To deal with these conflicts of interest, Wall Street's favorite solution has been to erect a so-called Chinese Wall between the lines of business that have the conflicts of interest. Left unanswered is the question "Does Wall Street's version of the Chinese Wall function better than the original Chinese Wall which failed to keep out the Mongol invaders?"
BlackRock Solutions is the risk management division of the money management firm, BlackRock. If all it did was focus on helping to manage the risk of BlackRock's investment portfolios, there would be no conflicts of interest.
However, that is not all that it does. It also acts as an advisor to third parties, like the Federal Reserve. For example, BlackRock Solutions is advising the Federal Reserve on the sale of the assets the Federal Reserve acquired in the Bear, Stearns bankruptcy while at the same time the BlackRock money management arm is also a potential direct or indirect bidder for the assets.
To anyone not working on Wall Street, this looks like a situation with conflicts of interest.
Would the conflicts of interest go away if the money management arm agrees not to bid? No. So long as BlackRock manages a portfolio containing similar assets there are conflicts of interest as BlackRock is uniquely position to profit from the pricing information contained in the auction of the Federal Reserve's assets.
In another case, BlackRock Solutions has attempted to help an issuer of asset-backed securities provide loan-level information to the market. To anyone not working on Wall Street, this too looks like a situation with conflicts of interest given the fact that BlackRock manages a sizable portfolio of similar assets.
Now, the fact that BlackRock and other Wall Street firms have conflicts of interest does not mean that anyone has acted for its benefit on these conflicts of interest.
However, the fact that these conflicts of interest exist raises the question of "why work with a firm that has a conflict of interest if the alternative to work with a firm that does not have a conflict of interest exists?"
This can be easily done. First, have firms disclose publicly their potential conflicts of interest. Then, select from the firms that are free of conflicts of interest.
Clearly your humble blogger is not the only one concerned about eliminating unnecessary conflicts of interest. The European Commission expressed its concern about conflicts of interest with regards to financial information vendors when it announced its investigation of Markit, its shareholders who are also the source of its information and the credit default swap market.
Highlights from the WSJ article:
BlackRock Solutions has emerged as a key adviser in helping the government unwind the troubled assets it accumulated during the financial crisis. ...
Yet with the recent success has come some unwelcome attention over how it handles that business—as well as more competition in risk management.
With more than $3.6 trillion under management, BlackRock is best known for its bond portfolios, including some that hold the same kinds of securities that BlackRock Solutions is helping the government value and sell.
BlackRock has gone to considerable lengths over the years to keep its Solutions business separate from its core money-management operation. Solutions' employees are housed on separate floors of the firm's headquarters and are accessible by different elevators than other parts of the firm that could profit from its knowledge. All of their data and computer systems are separate from those of the main company.
Still, some analysts are raising concerns that the firm's government dealings give BlackRock too much access to market-sensitive information—and too many temptations to use that information to boost its main business.
"They've combined asset-management and advisory businesses, and it raises some issues of conflicts," says Christopher Whalen, co-founder of risk-management consultant Institutional Risk Analytics. He said he isn't suggesting that there have been problems.
Mr. Goldstein says BlackRock Solutions has been sensitive to such perceptions since its inception.
...The Solutions group has found a new market since the financial crisis. Not only are many mortgage-related bonds difficult to value these days, but some investors have lost faith in the big bond-rating firms' credit-scoring capabilities, say analysts. Last year, BlackRock Solutions took on 62 new assignments, up from 48 in 2009.
During an April 21 conference call with investors, BlackRock Chief ExecutiveLaurence Fink singled out Solutions as a high performer, saying it did "an exceptional job" in helping the Central Bank of Ireland understand the market dynamics affecting its banking system. The central bank rescued many of the country's banks after the country's real-estate bubble burst, leaving lenders saddled with souring loans.As was pointed out previously on this blog, the work performed by BlackRock Solutions, while very expensive, has failed to restore confidence in the Irish banking system.
... The firm's secretive valuation process also has raised questions. Since the government owns so many subprime assets, critics contend, taxpayers have a right to know how those assets are being valued. BlackRock doesn't discuss its methods publicly, and the Fed offers only broad disclosures about how values are reached.
"It should all be open," says Allan H. Meltzer, a professor at the Tepper School of Business at Carnegie Mellon. "They may be doing things honestly and above board, but we won't see that unless we see how they got the numbers.…How they calculate the portfolio of those assets is how we know how much the taxpayers are going to pay."
... "We spend a very significant amount of time teaching clients what the limitations of the risk models are," BlackRock Solutions' Mr. Goldstein says.