Why Big Firms Are Courting the Day Traders
By DAVID BARBOZA
New York Times
August 13, 1999
Despite growing regulatory concern about the world of day trading, some of the nation's leading investment and securities firms have held talks in recent months with a number of day-trading firms.
Fidelity Investments, Lehman Brothers and Instinet, a division of Reuters Group, have discussed adopting the software platforms of day-trading firms, forming alliances with them or making outright acquisitions, according to several executives who were briefed on the meetings. Executives at the three firms declined to comment on any deal.
Why would big firms want to get involved in such a small industry with a poor reputation and an uncertain future?
The electronic trading boom is forcing them to look for cheaper and more efficient trading formats. Day-trading firms, which in the 1980's and 1990's paved the way to faster and cheaper trading that rankled the powers on Wall Street, now have critical experience developing and using advanced trading and trade-routing software, systems that could someday give all investors instant access to the financial markets.
To be clear, Wall Street firms have little or no interest in the computer-jammed offices where day traders converge to make rapid-fire trades. Instead, they want the software and in some cases the transaction volume generated by these smaller firms.
People briefed on the talks say that the big firms are moving gingerly because of the day-trading industry's recent spate of bad publicity, including the shootings in Atlanta by a disgruntled trader, Mark O. Barton. Just this week, state securities regulators blasted day-trading firms for misleading na‹ve investors into the risky world of rapid-fire trading.
The day-trading firms at the center of the talks have largely avoided regulatory fines and are best known for their software development and relatively heavy trading volumes. Broadway Trading, Tradescape.com and Cybercorp, all privately held companies, have each been approached in recent months by companies interested in buying a stake or acquiring the firms, executives close to the talks said. The three firms declined to comment.
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Some great software to go with a recent spate of truly dreadful publicity.
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Although some industry officials warn that Wall Street firms may be talking to day-trading firms simply to gain valuable insights about their technology, a deal between a major broker and one or two day-trading outfits is expected within a few weeks. At least one offer has been made, by Lehman Brothers to acquire Cybercorp, according to someone briefed on the proposal. A major online broker is also bidding to acquire a day-trading firm, industry executives said.
"Day trading firms clearly understand the notion of faster, smarter better technology," said Henry H. McVeigh, who covers online brokers at Morgan Stanley Dean Witter. "So while it's taboo to be associated with a day-trading firm, the technology they have is extremely sophisticated and it can be leveraged."
A steady stream of orders to buy and sell stocks is also appealing to some of the bigger firms in the talks. With most financial services companies scrambling to find the right system and the right platform, the number of trading venues has multiplied. The new systems need liquidity, or heavy trading volume, to assure that investors get good prices for their trades. And that is where day-trading firms come in. "The key battle is going to be over order flow," said McVeigh of Morgan Stanley.
Fidelity Investments, a unit of FMR, has said in recent months that it would like to attract more active traders, or those who trade more than 36 times a year. Although its Fidelity Brokerage Services unit has nearly three million accounts, the unit's trading activity lags behind that of E*Trade, which has fewer accounts.
Fidelity executives see faster and more efficient trading systems as a way to attract active investors, though they say they are not searching out day traders. "We talk to a lot of companies about what technology is out there," said Robert P. Mazzarella, president of Fidelity Brokerage Services. "We just launched our active trader Web site. We want to improve the experience and help people trade quicker."
Lehman Brothers, an institutional brokerage firm that has talked to two day-trading firms, is seeking to improve and upgrade its institutional trading systems, executives briefed on the talks said.
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Forum
How Safe Is Internet Trading?
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Instinet, an electronic network that is a leader in institutional and after-hours trading, said last May that it was interested in breaking into the booming retail market of online trading. It has held talks with Cybercorp and Tradescape.com, according to people briefed on the talks. Such a deal would give Instinet additional day-trading volume for its electronic communications network, which competes against Island E.C.N., a network widely used by day traders and developed by Datek Online Holdings.
Those who have been briefed say that at least one large online broker talked with Broadway Trading in New York about buying all or part of the company before talks broke down. Broadway does not employ its own proprietary software; it uses a platform called the Watcher, which was developed by Datek.
Tradescape.com in New York and Cybercorp in Austin, Tex., are generally considered the most attractive targets, largely because of their software capabilities. Each company has developed proprietary software that can be used on the Internet to trade and get more direct access to the stock market. Tradescape.com recently announced a merger with Momentum Securities in Houston, making it perhaps the nation's largest day-trading firm in trading volume. Softbank, an early investor in E*Trade and Yahoo, recently agreed to invest $40 million in the combined company.
Though executives at Tradescape.com and Cybercorp declined to comment on any talks, they acknowledged that everyone is talking to everyone.
"Some of the largest Wall Street firms recognize they were blind-sided by the electronic execution technology," said Philip Berber, chief executive at Cybercorp. "Primarily these firms want to save themselves two years of time and tens of millions of dollars that it would take to re-create this technology."
They also want to gain order flow at a time when more and more trading activity is taking place outside the purview of major Wall Street brokerage firms or even the major stock exchanges, like the Nasdaq stock market. Electronic communications networks are gobbling up a growing share of the marketplace, and firms want to make sure they do not miss out. The firms say they have technology that works with E.C.N.'s to hunt for the best price.
In turning to day-trading firms, the major Wall Street firms are imitating a model developed by Datek Online, which got its start as a day-trading firm and later developed fast execution and trade-routing technology that spawned the Island E.C.N., which is heavily used by Broadway Trading, Tradescape.com and Heartland Securities, a day-trading unit that was spun off of Datek in 1998 amid regulatory questions and investigations of its trading practices.
Still, Datek is considered a pioneer in developing technology for day trading and transferring that technology to more mainstream applications, a knack that has made it one of the nation's fastest growing online brokerage firms.
Day trading, which has been driven by the opportunity of fantastic profits during a stunning bull market, now appears to be evolving again. Wall Street analysts and day-trading officials say many former professional traders, brokers and financial services professionals are quitting their jobs to work full time as day traders or money managers from home offices.
Most people with online accounts now e-mail an order to the online broker, who then routes the order, often selling it to Wall Street wholesalers, who execute the trades. The future lies in faster, cheaper, quicker access to the markets, which will create a bulge in online brokers. Perhaps, the technology visionaries say, online brokerage firms will then hire sales forces and money managers, who can work from home offices trading accounts for their customers. It would be a virtual retail brokerage firm.
The whole concept of direct access to the markets is coming out of day trading, said James H. Lee, head of the Electronic Traders Association and president of Momentum Securities. "That's why we see some of this hysteria," he said. "It rocks right to the core of the Wall Street establishment." |
