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"For all the flash and discounting, online brokers rely on many of the same sources of revenue that old-fashioned brokers do. Payment for order flow, for example. That's when market makers offer brokers a piece of the spread between the bid price and the ask, as a reward for sending orders their way. "They're kickbacks, quite frankly," says Piper Jaffray's Burnham. And while payment for order flow is under pressure from NASD regulations aimed at protecting small investors, it still accounts for some 20% of a typical online brokerage's revenues. Without it, Web Street Securities wouldn't be filling large Nasdaq trades "free."
Even more important for online brokers that clear their own trades is money earned on idle cash in customer accounts. Ameritrade, for example, pockets the difference between the interest it pays on cash balances, 3%, and the interest it collects on margin loans, which is tied to the prime rate and varies with the amount borrowed. "We have a four- to five-point spread," says Ricketts. "That's really where we make our money." Both margin lending and payment for order flow are, if anything, more important to online brokers than they are to their older offline peers... |
