Wall St. Faces Specter of Lost Trading Units

They are the elite among the elite at Goldman Sachs, highfliers who are the envy of Wall Street.

But on Washington’s orders, Goldman is now considering a step that once would have been unthinkable: disbanding the corps of market wizards at the heart of its lucrative trading operation.

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AP

Under the new Dodd-Frank financial regulations, Goldman must break up its principal strategies group, the wildly successful trading unit that has helped power the bank’s profits. Goldman is considering several options, including moving the traders to another division or shutting the unit altogether, according to people briefed on the matter.

Across Wall Street, other financial giants are also embarking on the delicate task of complying with the new rules governing their trading and investments.

Morgan Stanley is considering ceding control of its $7 billion hedge fund firm, FrontPoint Partners. At Citigroup, executives have sold hedge fund and private equity businesses and are now discussing paring back proprietary trading, which relies on a bank’s own capital to make bets in the financial markets.

JPMorgan Chase has already begun dismantling its stand-alone proprietary trading desk and is now preparing to wind down One Equity Partners, its internal private equity business. While many of these plans are still under discussion and could take years to fully put into effect, the Dodd-Frank rules are slowly starting to change Wall Street, at least on the surface.

How deep the changes will go is uncertain. Citigroup and others, for instance, are considering moving proprietary traders to desks that handle trades for clients, although the traders would still be able to make their own bets in the markets.

Analysts nonetheless characterized the coming shift as nothing short of a sea change. Some of the banks’ big businesses — trading, hedge funds and private equity, for example — must now be overhauled.

"“It shows that if you squeeze Wall Street, like a balloon it will come out somewhere else." -, Brad Hintz

“This is the real stuff,” said Brad Hintz, an analyst at Sanford C. Bernstein & Company. “It shows that if you squeeze Wall Street, like a balloon it will come out somewhere else, and we really are squeezing Wall Street. Their business models are changing.”

The changes are aimed at complying with rules intended to reduce risk and speculation.

Perhaps nowhere is this shift more profound that at Goldman, whose powerful proprietary trading operation is legendary on Wall Street. In the 1980s, under Robert E. Rubin, its arbitragers profitably navigated an era of heady mergers. Today, the group is walled off from other traders on Goldman’s trading floor.

The loss of the division would be a big change for Goldman. The group has long been one of the most sought-after places to work at Goldman, and one of the most highly compensated.

One option under consideration would be to fold the group into Goldman’s asset management unit, allowing it to bring in outside investors. This way, Goldman would gradually reduce its direct financial stake in the unit.

Another option would be to shut the group or let its traders spin it off into a separate fund or funds and seek capital from outside investors.

A Goldman spokesman, Lucas van Praag, said: “We are reviewing our options and will, of course, comply with the new legislation.”

In recent years, the group had as much as $10 billion of Goldman’s capital and focused mostly on stocks. It has also produced several prominent hedge fund managers, among them Edward S. Lampert, Thomas F. Steyer and Daniel S. Och.

At Morgan Stanley, executives have decided to spin off FrontPoint to the fund’s management, according to two people with knowledge of the matter. FrontPoint’s principals were negotiating terms, and the deal could still founder.

Under a tentative plan, Morgan would reduce its ownership of FrontPoint, which employs about 180 people, to about 25 percent. That stake could then be reduced further over the next five years.

Morgan Stanley executives view the restructuring not as a reaction to the financial overhaul but as part of the bank’s recovery since the financial crisis, and as part of the reorganization of its asset management business that was set in motion by the new chief executive, James P. Gorman. The move would represent something of a break with the era of John J. Mack, Morgan Stanley’s chairman, who pushed the bank into areas like hedge funds. But even if Morgan Stanley spins off FrontPoint, it will still own minority stakes in several other hedge funds.

Like other banks, Morgan Stanley is also reviewing the future of its large and successful proprietary equities trading unit. Mr. Gorman is considering whether to spin it off into the asset management division.

Citigroup has already sold its real estate arm, its SkyBridge Capital hedge fund group and its private equity division. It has also been scaling back its proprietary trading operations.

Now, Citigroup executives are discussing plans for broader changes. One alternative is to shift some of its proprietary traders onto other trading desks. Another would be to fold them into the asset management area.

While JPMorgan is also scaling back its stand-alone proprietary trading operations, its giant hedge fund firm, Highbridge Capital Partners, will be unscathed by the Dodd-Frank rules. That is because Highbridge, with $21 billion in assets, is considered an asset manager, as it relies primarily on capital from investors, rather than Morgan.

Louise Story contributed reporting.