–Matthew Goldstein is a Reuters columnist. The views expressed are his own.–

Did someone try to steal Goldman Sachs’ secret sauce?

While most in the United States were celebrating the Fourth of July holiday, a Russian immigrant living in New Jersey was being held on federal charges of stealing secret computer trading codes from a major New York-based financial institution.

Authorities did not identify the firm, but sources say the institution is none other than Goldman Sachs .

The charges, if proven, are significant because the codes that the accused, Sergey Aleynikov, tried to steal are the secret sauce to Goldman’s automated stock and commodities trading business.

Federal authorities contend the computer codes and related-trading files that Aleynikov uploaded to a German-based website help this major financial institution generate millions of dollars in profits each year.

The platform is one of the things that gives Goldman an advantage over the competition when it comes to the rapid-fire trading of stocks and commodities. Federal authorities say the platform quickly processes rapid developments in the markets and using secret mathematical formulas, allows the firm to make highly-profitable automated trades.

The criminal case has the potential to shed a light on the inner workings of an important profit center for Goldman and other Wall Street firms. The charges also raise serious questions about the safeguards that Wall Street firms deploy to protect these costly-to-build proprietary trading systems.

The criminal case began to unfold on the evening of July 3, when Aleynikov was arrested by FBI agents at Newark Airport after returning from Chicago.

Aleynikov apparently had just started a job with another big firm in Chicago after leaving his previous employer in New York in early June. It appears that the financial institution allegedly victimized by Aleynikov had alerted federal authorities that its former employee might be up to no good.

On July 4, Aleynikov was processed on a “theft of trade secrets charge” in a criminal complaint. As of Sunday morning, he was still being held at the Metropolitan Correction Center in Brooklyn.

A Goldman spokesman declined to comment on the incident. A spokeswoman for the United States Attorney’s Office in Manhattan did not comment.

Sabrina Shroff, Aleynikov’s lawyer, says the facts will bear out that her client is innocent. She’s hoping he will be released from custody soon.

His wife, Elina, says her husband is innocent. Speaking in a phone interview from the couple’s New Jersey home, she says her husband worked hard for Goldman and has been a good citizen — noting he’s lived in the United States for 19 years. She seems mystified that federal authorities would arrest him on the eve of a holiday.

The Federal Bureau of Investigation, in charging Aleynikov, says he began working for the major financial institution in May 2007 as a computer programmer and left in early June. That matches the description of a man named Serge Aleynikov on the social networking site LinkedIn (the difference in spelling of the first name could not be immediately explained).

The biographical information for Aleynikov on LinkedIn says he joined Goldman in May 2007 and was vice president for equity strategy. The bio says he was responsible for “development of a distributed real-time co-located high-frequency trading platform.”

The case against Aleynikov may explain why the New York Stock Exchange moved quickly last week to stop reporting program stock trading for its most active firms.

Goldman was often at the top of the chart — far ahead of its competitors. It’s possible Goldman had asked the NYSE to stop reporting the number after it discovered that someone may have infiltrated the proprietary computer codes it uses.

Here’s the way the criminal complaint describes the Goldman trading platform:

“The Financial Institution has devoted substantial resources to developing and maintaining a computer platform that allows the Financial Institution to engage in sophisticated high-speed, and high-volume trades on various stock and commodities markets. Among other things, the platform is capable of quickly obtaining and processing information regarding rapid developments in these markets.”

Federal authorities appear to believe Aleynikov may have had help. The German website that Aleynikov is accused of uploading the stolen information to is registered to a person in London.

While the case is still unfolding, there is more information to unearth about Aleynikov. For instance, it appears he and his wife are competitive ballroom dancers — there are videos of them on YouTube.com.

Many questions remain.

Which Chicago firm hired Aleynikov? The job he took in Chicago, according to the criminal complaint, paid nearly three times more than his $400,000 salary at Goldman.

Also, there’s more to learn about anyone who might have been helping him and the fallout the case may have for Goldman. When he was arrested, Aleynikov told the FBI he “only intended to collect ‘open source’ files on which he had worked, but later realized that he had obtained more files than he intended.”

Quick, get this guy a good lawyer.

One question investors need to ask is whether this incident will have any impact on Goldman’s second-quarter earnings. The alleged wrongdoing by Aleynikov took place at the beginning of June — although it’s not clear if it had any material impact on automated trading.

You have to marvel at the seemingly Midas touch of Larry Fink.

