We Pay You To Trade: Online Broker

NEW YORK — Andrew Sycoff and Don Camillo are looking to take on the Goliaths among the online brokers.

On Monday, they will launch BrokerageAmerica Inc., a new online trading firm, that they hope will mark a new generation in electronic brokerages for active individual investors. A unit of Andrew Garrett Inc., a New York market maker in 1,000 Nasdaq stocks, BrokerageAmerica will offer free online stock trading, sweetened with a rebate.

“We’re going to pay you” to trade, said Mr. Sycoff, chief executive of BrokerageAmerica and Andrew Garrett. “It’s such a compelling value proposition, why would you want to trade anywhere else?”

BrokerageAmerica opens shop at a time when the securities industry is struggling with sharply lower trading volumes, which has hurt revenue and profits.

“It’s not a fun time,” said Dan Burke, an industry analyst at Gomez Inc. “It’s going to be a difficult environment for them to bust through” and build their brand name and customer rolls. The company also faces stiff competition from online trading firms with household names and loyal clienteles. “I think the deck is stacked against them.”

BrokerageAmerica has what it considers to be an unusual business model. The firm will rely on two somewhat controversial practices: internalization, or heavy use of the company’s own market-making operations for order execution, and payment for order flow, the fees often collected by brokerages from market makers, which critics call kickbacks.

“Our business model is so powerful that eventually it will be copied,” boasts Mr. Camillo. “The space will have to come here. It will be painful, but it will happen.”

BrokerageAmerica’s central reason for being is to drive orders to the firm’s own market-making operation, which makes money the way other market makers do, by pocketing the difference between the bid and the ask price on each trade, or the “spread,” and by its own stock trading activity. As such, it can offer market and stop orders for free, though limit orders will cost $5 each.

Andrew Garrett raised $20 million to launch the BrokerageAmerica site. Mr. Camillo, BrokerageAmerica’s president and chief operating officer, said it has the investment banking relationships “to attract virtually limitless levels of capital” if it needs more money. BrokerageAmerica aims to capture 1% to 5% market share within three years and achieve operating profitability within 12 months. The top 10 firms control about 93% of 20.6 million online trading accounts, according to data from J.P. Morgan Securities.

The firm is working with the National Association of Securities Dealers to expand its coverage to more than 10,000 Nasdaq stocks in the next nine months to a year. That would help BrokerageAmerica reach its goal of executing 70% of orders in house, said Mr. Camillo, who formerly led the development of CSFB’s e-brokerage business and managed trading operations at E*Trade Group Inc. (ET). Trading is headed by Robert Cheslow, former head of market making operations for Schwab Capital Markets.

BrokerageAmerica has relationships with about 10 other market players to execute orders for stocks the firm doesn’t make a market in. Those transactions will generate payments.

The 1/10 cent per-share rebate the firm will deposit in its customers’ accounts will be paid for out of either savings gained from internalization, namely the removal of the broker middleman, or from a portion of the payment for order flow it receives from other market makers, typically 3/10 cent.

Both internalization and payment for order flow have been subject to criticism because they could work against best-execution, a Securities and Exchange Commission requirement that brokers execute trades at the best available price.

BrokerageAmerica’s principals insist its prices will be based on best-bid-and-offer. “We are held to the same standards that the SEC sets down for every brokerage firm that does business in the U.S.” said Mr. Sycoff. “There’s no room for flexibility there.” Moreover, inferior prices will mean a loss of customers, and that’s reason enough to execute at the best price available, he said.

To help ensure customers buy and sell at the prices they expect, trades will be quick. BrokerageAmerica expects to complete trades in 30 seconds or less.

Statistics like execution speed and price improvement will eventually be available on the site. They will be key to convincing active retail investors to trade with them, by countering what are dim perceptions of market makers, if the commentary on stock-talk Web sites is any guide.

Pressure on BrokerageAmerica’s expected revenue sources will also pose a challenge. The recent switch to trading stocks in dollars and cents instead of fractions, known as decimalization, allows stock prices to move in increments as small as one cent. For stock dealers who had grown used to trading stocks in increments of one-sixteenth of a dollar, or 6.25 cents, trading in pennies has squeezed a key revenue source, the spread. That loss in revenue has also hurt dealers’ ability to pay for order flow. Both trends could make it more difficult for BrokerageAmerica to pay rebates to customers.

But Messrs. Sycoff and Camillo aren’t worried about spreads, and they don’t intend to overly rely on payment for order flow. “Liquidity creates the spread” said Mr. Sycoff. Thinly traded securities tend to bring in much larger spreads than widely traded stocks like Intel or Oracle. While decimalization, which went into full effect on April 9, has had an impact on spreads, Mr. Camillo believes that “in the long-term, spreads will come back and represent actual liquidity and interest.”

The central challenge will be attracting enough customers and trading volume to make the business work. Doing so will entail the expensive proposition of competing with better-known firms for a much-reduced pie of coveted active traders.

BrokerageAmerica says being a latecomer is a plus. It’s betting that its platform, created with the newest technology, will beat out established players’ slower legacy systems. And because it’s leasing already developed online-trading technology, getting a site up and running cost less than $1 million.

The firm is also planning a $7 million to $10 million advertising blitz over the next six months. Ads will run on major financial television channels and newspapers, like CNBC and The Wall Street Journal, as well as on the key financial Internet portals, like MarketWatch, Yahoo!Finance and AOL. The cost of all those spots will be a fraction of what they would have cost when the economy and stock market was still strong a year ago. That’s as asset when some competing sites are saddled with long-term marketing deals at rates that are now highly unfavorable.

Copyright (c) 2001 Dow Jones & Company, Inc.