm Kohlberg Kravis & Roberts (KKR.N). [ID:nN21290478]

Another Goldman trader, Morgan Sze, left the company in December to raise a $1 billion Asia-focused hedge fund. [ID:nLDE6BF0LR]

Other banks, including Citigroup Inc (C.N), are considering shifting teams of proprietary traders to asset management divisions that manage clients’ money, rather than betting with the bank’s own capital.

Morgan Stanley’s move is the second major divestiture by the bank because of the Volcker Rule. In October, the New York-based investment bank announced plans to sell hedge fund FrontPoint to its portfolio managers.

The FrontPoint sale came just four years after the bank paid $400 million to acquire the firm, co-founded by Morgan Stanley’s former chief financial officer, Phil Duff. [ID:nN20212023]

Morgan Stanley shares closed down 0.5 percent to $28.05 on the New York Stock Exchange. (Editing by John Wallace, Phil Berlowitz and Steve Orlofsky)

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