The BlackRock Inc. chief executive avoided taking over the helm of Merrill Lynch -- something John Thain probably wishes he had done. Fink's firm emerged from the financial crisis as the Federal Reserve's favorite private money manager, with BlackRock getting the lion's share of the government's work for managing troubled assets. And the $13 billion deal Fink just reached with Barclays Global Investors has turned BlackRock into the outright titan of the asset management world with $2.7 trillion in other peoples' money under management.

It's often been said Jamie Dimon is the new king of Wall Street. But one can argue that the 56-year-old Fink, who started BlackRock as a small bond investment shop two decades ago, can also rightfully lay claim to that honor. Even as the Obama administration is about to announce its plan for managing so-called "too big to fail" financial institutions, Fink's BlackRock is getting bigger and more consequential than ever.

The deal puts BlackRock's fingers firmly into every significant asset class-corporate bonds, mortgage-backed securities, mutual funds, stocks, cash, hedge funds and now the ever popular exchange traded funds -- a stock index-like security. Barclays now joins Bank of America and PNC Financial in having major equity stakes in BlackRock and a vested interest in the money manager's long-term health.

The danger, of course, in creating a money management firm the size of BlackRock is that it puts a lot of people's retirements at risk if the firm were to collapse, or its investment funds were to implode. To put BlackRock's size in perspective, it's now bigger than the combined assets managed by mutual fund giant Fidelity Investments and the entire hedge fund industry.

Wall Street historian Charles Geisst says money managers traditionally have not posed the same kind of risk to the financial system as a commercial bank or investment. But Geisst worries whether Wall Street is laying the groundwork for a new kind of systemic risk, if the BlackRock deal with Barclays encourages a consolidation of too much pension and retirement money into the hands of just a few players. "We could have big problems with these huge asset managers down the road," he says.

To be sure, BlackRock is not too big to fail in the way that phrase came to be used during the current crisis. The firm is not a primary lender to other institutions and BlackRock is not widely leveraging its own balance sheet to fund its operations. The firm has just $1 billion in debt on its balance sheet. More significant, the investments that BlackRock manages aren't insured by the federal government -- so a collapse of its many investment vehicles wouldn't require any direct payout by taxpayers. And it's hard to imagine all of BlackRock's many funds going south at the same time.

Still, it's worth remembering that no money manager always has the golden touch. Consider the case of Anthracite Capital, a commercial mortgage-focused real estate investment trust (REIT) that is teetering, and which long has been tied to both Fink and BlackRock.

Last year, Anthracite shelled-out about $24 million in management fees to BlackRock. In March, Anthracite's auditors officially voiced doubt about Anthracite's ability to survive as a "going concern", although it has since renegotiated some of its credit lines. The shares are trading around 80 cents -- down from $8 a year ago. Anthracite hasn't paid a dividend to most shareholders since the end of 2008.

Anthracite, meanwhile, owes its very existence to BlackRock. Back when BlackRock was still a subsidiary of PNC, it took Anthracite public in 1998 with Fink as the REIT's first chairman. Trying to decipher the many related party transactions between the two firms is enough to give you a headache. But suffice to say, the connections between the two financial firms are substantial.

Over the years, BlackRock has relied on Anthracite to provide $150 million in equity capital for two separate real estate funds Fink's firm manages, and BlackRock also is one of the REIT's main financiers.

Now if Anthracite were to go bust, the impact on BlackRock wouldn't be immense. (BlackRock declined to comment.) But the firm would be forced to take a write-down on the lost management fees, its remaining equity stake in Anthracite and the roughly $30 million in loans it has extended to Anthracite.

But the more significant impact might be to Fink's reputation. For Anthracite's collapse could come just as he is reaching for his share of the Wall Street crown.

– Matthew Goldstein is a Reuters columnist. The views expressed are his own –

Many critics of the Securities and Exchange Commission point to Christopher Cox’s appointment as chairman in August 2005 as the day the wheels came off Wall Street’s top cop.

But in some ways, the SEC began to veer off course a few months earlier, when the agency moved its Washington headquarters into a sparkling new office building that would make even a corporate law firm jealous.

The plush environs made it all too comfortable for lawyers and investigators and discouraged them from venturing out to discover what the Wall Street banks were doing with all that leverage or sniffing out what Bernie Madoff and R. Allen Stanford were really up to.

As she fights to keep Congress from diminishing her agency’s mandate, Mary Schapiro, the commission’s chairwoman, vows to put an end to the regulatory lethargy. Schapiro, according to The Wall Street Journal, recently told some of her senior lawyers, “We need to demonstrate that we’re going to make changes.”

