For full-service brokers, these are the best and the worst of times. With the Dow hovering above 10,000, it has been relatively easy to be a hero to one’s customers. At the same time, the advent of electronic trading has many brokers wondering whether they may play out their heroic parts by falling on their swords. As a New York Times article recently noted, "for many people, the Internet could replace the functions of a broker, whose stock in trade is information, advice and execution of transactions, all of which may be cheap and easy to find on the net." The most visible sign of this transformation took place in the first week of June. After years of holding out, Merrill Lynch declared that it would offer online trading starting from this summer.
Broker anxiety was palpable even before Merrill Lynch’s announcement, at the Wharton/SIA Branch Management Leadership Institute, a three-day program in April co-developed by the Wharton School and the Securities Industry Association to enhance the managerial and leadership skills of high-potential branch managers. Some 30 brokers heading different branches of a number of securities firms attended the institute, and virtually all expressed concern about their ability to stand up to the competition of electronic trading, with its low fees, 24-hour access to markets and information, and comparatively unregulated environment.
"The paradigm of investing is shifting," acknowledged Mark Lackritz, president of the SIA. "At one time, the securities industry had two monopolies, on information and on execution. Today both those monopolies are gone."
But while their world is undergoing rapid change, that change represents opportunities as well as challenges, the brokers were told by Lackritz and Wharton faculty who addressed the group. "The game is definitely changing, but this isn’t the end of the world," observed Don Huesman of Wharton. Brokers who "get ahead of the game now" will survive.
A quick review of the statistics reveals why brokers may have trouble sleeping at night. In the last five years, the number of Internet brokers has risen from 0 to 100. On-line trades per day increased 3.5 times in two years. According to CS First Boston, 17% of all equity trading occurs on-line. Last year 27 percent of all retail trades entered over the Internet. "The ECNs–electronic communications networks–have grown up like kudzu," said Lackritz.
Admittedly, not all the news favors electronic commerce, or those upstarts that respond only to the click of a mouse. Charles Schwab, the discount brokerage, had 30% of on-line trades last year–as measured by monetary value by CS First Boston–compared to 11% for newcomer E*trade. Buy-and-hold investments turned in approximately the same performance whether they were made on-line or through a full-serve broker, but on-line day traders have fared badly, and the Securities Exchange Commission is scrutinizing that area for fraud. Nor is the technology foolproof. E*trade, for example, has had severe outages when trading volume is high. And none of the ECNs has yet undergone the baptism by fire of a bear market.
Furthermore, much of the market share going to electronic traders is new, coming from either new investors of second accounts. So far, at least, the large retirement accounts have remained with full-service brokers. In effect, securities investing hasn’t been a zero-sum game.
Still, with the growth in on-line investing outpacing everyone’s projections, it was painfully clear that the brokers would need to learn a new way of doing business. "The question isn’t, ‘Should we use the Internet or not?’" said Lackritz. "It’s a matter of how."
At its best, the Internet offers fabulous opportunities for brokers to provide more and better information to their customers. Sites like Big Charts allow users to chart and compare the financial performance of different companies with the Dow and other indices. The computer also provides the financial community the possibility of "microsegmentation" of its marketplace, customizing its marketing efforts to more narrowly defined groups of investors, noted Barbara Kahn of Wharton.
With some justification, the brokers argue that they’re not competing on a level playing field. The e-trading companies have been subject to a comparatively low level of regulation, while full-service brokers must collect 26 bits of data for every transaction. E*trade and the others take potshots at them for their fees, and the brokers can’t retaliate. Worse still, the web is a strange and uncomfortable place for many of the brokers. They are mystified by the guidelines for using e-mail, recently handed down by the Securities Exchange Commission. In fact, most of them probably have children who could surf the Net more confidently.
"Get your feet wet," urged Huesman. "Don’t resist the client who’s interested in on-line trading–he may be your best customer. The days of the little black book are over. You must be connected."