The structured note industry is largely built on misinformation and deception, says a new book on the derivatives industry.
Structured note buyers either don't know what they are buying, or don't want their clients to know what they're buying, according to Frank Partnoy's "F.I.A.S.C.O.: Blood in the Water on Wall Street," published by W.W. Norton & Co. Inc., New York.
And the fat fees in structured securities drive dealers to seek exotic and varied ways to rip off their customers, the book states.
"F.I.A.S.C.O." is a memoir of Mr. Partnoy's two years devising emerging markets derivatives for his old employers, CS First Boston and Morgan Stanley Dean Witter Discover & Co.
The book is woefully lacking in attribution for statements Mr. Partnoy makes regarding major events he clearly had no direct knowledge about. But his stories about his personal interactions at the investment banks are credible. Nonetheless, some in the industry may find parts of the book hard to believe.
Mr. Partnoy's blend of humor and an insider's knowledge creates a disturbing portrait of the derivatives industry. Institutional investors are either "cheaters" or "widows and orphans." The cheaters use structured notes to get around investment restrictions, while the widows and orphans barely understand what they have bought. He doesn't break new ground regarding derivatives blowups, such as those at the Wisconsin Investment Board, Madison, and Procter & Gamble Co., Cincinnati.
But Mr. Partnoy's descriptions of derivatives dealers' business practices are chilling. A Morgan Stanley salesman related to Mr. Partnoy a story regarding a customer's loss on $85 million of structured notes known as "PERLS."
"This salesman had earned a giant commission on this PERLS trade, and he laughed uncontrollably at his story," he recounts in his book.
"I laughed, too. When he finished his story, he asked me if he knew what it was called when a salesman did what he had done to one of his clients. I said I didn't know. He told me it was called 'ripping his face off'."
On one Mexican structured note, Morgan Stanley turned to Bermuda's less stringent investment regulations for its domicile. "Overall, Morgan Stanley's actions were barely distinguishable from those of a drug kingpin seeking an appropriate tax haven to launder drug money," the book states.
"Morgan Stanley was taking precisely the same steps drug dealers took to evade U.S. regulators."
Regarding a temperamental executive who played computer chess all day, Mr. Partnoy wrote: "As far as I could tell, he did almost nothing to earn the millions he received every year, apart from yelling at some of the other managers."
Mr. Partnoy's boss, a Morgan Stanley executive nicknamed Scarecrow, was obsessed with guns and warfare and was "the antithesis of the prototypical derivatives salesman," having no math degree or "enormous brain."
"Ultimately, Scarecrow's military talents proved far more valuable than mere math skills," the book relates. "He and others were able to persuade the rocket scientists that shooting was more effective than thinking. This was the key to Morgan Stanley's new philosophy."
The quickness with which Mr. Partnoy advanced in the industry despite his inexperience amazed even him. "For some reason I have a knack for getting people to hire me for jobs I am utterly unqualified for. . . . (N)ow Morgan Stanley was asking me to sell even more exotic derivatives to the Japanese. I had never met or even spoken to a Japanese client, and I had no knowledge of the Japanese financial or regulatory systems."
While Mr. Partnoy has left the derivatives world to practice law, and now teaches it at the University of San Diego, "F.I.A.S.C.O." could leave a lasting mark on investors who read it.