When Frank Fu, a Cornell-educated engineer, opened his own hedge fund two years ago, he picked an unlikely niche for an introvert.
His CaaS Capital Management would focus on block trading, one of the last bastions of old Wall Street, where big slugs of stock are sold through person-to-person negotiation, even cajoling, rather than electronic venues. Many practitioners are bro-y -- the type who played college football. For Friday happy hours, Fu’s colleagues unzip their CaaS puffer vests and break out chess boards in a conference room.
Yet Fu, 39, soon managed to establish close ties with investment banks including Morgan Stanley, the juggernaut of the equities world. His pitch: CaaS would “partner” with them, positioning itself for preferential treatment. Prospective investors say CaaS has boasted to them of quickly becoming one of the biggest U.S. funds dedicated to block trading, getting a first look at deals and gaining entry to virtually every IPO in the country. In the firm’s first full year Fu posted a jaw-dropping 76% return.
Now, Fu and one of his key contacts at Morgan Stanley, Pawan Passi, are said to be among more than a dozen industry executives whose communications are being scrutinized in a sweeping U.S. probe into how Wall Street firms handle big trades. Investigators are examining, among other things, whether banks improperly tipped hedge funds to pending sales big enough to move markets.
“CaaS has earned a reputation in the market as the firm that receives an early, if not first, call.”
While a coterie of firms has said they, too, help banks with block trades, none has been more effusive than CaaS in making that its raison d’etre. Its name is an acronym for “Capital as a Service.” The firm had just over $650 million in assets under management at the end of February, but it’s been able to leverage that up, wielding somewhere around $5 billion in firepower so it’s able to pounce if banks need to unload stock.
The probe may test whether Morgan Stanley or others involved in such symbiotic relationships crossed legal lines.
Investigators at the Department of Justice and the Securities and Exchange Commission haven’t accused anyone of wrongdoing. Morgan Stanley placed Passi, one of its top executives on block trades, on administrative leave in November and in a regulatory filing last month acknowledged it faces Justice Department and SEC inquiries. Spokespeople for the bank and U.S. prosecutors declined to comment for this story, as did a representative for CaaS and Fu.
Anticipating Flows
Though Wall Street’s boisterous trading pits have long been overtaken by the hum of electronic venues, the art of trading blocks of stock still endures in Manhattan’s towers. Indeed, its importance has swelled in recent years, as young companies have come to rely on rounds of funding from venture capital and private equity firms.
Morgan Stanley, in particular, has built up a franchise helping Silicon Valley startups carry out those funding rounds. So when companies eventually do hold an initial public offering, they may have a long list of early stakeholders still holding large amounts of stock. Morgan Stanley can earn extra fees helping them cash out, offering shares to investment firms with desks handling blocks, as well as specialized shops such as CaaS.
Those dealings can tread into gray legal areas.
One way money managers can get an edge is by anticipating flows. Say a banker is angling to help a big shareholder reduce its stake. To pitch a competitive price, the banker might call around to money managers to gauge their theoretical appetite. Market participants say that some traders have been known to bet against shares after getting those calls, assuming a deluge of stock will soon hit the market and push down the price. That short-selling also depresses the price and raises the question of whether the trader acted on material non-public information, a key ingredient of insider trading.
“The definition of material nonpublic information is pretty broad,” and can be murky, said Dan Viola, a partner overseeing law firm Sadis & Goldberg’s regulatory and compliance practice. “Funds shorting after such calls are taking an aggressive stance. Regulators appear to be concerned about a banker giving confidential information to preferred customers at the expense of the person who is selling the big block.”
Still, bankers might find some advantage in letting traders know blocks are coming. If those traders short the stock, they might be more amenable to buying a piece of the block at a thin discount. The government is looking into whether such trades took place.
A $40 Million Haul
In his early career, Fu focused on types of trading that depend more on math than networking. Born in Shanghai, he came to the U.S. to study at Cornell University in the early 2000s, earning a bachelor’s degree in operations research and industrial engineering and a master’s in financial engineering in 2006, after which he landed at Susquehanna International Group, where he spent two years trading options.
He then moved to Laurion Capital Management. Looking for additional ways to make money, he started wading into block trades around 2012. Within a few years, he established himself as one of the top rainmakers at the firm and a key player in providing liquidity to banks. He and Passi met around 2016, a person with knowledge of their relationship said. During Fu’s last five years at Laurion, he made more than $40 million, according to a lawsuit filed over the terms of his exit in 2019.
Fu set up his own shop with early backing from BlackRock Inc. and New Holland Capital. He told investors he planned to position himself as an aide to banks, which after the 2008 financial crisis weren’t able to pile on big blocks of stock like they used to. In more recent months, CaaS has told prospective investors it had ties to about 30 banks.
“Due to the breadth and strength of these relationships, CaaS has earned a reputation in the market as the firm that receives an early, if not first, call,” the firm wrote in a recent marketing presentation.
Fu wasn’t flashy with his growing wealth. One associate described him as one of the cheapest dinner meetings on Wall Street, typically ordering just an entree and a Diet Coke. He bought investment properties in Weehawken, New Jersey, and surrounding areas and started a foundation with his wife, which has donated to Cornell and Horace Mann, a private school in the Bronx.
Fu typically agrees to participate in about half the blocks he’s offered, making the decision based on the discount, his portfolio’s other holdings and computer models, CaaS told prospective investors. The firm typically carries about 200 blocks at a time, waiting anywhere from two days to five months, or longer, to unload them after purchase. As a good trading partner, Fu expects banks to send shares from hot IPOs his way. Indeed, the firm has been bragging to potential investors in recent months about its access.
His singular focus contrasts with many of his competitors. For example, Islet Management's Joseph Samuels, another hedge fund manager whose communications have been sought by the feds, runs a few strategies. When it comes to blocks, he’s told investors he employs an event-driven approach: By keeping an eye out for companies with backers whose stakes are exiting lockup periods, he can try to anticipate big sales. Investigators have also gathered information on traders at other firms including Andrew Liebeskind at Citadel’s Surveyor Capital and Jon Dorfman at Element Capital Management, Bloomberg reported last month. Representatives for all three declined to comment.
Fu’s Purchases
Not every bank took up Fu’s offer. One banker, speaking on the condition that he and his employer not be named, said his firm twice sold Fu a block of shares from its own book, but each time noticed a drop in the public price before the transaction was finished, reducing the bank’s proceeds. Suspicious that the drops might not be coincidental, the banker made a personal decision a few years ago to stop trusting Fu with new business.
Banks sometimes find themselves in urgent need of trading partners who can help them unload large quantities of stock that other investors — rattled by price drops or other uncertainties — won’t touch.
The collapse of Archegos Capital Management late last March set off a race among lenders including Morgan Stanley, Goldman Sachs Group Inc. and Credit Suisse Group AG to sell billions of dollars of shares as they unwound the family office’s highly levered portfolio. And Fu was there to buy.
At the end of the month, a regulatory filing showed CaaS scooped up more than $440 million of the stocks that Archegos had been betting on. Another major buyer of those blocks, George Soros's $27 billion investment firm — roughly 40 times larger than CaaS — held about $400 million.
In the months that followed, Fu’s firm reported significant stakes in companies that held some of the year’s most highly sought-after IPOs, including Honest Co., Oatly Group AB and UiPath Inc.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
