Jan 25, 1999
Online Brokers Tell Customers to Ante Up
By Amy Olmstead and Dagen McDowell
Staff Reporters
Online brokers are snapping their wallets shut to Net-stock traders.
Charles Schwab ( (NYSE:SCH - news) ), the top online broker, Tuesday added 31 stocks to its list of stocks with a margin maintenance requirement of 50%. There are 75 Nasdaq -- mostly Internet -- stocks on its list, up from around 22 in early December, according to a spokesman. Schwab's base margin maintenance rate is 35%. (At 50%, a customer would have to have equity in the account equal to the value of half the position.)
The stocks include Amazon ( (Nasdaq:AMZN - news) ), Ameritrade ( (Nasdaq:AMTD - news) ), @Home ( (Nasdaq:ATHM - news) ), eBay ( (Nasdaq:EBAY - news) ), E*Trade ( (Nasdaq:EGRP - news) ), InfoSeek ( (Nasdaq:SEEK - news) ), Onsale ( (Nasdaq:ONSL - news) ) and theglobe.com ( (Nasdaq:TGLO - news) ).
The idea behind raising margin requirements is to protect brokers and investors from the heightened risk of loss associated with volatile stocks, such as Internet stocks. But the moves could dampen liquidity in the stocks and risk making the brokers unpopular. Precocious Internet stocks are favorites of online traders, fueling trading enthusiasm. Many online brokerage customers are new to trading and don't readily understand the conditions associated with margin trading.
Late last week, E*Trade had a margin maintenance requirement of 100% on 15 stocks, according to one customer. Those stocks included Broadcast.com ( (Nasdaq:BCST - news) ), K-Tel International ( (Nasdaq:KTEL - news) ), Ticketmaster Online-CitySearch ( (Nasdaq:TMCS - news) ), uBid ( (Nasdaq:UBID - news) ) and Xoom.com ( (Nasdaq:XMCM - news) ). (They carry 50% maintenance requirements at Schwab.) A 100% margin maintenance requirement means an investor needs cash in her account equal to 100% of the value of the position, defeating the point of borrowing to own the stock. Another 39 stocks or so had margin requirements between 40% and 60%.
On Dec.5, an E*Trade customer alert regarding higher margin requirements had only four of 17 stocks with a 100% margin maintenance requirements.
E*Trade, the No. 2 online broker in terms of market share, declines to mention specific margin requirements for particular stocks because it also considers the customer circumstances, a spokeswoman says. In general, E*Trade's minimum margin maintenance requirement is 35%.
Fidelity, the No. 3 online broker, also refuses to comment on the margin maintenance requirements on particular stocks. However, some customers were told that Fidelity has recently raised maintenance requirements on about 50 Internet stocks to 80%.
Quick & Reilly raised the margin maintenance requirements on some stocks a few weeks ago, mostly of the Internet ilk, to as high as 65% from 35%. Last week, Toronto Dominion Bank ( (NYSE:TD - news) ) unit Waterhouse, the No. 4 broker, said it had a maintenance requirement of 100% on 10 Internet stocks. It tightened maintenance requirements on about 40 other stocks, as did Ameritrade.
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Online brokers are on the verge of their biggest PR problem since October 1997.
Faced with a market as hard to handle as a 2-year-old in mid-tantrum, online brokers are straining to serve customers. As a result of the volume and volatility, for the first time since the 1997 crashlet, the industry soon may be at risk of turning off potential customers, says analyst Bill Burnham at Credit Suisse First Boston.
Given this, it was no surprise that the trio of online broker tech people were humble Wednesday when they spoke before a packed workshop at the Securities Industry Association Internet Update Conference in New York.
The techies from DLJdirect, Waterhouse and Datek had similar lists of problems facing online brokers. Unpredictable traffic spikes, lack of control over the Net and customers' PCs and Internet connections and difficulty testing and making changes on the run are aggravating their ability to deal with tremendous growth.
The recent storm of customer complaints raise the question of whether online trading is compatible with the habits of today's investors. For example, customer inexperience with the Web and with trading fast-moving stocks can lead to problems full-service brokers may not experience. Customers could, for instance, accidentally pile up orders in the same stock or try to cancel trades after they've been executed. While the problems may not be the brokers' fault, they tend to get blamed.
Recently, Waterhouse removed 11 Internet stocks from online trading. And Charles Schwab won't let customers trade certain (often Internet) IPOs online on their first day of trading and asks that change or cancel orders in fast-moving stocks be placed with a live representative. The aim is to protect customers from poor order choices or mistaken trades.
John Mullin, Waterhouse's senior vice president of electronic brokerage development, said the problem is that the broker hasn't figured out a way to adequately present the risk of trading volatile stocks to customers. At some point, with better awareness, he hopes customers will be able to trade all stocks online again.
And the Internet itself -- with traffic congestion and lost data -- can hurt online brokers. Anthony Naughtin, CEO of InterNAP Network Services, which provides Internet connections that aim to bypass Net congestion, says Internet connection quality is just as important as a broker's trading system. But Internet improvements aren't coming as quickly as customers are coming online, says Mullins.
Despite these issues, the top two brokers feel they are serving their customers well online. Both Schwab and E*Trade credit their Internet trading systems -- designed to take advantage of automation and minimize human intervention -- for dealing well with the volume and volatility.
"It's actually a proof of the system," says spokeswoman Lisa Nash at E*Trade. Unfortunately, customers have higher expectations for technologically complex Internet trading than they do for phone trading, says Suresh Kumar, DLJdirect's chief technology officer.
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Witnessing a reluctance by investors to pay for information on the Internet, Discover Brokerage Direct has expanded the pricing structure for its research subscription service.
The firm launched the fee-based subscription service, which includes real-time email alerts of report changes or analyst rating changes, in September with a two-tiered pricing structure. Discover charged $19.95 a month, or $199.95 a year, for reports on 20 stocks, and $34.95 a month, or $349.95 a year, for reports on 40 stocks.
Those two pricing levels are still in place, but Discover has added three other tiers. Customers now can buy a subscription for one stock for $4.95 a month, or $49.95 a year. The firm is also selling subscriptions for five stocks and 10 stocks.
Thomas O'Connell, a Discover executive vice president, said at the SIA meeting that the firm also is planning to offer reports on 20 equities for free to clients who have more than $100,000 in their accounts.
O'Connell said that so far customer reception of the fee-based service had been "the lower end" of what the firm expected.
The firm has two theories about the lackluster customer response. First, perhaps customers haven't understood that the research was from Discover parent Morgan Stanley Dean Witter, which has respected analysts. Second, the lowest number of reports available was for 20 stocks, which was too high.
Sell-side research on the Internet is quickly becoming a commodity, and Merrill Lynch ( (NYSE:MER - news) ) certainly pushed this phenomenon forward by giving its research away for free, albeit for only four months. Merrill launched its free research trial at the beginning of November. It is scheduled to end Feb. 28. The firm has signed up over 100,000 users and has captured "quite a few thousand leads" for its brokers, says a Merrill Lynch spokeswoman. The firm is considering whether it will continue giving away its research, change the program or end it.
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