Liquidnet Seeks to Cut Brokers Out of Big U.S. Stock Trades
New York, April 10 (Bloomberg) -- Putnam Investments Inc.,
AIM Group and 69 other U.S. money-management firms plan to start
using a system called Liquidnet to buy and sell blocks of stock
among themselves over the Internet, bypassing Wall Street brokers.
At stake is an estimated $100 billion a year in brokers'
commissions and other costs associated with trading. Money
managers hope to lower those costs to boost profits and returns to
shareholders.
``Those transaction costs are the difference between showing
up in'' the top or the bottom of the performance rankings for a
fund manager, said Seth Merrin, founder of Liquidnet. ``That is a
serious difference.''
Liquidnet, which begins operation today, lets institutional
investors trade anonymously through a system integrated with their
existing trading software, said Merrin, who also created a stock
order management system that he sold to Automatic Data Processing
Inc. in 1996.
``You've got so many costs involved in executing trades, not
just the nickel a share'' commission charged by traditional
brokers, said Michael Price, the largest outside investor in
Liquidnet. Price sold his mutual fund firm, Mutual Series, to
Franklin Resources Inc. in 1996.
Institutional investors now pay an average 40 cents in costs
for every share of large-company stock they buy, and 77 cents for
small-capitalization shares, according to consultants Plexus Group
Inc. The costs come largely from movements in the stock's price
when word gets out that a large investor is looking to make a
trade.
Charging Less
For example, traders may buy shares of a particular stock
knowing they can quickly resell them at a gain to an institutional
investor with a pending order.
Institutions that trade over Liquidnet will pay the firm a
commission of 2 cents a share, less than the 5 cents traditional
brokers charge.
``It's not just that we're charging less, but that the
movement, the front-running by the specialists and market makers
and block traders, will just be eliminated on the shares we
trade,'' Price says.
Liquidnet is the latest system to try to bypass Wall Street's
brokers. So far, no so-called alternative trading system has won a
sufficient following to dislodge brokers and the exchanges.
OptiMark Technologies Inc., last fall suspended trading
operations after failing to attract enough business for its
anonymous system, which traders said was difficult to use.
Merrin says his product is different.
While other systems ask traders to enter orders, Liquidnet
takes information from orders already entered and sent elsewhere,
Merrin said. That should attract enough investors to ensure there
are enough bids and offers to make it easy to execute a trade,
backers say.
`A Threat'
While Merrin says there's room for Liquidnet and traditional
brokers, Wall Street is watching to see how he fares.
``It could be a threat,'' said Bill Schneider, head of
trading at UBS Warburg LLC. ``I didn't hear that much advance
endorsement of OptiMark, and I do for Liquidnet.''
Bloomberg LP, the parent of Bloomberg News, operates an
electronic trading system.
``We tell a buyer of IBM there are X number of sellers of IBM
on the network, and then they decide if they want to negotiate for
it'' via an online chat room, Merrin said.
Merrin said he has signed contracts to use his system from 71
fund firms that together manage more than $3 trillion. Money
managers must have a minimum of $2.5 billion in stocks under
management to participate.
Success will depend on whether institutions allow their
entire order pad to be catalogued on Liquidnet, and whether
institutional traders will be comfortable negotiating between
themselves to get a trade done, said Robert Colgan, who served as
president of OptiMark last year.
``In the end it all comes down to human behavior,'' said
Colgan, who now is head of strategic planning at brokerage W.R.
Hambrecht & Co. ``Will traders want to trade 500,000 shares in a
chat room? I don't know if they're going to do it with no one to
blame but themselves if it turns out to be a bad trade.''
Liquidnet's advisory board includes Putnam, the fourth-
largest U.S. mutual fund manager and a unit of Marsh & McLennan
Cos.; AIM, a unit of Amvescap Plc; and T. Rowe Price Group Inc.,
among other fund firms. If the advisory board firms participate
fully, they alone should be able to make available about 1 billion
shares a day, Merrin said.
If six million shares of that are actually traded daily over
Liquidnet, the company will make money, Merrin says.
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