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Proprietary Trading Isn't the Profit Center It Used to Be

Friday, 6 Aug 2010 | 1:44 PM ET

The Volcker Rule may have come at an opportune time for Wall Street’s internal hedge funds.

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The market was atwitter this week with revelations that Goldman Sachs, faced with a new legal requirement to divest itself of proprietary-trading operations, planned an imminent spin-out of well-known internal trading unit, Goldman Sachs Principal Strategies (GSPS).

GSPS will make a go of it as an independent hedge fund, according to people familiar with the matter, in a transition that could begin as early as today.

Other internal prop-trading groups, including a team within Goldman’s Special Situations Group and Morgan Stanley’s Process Driven Trading group, may soon follow suit, according to other people familiar with the matter.

But there’s more to this story than simple compliance with the newly-minted Dodd-Frank Act (whose “Volcker rule” clause will curtail both prop trading and private-equity and hedge-fund investments at banks). There’s also the fact that the importance of prop trading at Wall Street firms has been on the wane for years.

Back in 2002, the Wall Street Journal reported that prop-trading activities likely accounted for a quarter or more of Goldman’s pre-tax profits.

In the years that followed, risk-taking came back in to vogue, and firms began ramping up their internal trading operations, making bets with massive downside and in some cases, limited supervision.

Latest on Goldman
CNBC's Kate Kelly reports on the latest developments in Goldman Sachs' efforts to spin off its prop trading units.

Then came the financial crisis, trading blowups at places like Bear Stearns and Morgan Stanley, and billions of dollars in write-downs at Merrill Lynch and many others.

Goldman and Morgan survived the crisis intact, but their prop-trading results have been muted in recent years, say people familiar with the matter.

This year, in which hedge funds and Wall Street trading desks have contended with a volatile, often low-volume stock market, has been no exception, these people add—and the Volcker Rule may have been the perfect excuse to pull the ripcord.

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