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Total order control. In a nutshell, this is the feature that has historically separated electronic stock traders, who employ a direct-access-brokerage system from those who use an online-discount-brokerage platform. Whereas the discount brokers have, at times, sold their customers' orders to market makers in exchange for a fee, direct-access brokers have equipped their clients with order autonomy. But today, as more and more online-discount shops acquire direct-access firms, the lines between these two distinct types of brokers have become blurred.
Indeed, with E-Trade Group and Ameritrade Holdings Corp. on the verge of swallowing up the direct-access businesses of Tradescape Corp. and Datek Online Holdings, respectively, questions are now beginning to arise about whether newly acquired direct-access firms will be forced to adopt the payment-for-order-flow practices of their online-discount parents. E-Trade and Ameritrade both derive a sliver of their revenues from the controversial practice, which calls for brokers to sell their customers orders to market makers in exchange for a small fee - typically a penny per share - even if the market maker on the receiving end of an order is not at the national best bid or offer (NBBO).
"The first question that we have to ask ourselves (about these acquisitions) is how unbiased is the order routing? Direct access came to be because there was need for a trader or a customer to get the best execution possible ... So if these Web-based brokerages are buying direct-access brokers, are their order-routing algorithms going to change?" questions Ross Ditlove, chief executive officer of the direct-access broker MB Trading. "If they route orders for payment, or if they just give a first look at an order to a particular counter-party, then it's not beneficial to the direct-access trader."
However, Fritz McCormick, an analyst covering institutional e-brokerage for the research and consulting firm Celent Communications, says that it is unlikely the new parents of Tradescape and Datek will pressure the brokers to adopt payment for order flow. Order autonomy, he notes, is the "fundamental service" that firms like Tradescape provide via their direct-access software - stock-trading technology that enables traders to speedily route orders to the execution destination of their choice.
"The idea that (these online brokers) would buy these firms and then change them, in order to increase payment for order flow, does not really seem to be legitimate," says McCormick. "If I am E-Trade and I say, 'I'm buying Tradescape and I'm going to adjust the order-routing algorithms and smart-order-routing capability, and fundamentally alter the value of the system,' then (I am) sure to lose volume and customers. And then what purpose have you served?"
E-Trade, which has received anti-trust approval from the Securities and Exchange Commission and is awaiting regulatory approval from the National Association of Securities Dealers, is actually acquiring a trio of Tradescape businesses: Tradescape Securities LLC, a direct-access broker; Momentum Securities LLC, an onsite-brokerage firm; and Tradescape Technologies, a direct-access software and networking vendor. Ameritrade Holdings, which purchased the direct-access vendor TradeCast Ltd. last February, is currently working out the final details of its $1.29 billion merger with Datek, the high-speed-brokerage firm that founded the Island ECN.
Just Say No to PFOF
Omar Amanat, chief executive officer of Tradescape, says he definitely considered the potential payment for order flow conflict before striking a deal with E-Trade. But Tradescape ultimately decided that E-Trade would provide its direct-access firm with excellent access to market makers without compromising its business model. "Our entire business model has centered around customer-driven execution. It's up to them if they want to route to Knight or route to Island. That order-routing decision is based entirely on who's at the NBBO," says Amanat. "E-Trade and all these online brokers are very heavily involved in payment for order flow, and that runs directly counter to our strategy of not accepting payment for order flow, and delivering the best execution at the best price in the fastest amount of time .... But our business model will not change whatsoever (following the merger). We don't accept payment for order flow."
Via E-Trade, he says, Tradescape will be able to gain direct access to a whole new group of market-maker-execution destinations. Ethically, Amanat notes, Tradescape is not opposed to selling its orders to market makers - as long as the market maker on the receiving end of an order is at the NBBO. "If someone is going to pay us and give us the best price, we'll send our orders there. But the reality is that market makers have historically considered day-trading order flow toxic," he says.
Noting that the Ameritrade/Datek merger is currently in a "quiet period," an Ameritrade spokesperson declines to comment on the impact Ameritrade could potentially have on Datek's order-routing model. However, Luis Gonzalez, chief operating officer of TradeCast, says Ameritrade has kept TradeCast's business model intact - while simultaneously providing the direct-access broker with enhanced customer service and financial stability.
"We are a separate entity, and in a lot of ways we just have a great partner in Ameritrade, and it's incidental that they own us," says Gonzalez, noting that the Houston, Texas-based TradeCast is now a subsidiary of Ameritrade. TradeCast, he emphasizes, is completely free from payment for order flow, and continues to provide its clients with the "power to choose where it is that they route and execute their orders.
"So we don't agree with (MB Trading's Ditlove) at all," says Gonzalez. "We think that the acquisition of these direct-access companies (by online-discount brokers) is actually very good for traders."
Celent's McCormick, however, is not so certain that the Ameritrade/Datek and E-Trade/Tradescape unions will have a positive impact on direct-access traders. "There is a fear among day traders that these types of purchases will erode customer service and technology support," he says. "They are scared, and maybe deservedly so, that the emphasis will be taken off of them and placed on other segments."
That said, from an industry perspective, the mergers should be beneficial, because they will provide direct-access firms with the resources to create new products and services, as well as capture "significant market share," says McCormick. "I would say (the mergers) are a positive for the overall industry, because they are bringing direct access more into the limelight," he says.
There is no question that Ameritrade and E-Trade, large, well-capitalized firms that boast millions of online accounts, will help expand the reach of direct-access technology. However, while acknowledging that it will be hard to compete against the likes of Tradescape from a resources point of view in the future, MB Trading's Ditlove says there will always be room for independent, knowledgeable direct-access brokers. If firms like Ameritrade and E-Trade truly understood the direct-access market, he says, they could have simply built a platform internally and saved themselves a lot of money. "Even though they have money does necessarily mean they have the know-how," Ditlove cautions.
