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Early Industry Reaction To F.I.A.S.C.O.

That #%@! Book

News that somebody had written a tell-all book about the derivatives business swept quickly through the Wall Street rumor mills in early October. F.I.A.S.C.O.: Blood in the Water on Wall Street, written by Frank Partnoy, a 30-year-old former Morgan Stanley associate, boldly alleged that the firm consistently tried to rip off its customers with high-tech derivatives products.

Morgan Stanley's reaction to the charges was predictable: "The book is clearly a combination of inaccuracies and sensationalism,” said a spokeswoman. "Our business is based on consistent and professional service to our clients and customers. We do not engage in conduct that would violate the trust that they place in us. We stand on our record.”

Other derivatives dealers who had read the book at press time had a wide variety of reactions. One former Morgan Stanley derivatives employee took particular issue with Partnoy's claim that salespeople boasted about "ripping someone's face off.” "You heard it, but not as a bragging claim,” she says. "You heard: ‘I don't want to rip this guy's face off. He's an account that I care about.'”

She also objected to the notion that end-users were passive suckers who got taken by complex deals developed by savvy dealers. The formulas for some of the most complex structured-note ideas, she notes, came from the clients themselves.

Ditto for the idea that all money managers are rubes. In fact there were managers who were famous for asking for structured notes to be customized to make the bets they wanted to make and then later inventing even more complex structured transactions to restructure those bets.

This particular dealer remembers Partnoy as "an affable young man who never had his heart in it. He wasn't as successful as he thought he was and he was something of a smart ass. Frank was part of an unhappy troika of people who all quit at about the same time.” One of the troika, she says, was not as disillusioned by the business as Partnoy claims: he now runs the desk in collateralized bond obligations at one of Morgan Stanley's rivals.

"The problems are too subtle in derivatives,” she concludes. "The descriptions of the people weren't far off the mark, but he had to find demons where none existed to make this a book with any popular appeal.”

Little fry

One industry veteran who acts as an adviser to some of the world's largest hedge funds thought Partnoy's boasts about ripping off investors with multimillion dollar fees was a form of self-delusion. "The sell side only sees one side of the transaction,” he explains. "A bonafide customer is willing to pay the broker in the pit even though he knows the broker is stealing money from him. That's just the friction, working for very small spreads. Partnoy is a guy from the pit, and he doesn't understand he's just friction. It's an unpleasant cost, but it's not really a big cost. A good trade will make you 300 percent or 400 percent, so the extra one percent or two percent you pay is not a big deal.”

He points out that Morgan Stanley and other firms were eager to sell George Soros options on European currencies right before the collapse of the ERM at what the dealers thought were huge profits. "Morgan Stanley was just another sucker selling Soros options,” he says.

What really brands Partnoy as a bit player, he notes, is the way Partnoy is impressed with the multimillion dollar salaries of his bosses. "What he thinks of as a lot of money isn't a lot of money. He thinks that people who are worth $50 million are rich guys. In this world, lots of people have that kind of money. Nobody's impressed when they hear you have guys in the firm making $6 million. Hedge funds pay administrators that much just to keep track of their positions.”

"The notion of gouging a client for a huge commission is acceptable, because the profit is completely buried. But selling a derivative that blows up in the client's face is not.”

Another senior options trader at a French bank objects to the notion that there was something inherently wrong with taking advantage of people who have less information. "That's standard information economics,” he notes. "Sellers always know more than the buyer. A used car dealer knows a lot more about the car he's selling than you do.”

He also points out that derivatives have been a major force for good in the world economy. Although Partnoy sold emerging market paper, the trader notes, Partnoy never seemed to understand that the acceleration of growth in many emerging market economies was the direct result of major derivatives-linked investments by U.S. pension funds and other institutional investors.

One attorney who works at a leading derivatives firm disagrees with Partnoy's conclusions about the industry, but says he loved his descriptions of how it worked. Although he admits "ripping someone's face off” is a common enough expression, he doubts that anybody would brag about blowing up a client. To drive home his point, he makes a subtle moral distinction that may be lost on those outside the market: "The notion of gouging a client for a huge commission is acceptable, because the profit is completely buried. But selling a derivative that blows up in the client's face is not.”

Thus far, the book has received a decidedly mixed reception in the business press. A long article on Page 2 of The New York Times business section recounted Partnoy's charges but stopped short of praise. The New York Post, true to form, focused almost exclusively on the lurid sexual accounts that spice the book.

But a Business Week review complained that "...the author provides little hard evidence that Morgan Stanley systematically mistreated its customers by selling them garbage products.” The review concluded that "it's hard to avoid feeling that Partnoy is not being completely honest,” and that Partnoy was "stretching his somewhat skimpy experience over too large a set of allegations.”

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