That’s great news. Here are five things Schaprio can do right away to dust the cobwebs off and get the 75-year-old agency back into the business of protecting investors.

1) Transfer scores of lawyers and investigators from the Washington office to the agency’s 11 regional offices. Roughly 60 percent of some 3,500 employees work in the headquarters.

Now to be fair, only 500 of those 2,100 workers in Washington are directly involved in either enforcement work or regulatory oversight.

But that’s probably several hundred employees too many. The SEC would be better off with more eyes and ears on the ground in the regional offices-which would allow for more direct oversight of public companies and brokerage firms.

2) Open more regional offices. Moving lawyers and investigators out of the home office would make it easier for Schapiro to open more regional offices, enabling the agency to better protect the investing public.

It’s crazy that the SEC doesn’t have a regional office in Charlotte, N.C., which is home to Bank of America, the nation’s largest lender by assets. Even after Wells Fargo’s acquisition of Wachovia, Charlotte will remain a major banking hub.

The SEC needs to be there on the ground. Opening a regional office in Phoenix, one of the fastest-growing cities and home to many retirees, makes a lot of sense. For that matter, Las Vegas is a natural place too. After all, retirees are prime target for investment scams.

3) Require public companies and brokerages to report prominently on their websites if they are the subject of an active SEC investigation.

It’s long been up to the discretion of public companies and Wall Street firms to disclose whether the SEC has opened a formal investigation. And many companies and brokerages, on the advice of their lawyers, don’t disclose, arguing that many regulatory inquiries never result in an enforcement action.

But this does a disservice to the investing public, especially since SEC investigations can often take years to complete. Just imagine how many investors might have been protected, if Stanford Financial had been forced to put a red flag on its website, noting the SEC was investigating its certificates of deposit business since 2005.

4) Publish meaningful investor alerts. A year ago, the SEC initiated a good investor protection program called PAUSE-a website that lists unregistered investment firms operating in the U.S. that appear to be involved in fraudulent schemes.

Never heard of it? That’s not surprising because the SEC has done a poor job of publicizing its own initiative. In fact, since the PAUSE website began in April 2008, the number of potential bad actors identified by the SEC has nearly doubled to 112 unregistered investment firms.

But the SEC has not once issued a press release announcing the addition of new name to the PAUSE list. Publishing an investor alert about PAUSE firms would not only bring attention to the good work the SEC is doing, it also makes it easier for investors to do online due diligence.

5) Think like a cop on the beat. To catch bad guys, you sometimes have to think like them. For too long the history of the SEC is that it ends up fighting yesterday’s battle.

By the time it brings a regulatory action, the Wall Street scamsters are coming up with another way to defraud investors.

Or the big Wall Street firms have dreamed up another way of slipping through the regulatory cracks and coming up with an investment product that skirts SEC oversight-think credit default swaps.

Now it may be asking too much of the SEC to stay one-step ahead of the fraudsters, the investment bankers and derivatives traders. But there’s nothing preventing them from staying current by getting out more and talking to traders, investors, hedge fund managers and the mathematicians who develop trading algorithmic formulas.

For too long, critics have joked that the SEC brings its enforcement cases after reading about them in the business press. That’s not totally fair. But if the SEC got more of its people spread across the country and started talking to investors and traders like reporters do, it might actually stop looking like it is always late to the game.

– Matthew Goldstein is a Reuters columnist. The views expressed are his own –

We’re not quite there yet, but hedge fund managers may soon need to start giving away toasters – or perhaps plasma TVs — to woo new investors. Forcing the funds to eat a little humble pie now would benefit hedge fund investors in the long run.

Most hedge funds are off to a decent start this year — the average return to date is 9.43 percent, says Hedge Fund Research. Yet it’s a particularly tough time for launching a new fund. In the first five months of 2009, just 40 new funds have begun reporting performance figures, BarclayHedge reports.

That’s a pittance compared with the same time last year, when 240 new funds started trading.

And investors, who were badly burned last year, seem more interested in pulling money out of hedge funds. This year the pace of redemptions is down only slightly from the fourth-quarter of 2008 — when investors pulled some $165 billion out of hedge funds.

Look for redemptions to continue well into the summer, as temporary “gates” that blocked investors from fleeing for the exits, start to get lifted at some big funds.

Sol Waksman, BarclayHedge’s president, says it will probably take “some period of sustained positive performance” before investors are willing to commit money to new funds.

