Saturday, June 30, 2012

Clearing Firm's Exit Will Cost Brokers

Penson Worldwide recently wound down its business at a surprisingly rapid rate. Its successor, Apex, is trying to raise rates on some online firms.

Penson Worldwide, a big clearing firm that drew lots of unwanted attention to itself a year ago by disclosing it held millions of dollars worth of potentially illiquid bonds issued by a horse-racing track operator tied to one of its directors, has wound down its business with surprising speed in the past few weeks. Much of it has been transferred to a new outfit, Apex Clearing, which has angered some brokers by seeking more capital to offset their risk taking.

In recent weeks, the situation apparently became untenable at Penson, which handled transactions for several hundred online brokers and hedge funds. In its quarterly report to the Securities and Exchange Commission in mid-May, Penson said it was pursuing a number of “strategic restructuring initiatives” to improve its financial liquidity and increase its regulatory capital. A couple of weeks later, on May 31, Penson formed a partnership with options-market maker Peak6 Investments, the parent of electronic broker OptionsHouse, creating Apex. Penson still owns clearing operations in Canada as well as some futures-clearing business, but all of its U.S.-based business now belongs to this new entity. Penson stock (ticker: PNSN) traded last week at 17 cents a share, down from $3.12 a year ago.

Apex began operating on June 6. Trades previously cleared through Penson were transferred to the new entity. About one million customer accounts and a number of exchange memberships migrated from Penson to Apex without apparent problems. Clearing firms like Penson process trades electronically for broker clients and make sure funds are properly segregated.

The firm’s swift departure suggested that regulators had stepped in to avoid a bigger problem. “This whole deal has Finra’s [Financial Industry Regulatory Authority] fingerprints all over it,” says one executive. Finra is the largest independent regulator for securities firms operating in the U.S., and its mission is to protect investors by ensuring the integrity of the brokerage business. A Finra official acknowledged the agency’s “heightened scrutiny” of Penson in recent months as well as its intention to monitor the transition to Apex.

The first news of problems at Penson came about a year ago. The firm disclosed in a routine filing that it had certain receivables whose collateral had reduced liquidity. Among them: $42.6 million in bonds issued by a Texas horse-racing track, run by Call Now, an early investor in Penson. Call Now CEO Thomas R. Johnson was a Penson director. He left the board shortly thereafter.

PENSON WAS EXPANDING aggressively, according to several sources. The growth was funded by debt that increasingly strained Penson’s finances, they said. It also was allowing its clients to take on too much risk, says one of the sources. Penson referred any comment to the Apex team.

Announcing Apex’s start, Brad Goldberg, Peak6’s president, said in a release: “This transaction resolves an urgent need in the marketplace today to maintain stability and continuity for Apex Clearing’s customers.”

Brokers apparently started looking for an exit after last year’s news broke. “If there had been an easy alternative, their customers would have left last year,” says one observer. Switching clearing firms can be a prolonged process, given the technology and sensitive client knowledge involved. Brokers don’t want their customers to experience any sort of disruption.

Peak6 partner Danny Rosenthal is the CEO of the new firm, and he says that Apex will focus on building stability while using capital more efficiently. Apex will exit from some businesses, such as clearing foreign equities, which were a drain on capital. Rosenthal also notes that Apex will leverage Peak6’s focus on automation.

Although brokers were generally pleased that Apex will be a more stable operator with a good management team, some were worried about the role of OptionsHouse, the Peak6 unit that competes with many electronic brokerages. They don’t want the broker to gain any advantage. Rosenthal assures us that there are firewalls in place to prevent one piece of Peak6 from influencing another.

More controversial is Apex’s new deposit plan for brokers. Goldberg explains that Apex has developed a formula asking correspondent firms to increase their deposits based on the types of trades that they handle. “All of our correspondents are coming up to a formula-driven level,” notes Goldberg. Some smaller brokers complain they are being asked to put up as much as 5 to 10 times more than previously.

Some online brokers were fighting back last week. TradeKing and Zecco, which are slated to merge, were granted a temporary restraining order against Apex’s increased capital requirements. TradeKing said it had been asked to lift its deposit from $100,000 to $13.1 million, while Zecco said its required deposit was raised from under $100,000 to over $9 million.

TradeKing CEO Don Montanaro, told Barron’s: “We run a very safe business and felt that $100,000 was plenty.” Zecco CEO Mike Raneri added that “the temporary restraining order is intended to let us maintain our current businesses with our customers and our prospective customers.”

Montanaro hopes to resolve the issues, but says, “We are certainly exploring all of our options when it comes to clearing, including the path of self-clearing.”

Brokers that don’t pony up within 30 days could face dire consequences. The head of another small firm that clears at Apex says that his choices are to come up with the huge deposit, or pay half of it within 30 days and change the terms of the clearing agreement, which he estimated would mean a tripling of fees. The third choice: move to another clearing firm within 90 days. But his firm would be unable to open new accounts during the switch.

Of the TradeKing and Zecco actions, Rosenthal says Apex’s new system is intended to provide stability and longevity for the new firm. “There’s no malice for particular customers in our request to increase their deposits with us, but there are some taking on more risk than we’re comfortable with.” He adds, “We’re still talking, and there are a lot of ways to resolve this.”

The outcome has ramifications in the cost-sensitive online broker market. In our most recent broker ranking ("Online Investors Cut the Cord,” March 12), 14 firms listed Penson as their clearing firm. (Click here for a list.)

With the TradeKing-Zecco merger, the number drops to 13. We’ll monitor to see if it falls further. It’s clear capital levels to support risk-taking are going up.

Published in Barron’s, June 25, 2012. 

Posted by twcarey on 06/30 at 11:45 AM
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