Net brokerages lose momentum

Online brokerages triumphantly marched into the year as the hottest industry on the Internet, but they leave a bit humbled.

Greg Sandoval Former Staff writer
Greg Sandoval covers media and digital entertainment for CNET News. Based in New York, Sandoval is a former reporter for The Washington Post and the Los Angeles Times. E-mail Greg, or follow him on Twitter at @sandoCNET.
Greg Sandoval
3 min read
Online brokerages triumphantly marched into the year as the hottest industry on the Internet, but they left a bit humbled.

In the first fiscal quarter, online trading firms continued to mark year-over-year increases in revenues, the number of online trades per day surpassed the 450,000 mark, and shares in Net market leader Charles Schwab grew more valuable than one of the nation's most venerable brick-and-mortar investment firms, Merrill Lynch.

But by March, much of the industry's momentum was gone. Online trading fell under government scrutiny and Internet investment firms saw their stock plummet during a summer slump in trading.

Top-tier Internet brokerages--Schwab, E*Trade and Ameritrade--saw powerhouse offline competitors such as Merrill Lynch and Morgan Stanley Dean Witter launch online trading services, a venture that threatened to overwhelm the online upstarts.

As more brokerages set up shop online, a growing number of consumers followed. In 1999, the number of households that trade online increased to 3.1 million from 2.2 million in 1998, according to research firm Forrester Research.

While online trading grew, many questioned the long-term prospects of the business. Schwab co-chief executive David Pottruck perhaps best summed up the industry's year during a speech in October by saying: "This has been a very humbling year.''

An early sign that the year would be a difficult one came in January, when the Security and Exchange Commission said it wanted more oversight of online trading. Then in March, the SEC launched an inquiry of the business practices of online brokerages through an examination of several top firms.

SEC chairman Arthur Levitt complained that the industry's advertising campaigns were misleading because they didn't mention the risks involved in trading.

"It is just as easy, if not more so, to lose money through the click of a button as it is to make it," Levitt cautioned investors.

This fall, Levitt called on Internet firms to provide better information to investors.

The ad campaigns of online brokerages were a reflection of how hard upstarts 1999: The year in technology were working to drive more traders online. In such haste, many companies neglected to upgrade their Web sites in preparation for the throngs of new customers. Schwab and E*Trade Web sites, for instance, both were overloaded early in the year and suffered repeated site outages.

As a result, some customers claimed that the site failures prevented them from making important trades that resulted in losses. One E*Trade customer went so far as to file a lawsuit against the Internet's second-largest brokerage.

Such threats to Web firms paled in comparison to those made by traditional investment firms that were staking their turf online.

Merrill Lynch, Dean Witter and PaineWebber, with huge stockpiles of customers and cash, went online this year, expecting to win sizable market share.

The cutthroat competition resulted in companies increasing their spending on advertising and cutting their commission fees. The drop in trading over the summer and higher costs of doing business caused profits to evaporate. By the third quarter, Web brokerages started to see their stock prices dip and revenues shrink.

Third-quarter margins at Schwab fell to 14.1 percent, down from 15.4 percent in the second quarter as commissions dropped 17 percent. E*Trade lost $26.7 million in its fourth quarter, 75 percent more than the previous year's quarter. And most of the industry experienced a similar downturn.

But as Internet brokerages struggled, the numbers of online traders continued to climb. Day traders accounted for 11 percent of Nasdaq volume in the first quarter, and the volume in trading showed that one of out of every six trades was made online, according to report issued by Hambrecht & Quist.

As online trading grows, experts assert that Internet firms will have to offer greater services to lure new customers.

Analysts have said online brokerages must pry consumers away from traditional investment firms by offering more services such as estate planning, mortgage lending and credit card services. In addition, several online companies are rushing to offer wireless Internet services so customers can make trades away from their computers or phones.

One thing is clear: At a time when companies are pouring into the industry in hopes of cashing in on expected growth, which Internet research firm Jupiter Communications expects to hit 20.3 million trading households by 2003, earning a profit will be a challenge.