But it may take more than a few “up” months for the hedge fund industry to get its mojo back.

So-called funds of hedge funds, big pools of investor capital which direct money to an array of funds, are fast disappearing.

The incredible shrinkage of funds of funds, which once accounted for 43 percent of all the money raised by hedge funds, means fewer places for managers to turn to for raising money.

Banks, meanwhile, continue to clamp down on financing for hedge funds.

After the easy credit of the last decade — when starting a hedge fund was nearly as easy as opening a lemonade stand — a period of anemic growth should be welcome.

As managers go begging for money, investors will get a lot more leverage in negotiating deals on the managers’ fees that had once been considered sacrosanct: the 2 percent asset management fee and the 20 percent cut of the profits.

Investors should also seek their freedom from capital lockup requirements. Forcing investors to lock up their money for anything longer than a quarter at a time only makes sense for strategies that take a while to generate results, such as a fund that invests in distressed assets or agitates for management shakeups.

Investors stand to gain if the great hedge fund debacle of 2008 leads to a lasting rollback in hedge fund fees and culture that has emboldened managers to do as they please.

– Matthew Goldstein is a Reuters columnist. The views expressed are his own –

Three months after the Obama administration proposed the Public-Private Investment Program, banks remain lukewarm to the notion of selling ailing securities at a deep discount. Potential hedge fund buyers, meanwhile, are wary about government officials looking over their shoulders.

But it’s not too late for team Obama to change course and put in place a program that might actually entice the banks and hedge funds to participate, while also serving a civic good.

Let’s call this new bank detox plan CDOs for Charity. It may sound a bit wacky but the idea is quite simple: Encourage the banks through a series of favorable IRS rulings to donate ailing collateralized debt obligations and other untradeable real-estate related securities to private investment trusts set up by charitable organizations.

The banks that donate to these charitable trusts would be able to take a corresponding tax deduction, enabling them to reduce their corporate tax rate. The charities could then go out and hire asset managers, including hedge funds, to oversee their investments with an eye toward generating a profit if the securities recover in value.

The CDOs for Charity program would make it easier for banks to take big haircuts on the value of the securities they donate, since they’ll be able to offset some of that loss with a charitable tax deduction.

Any investors holding credit default swaps — insurance-like derivatives — on bank-donated securities probably would also have to qualify for a charitable tax write-off.

Cash-poor charities, which have seen donations dry up during the recession, get a chance to make up lost funding. In this instance, all sides win.

The federal government, to be sure, would take a hit on the lost tax payments from the banks.
But under PPIP, the government is committed to spending at least $100 billion to subsidize the plan and the runs the risk of absorbing additional billions of dollars in losses if the toxic securities decline further in value.

A CDOs for Charity program, on other hand, has the advantage of keeping the government from the messy of business of trying to create a market for these securities.

Of course, there will be issues determining the fair value for a security backed by collateral of dubious quality. But tax lawyers deal with this kind of issue all the time when a wealthy benefactor donates a sculpture or a painting to a museum.

It will require negotiations with the IRS, but Treasury Secretary Tim Geithner should be able to work that out since he’s the agency’s boss.

And there’s certainly precedent for Wall Street banks donating to charities assets they either don’t want or can’t sell. In 2004, Goldman Sachs donated 680,000 of unspoiled wilderness in Tierra del Feugo, Chile to the Wildlife Conservation Society.

Goldman took possession of the land when it acquired a portfolio of distressed loans in 2002 for about $60 million. One of the loans was secured by the land in Tierra del Feugo. Goldman, according to regulatory filings, “valued the land at $35 million, presumably taking a tax deduction in that amount.”
The Chilean government, according to the filing, had valued the land at $100 million. To be fair, Goldman didn’t just get a tax break from donating the land. It also spent millions of dollars to help maintain the site as a nature preserve.

Goldman, which declined to comment for this column, would go on to trumpet its charitable work and effort to save the environment. In a glossy brochure (see pdf) published shortly after the deal was announced, Goldman’s chief executive wrote: In determining the disposition of this wilderness, our team looked beyond traditional options and identified a rare opportunity. We determined this huge tract of unspoiled land should be preserved for the benefit of future generations.

The author of that lofty statement? Treasury Secretary Henry M. Paulson, Jr., who first proposed using federal money to buy up toxic assets from the banks in September.

Funny that Paulson never gave his Goldman experiment with Chilean land preservation a whirl when it came to dealing with unloved CDOs. Instead of being just charitable to banks, now may be the time to let charity help fix the banks.