Wall Street Trading Is Still a Black Box

It took a congressional inquiry this year to force Goldman Sachs (GS) to disclose how much it made in the mortgage market—and that was only for 2007. The Wall Street bank hasn't revealed mortgage-trading revenue since then. That leaves investors to guess how much that contributes to the fixed-income, currency, and commodities division, or FICC, which also trades junk bonds, yen, oil, and uranium, sells weather derivatives, and operates power plants.

While the company gives directional hints about the performance of the businesses within FICC in press releases about its quarterly earnings, that's not good enough for Mike Mayo, a bank analyst at Crédit Agricole Securities USA in New York. "That's just one big black box," he says. "You can't get around it."

Wall Street firms' tendency to hoard information about markets and how they make money has come under scrutiny after investors were caught by surprise in 2007, when confidence in everything except Treasury securities vanished and credit markets collapsed. Lawmakers and regulators are pushing firms to move derivatives trades onto clearinghouses, where prices can be monitored, while demanding fuller disclosure on consumer loans. Yet the Dodd-Frank Act, designed to prevent future financial crises, does little to improve investors' ability to analyze results at the five biggest U.S. firms that trade securities for clients and their own accounts—Goldman Sachs, Citigroup (C), JPMorgan Chase (JPM), Bank of America (BAC), and Morgan Stanley (MS).

Investment banks combine the results of trading categories to keep them secret from competitors and trading partners and to smooth out gains and losses from swings in individual markets, says Adam Hurwich, a former member of the Investors Technical Advisory Committee of the Financial Accounting Standards Board (FASB) who's now a partner at hedge fund Jupiter Advisors in New York.

The resulting opacity undermines confidence in the firms' results, says Brad Hintz, a former Morgan Stanley treasurer and Lehman Brothers Holdings chief financial officer. "Nobody believes the brokerage firms right now," says Hintz, now an analyst at Sanford C. Bernstein (AB) in New York. "When you're mixing euros and yen and dollars together, and then on top of that you're throwing in commodities, what I have is succotash, and it's very difficult for us to analyze."

The issue has taken on greater significance as the trading businesses have grown. The banks reported $79.9 billion in FICC revenue in 2009, more than double the amount in 2004. FICC accounted for 22 percent of the banks' total revenue last year vs. 14 percent in 2004. Goldman Sachs' FICC division last year brought in $23.3 billion, or 52 percent of the firm's total, making it the biggest based on revenue and the percentage of overall revenue. Spokesmen for Goldman Sachs, Citigroup, Bank of America, and Morgan Stanley declined to comment. Kristin Lemkau, a spokeswoman for New York-based JPMorgan Chase, says the bank tries to "provide sufficient disclosure to allow investors to make informed decisions about our business."

U.S. accounting rules allow companies "quite a bit of latitude" in how much detail to disclose about business segments, says Regenia Cafini, a project manager at the Norwalk (Conn.)-based FASB, which sets bookkeeping standards. Companies are supposed to break out business segments whose "results are reviewed regularly" by the "chief operating decision maker," typically the CEO or chief operating officer.

A July proposal by FASB staff to be considered later this year would require banks to report income and expense items "so that the information is useful in understanding the activities of the entity." Absent that, "there really aren't rules per se on defining a segment," Cafini says. "It's how the company sees itself. I'm a manufacturing company, and I make clothing. I could segment myself by shirts and pants and belts or I could lump them all together."

Former Securities and Exchange Commission Chairman Harvey Pitt thinks pressure from regulators and investors will force banks to be more forthcoming. "They're going to resist it, but they're going to have to disclose more," says Pitt, now chief executive officer of Kalorama Partners, a Washington-based consulting firm. "If there's one thing we've learned from the financial crisis, it's that a lack of transparency is absolutely devastating."

The bottom line: Wall Street banks still don't divulge much about their trading, making it hard for investors to know how much risk the firms are taking.

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