SAN FRANCISCO (01/26/2000) - Michael Dickman, an AT&T Corp. employee in New Jersey, considers himself a fairly active stock trader. Two or three times a week, he's online with his brokerage placing orders. But like most investors, Dickman says he doesn't really understand the concept of "payments for order flow" -- a common but obscure practice in the brokerage industry.
Payments for order flow work like this: When customers place trades, brokers pass the orders along to third-party market makers who execute them. In aggregate, the trades offer the market makers valuable market information, for which they pay the brokerage firms.
Investor ignorance of the practice is one reason why Datek is trying to make an issue of the payments. In announcing it would rebate the fees for its customers, the New Jersey-based online brokerage is hoping to distinguish itself from competitors, lure customers and focus attention on a practice on which its rivals depend for revenue. "We're letting investors know that we provide the best execution for our customers without conflict of interest," says Ed Nicoll, Datek's chairman and CEO.
But the real question is, do investors really care?
Not Dickman, who trades with DLJdirect and says he's just looking for the lowest price. "It doesn't really matter to me," he adds. "The important thing is that my broker gets me the best price out there when I trade."
Datek's competitors are downplaying the news. "We think our price schedule is still a darn good value for our customers," says Michael Anderson, a spokesman for Ameritrade, which charges $8 per trade for a market order, compared with Datek's $9.99. "This is another marketing opportunity for Datek, but we still charge less per trade than they do, and that's what our customers care about."
Other firms contacted by The Standard failed to return calls for comment.
It isn't hard to understand why Datek's competitors aren't scrambling to respond in kind. Payments for order flow produce millions of dollars in revenue for online brokers. Last year, 11 percent of E-Trade's revenue came from such payments; for Ameritrade, it was 8 percent and at TD Waterhouse it was 5 percent, according to filings with regulators.
At Datek, however, less than 1 percent of revenue comes from payments for order flow. That's because the firm does much of its business through electronic communications networks, rather than through market makers.
"It's very clever of Datek to try to make an issue of this," says Jim Marks, director of equity research for Credit Suisse First Boston. "It doesn't really cost the firm anything, yet it makes it look more on the up-and-up than its competitors."
Datek's move may be self-serving, but the payments practice has been called into question by the Securities and Exchange Commission. Brokers are required to provide the best execution possible for orders, but the commission raised concerns about this when money changes hands between brokers and market makers.
SEC Chairman Arthur Levitt noted in a November speech to the Securities Industry Association that the practice "can present conflicts between the interests of brokers and their customers."
But most online investors are more concerned with the commissions charged for trades and with quick execution and accuracy than with the small fees their brokers earn off them. There's quite a variety in pricing for standard market orders. While Ameritrade and Datek charge less than $10 per trade, TD Waterhouse costs $12 and E-Trade bills $14.95 -- a difference investors are willing to pay for perceived and real differences in service.
So unless regulatory changes require it, other online trading firms, especially those dependent on the payments for revenue, aren't likely to join Datek anytime soon.