Big Brokerage Firms to Launch
Online Trading Counterattack
By CHARLES GASPARINO and REBECCA BUCKMAN
Staff Reporters of THE WALL STREET JOURNAL
Big full-service Wall Street brokers are set to launch a counterattack to head off low-cost
Internet-trading rivals.
Prudential Insurance Co. of America's Prudential Securities Inc., Citigroup's Salomon Smith
Barney and even Merrill Lynch & Co. -- a firm that has long resisted offering cheap, online
trading to most customers -- all are moving toward giving more clients access to e-trading
through "fee-based" accounts. That is where investors pay a set annual charge for a package
deal including an allotment of trades, rather than pay commissions for each trade.
The big firms' plan for Internet investors: Charge clients a flat fee for investment advice and
research, and give them online trading as a bonus. At least two are considering something
even more revolutionary -- charging a nominal flat fee and a discounted per-trade
commission for online transactions, an acknowledgment that the act of executing a trade
simply isn't worth that much anymore.
No one is looking for the big brokers to offer online trading at the rock-bottom rates of Internet
upstarts like Suretrade Inc., a unit of Fleet Financial Group Inc., and Datek Online Holdings
Corp. (Each charge less than $10 a trade.) And some analysts say the moves may not
amount to much savings for full-service customers, because they will still pay a fee for the
privilege to trade online, and in some cases, a commission as well.
"Firms are looking to provide a variety of pricing options, and it's not a foregone conclusion
that the fee-based pricing structure is necessarily the least expensive," says Henry McVey,
an analyst at Morgan Stanley Dean Witter & Co.
Still, the new offerings could help the behemoths better compete with discount brokers such
as Charles Schwab Corp., which charge slightly higher commissions in return for extra
services. Commissions at securities firms vary depending on the size and type of account, of
course. But the current gap among firms is huge. For example, investors buying 300 shares
of Yahoo! Inc. pay roughly $315 in commissions at Merrill. At Datek, the same trade costs
$9.99. At Schwab, the trade costs $165 through a firm broker, and $29.95 over the Internet.
It is no surprise, then, that the bigger firms have been competing through fee-based accounts
-- rather than slashing their per-trade commissions, which would reduce revenues and profits.
Prudential Securities, for example, says it will soon charge clients just $24.95 to make a
trade either online or through a broker. The catch: It must be done in a new type of account
charging investors an annual fee of roughly 1% to 1.5% of assets. Currently, investors can
pay several hundred dollars in commission to buy and sell securities through a Prudential
broker.
"We understand that people pay us a fee for advice, and we also recognize that the cost of a
trade is a commodity, so we're willing to price it as a commodity," says Hardwick Simmons,
president and chief executive of Prudential Securities.
Salomon Smith Barney is considering adding online trading to its "Asset One" account,
where investors holding at least $100,000 will pay fees ranging from 0.5% to 2% of assets
under management -- and get at least 40 annual online trades free. For investors with a
$100,000 account, this translates into an annual fee of $2,000. Assuming they make 40
trades a year, investors would be paying the equivalent of $50 a trade, but that is no different
than what they pay now to trade through a broker handling this account. Though these fees
aren't razor-thin, investors do get Salomon Smith Barney's research reports and investment
advice.
Merrill, the nation's largest full-service brokerage firm, could launch lower-priced online
trading before the end of the year, people close to the company say. The firm currently offers
online trading only to its best customers -- those with at least $100,000 enrolled in two
specific fee-based accounts. The flat fee includes a set number of trades, which customers
can place over the Internet or with a broker.
But Merrill wants to open the Internet to many more customers, people familiar with the firm
say. So Merrill is working on new "pricing models" that allow the firm to do just that, the
people say.
These new programs show that full-service firms, after dismissing the significance of the
Internet as recently as two years ago, understand they need to make a stab at lower-cost
online trading. To attract and retain cyber-customers, though, they must play up their ability to
provide sophisticated advice, since many online brokers offer plain-vanilla trade execution
for just a few dollars a trade.
Meanwhile, full-service brokers are scrambling to retain clients who potentially could defect to
online rivals. At the same time, the big firms, with an older clientele than cyber-brokers, want
to attract a new generation of investors who are more techno-savvy.
Through it all, the volume of online trading just keeps growing. Even nagging technical
glitches, such as a 50-minute Web outage suffered by Schwab Monday, can't seem to stanch
the flow. A report Monday from U.S. Bancorp Piper Jaffray said the number of online trades
soared 49% from 1998's fourth quarter to this year's first quarter.
Yet investor activity at full-service firms is expanding smartly, too. Merrill reported a 7%
increase in first-quarter brokerage commissions, to $1.57 billion. There are plenty of
investors who don't prefer to manage their finances on the Internet. There always will be
some people busy or wealthy enough to pay for the kind of personalized investment advice
traditional brokers offer, Morgan Stanley's Mr. McVey says.
But Merrill's percentage increase pales compared with Internet brokers. Transaction revenue
(composed mostly of brokerage commissions) soared nearly 2.4 times in the first quarter at
E*Trade Group Inc., to $90.5 million.
The full-service firms acknowledge that many of their customers already keep small, second
accounts with online brokers. Forrester Research Inc., an Internet consulting firm, recently
said that 10% of affluent households -- those with $1 million or more in "investable assets" --
now trade with all-online brokers such as E*Trade and Datek.
Those investors aren't just using "play money" for cyber-trading, contends analyst Michael
Gazala, who wrote the report. He says 22% of the online house holds had more than half their
portfolios with the Internet-investment firms, instead of their full-service brokers.
But when they do start offering online trading, traditional brokers can't compete only on price.
Unlike E*Trade and Schwab, firms like Merrill employ expensive research analysts and invest
huge sums in their brokers, who often command six-figure salaries to dispense advice about
taxes, estate planning and retirement.
"The reality is, the advice component will likely be separated from the trade execution,"
Morgan Stanley's Mr. McVey says. "To some degree, I think that is where we're headed." Mr.
McVey should know: The Dean Witter arm of Morgan Stanley is expected to roll out online
trading later this year to customers with the firm's fee-based Choice accounts, a small
number of whom are testing online trading now. A pricing structure still hasn't been
determined.
PaineWebber Group Inc. is another online convert. After saying as recently as 15 months ago
that it still wasn't sure if it would deploy online trading, the firm now is gearing up to launch the
service in the third quarter. Pricing still hasn't been worked out.
Perhaps the biggest surprise is Merrill. Late last year, Merrill brokerage chief John "Launny"
Steffens publicly bashed online trading and do-it-yourself investing as a "serious threat to
Americans' financial lives."
Now Mr. Steffens is taking a slightly different tack. He has been discussing a plan to provide
low-cost online trading to more of the firm's customers, possibly even without ever talking to a
broker. Mr. Steffens declined to comment, but a spokeswoman confirmed that Merrill has
started looking at ways to open Internet trading to more of its customers.
Merrill, the spokeswoman said, wants to "expand client choice and how they do business
with us." The Internet, she said, "will play an increasingly important role in our service model
and the value proposition for our clients."
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