Competition Rages on How Stocks Trade
New York Times
In a television commercial, a client of Ameritrade (news/quote), the online brokerage firm, boasts to a co-worker that he paid 5 cents less a share for a stock they bought at the same time.
Datek Online, a competitor, is advertising what it describes as its unparalleled speed. Even the New York Stock Exchange is telling investors to demand an “N.Y.S.E. execution” from their brokers.
Facing a declining market, brokerage firms and stock exchanges can no longer boast convincingly of their ability to make clients rich. Instead, many are claiming that they can complete trades faster or at better prices than their competitors.
“Execution quality” has arisen as an issue partly as a result of the growth of alternatives for trading stocks. Investor orders may now be sent to the New York Stock Exchange, to regional exchanges in Boston and Chicago, to Nasdaq market-making firms that match customer orders or to electronic trading networks. While competition has helped to lower trading costs and to narrow spreads between bid and offer prices on stocks, it is often difficult for consumers to know whether they are getting the best deal.
Regulators have become concerned about potential conflicts of interest. Many market-making firms and electronic trading systems are now owned by brokerage firms, and some trading entities routinely offer rebates or payments to brokerage firms sending in orders.
The Securities and Exchange Commission stepped in last August and began requiring exchanges, electronic trading networks and other market centers to report when they improved or matched the current market price. Beginning on Friday, the commission will require brokerage firms to report where they routed customer orders, as well as the extent of financial arrangements held with those market centers.
“Most people still don’t know what happens when they place a trade and don’t understand how brokers are moving these orders around,” said Philip M. Aidikoff, a securities lawyer at Aidikoff & Uhl in Beverly Hills, Calif.
Online brokerage firms and exchanges are trying to turn their trading methods into a competitive advantage. Ameritrade’s advertisements, for instance, issue a stark challenge to rivals, stating that the firm is not linked to any market makers or captive trading networks – and implying that its rivals are.
Datek, an industry pioneer, built and owns a stake in Island ECN, an electronic trading platform. Charles Schwab (news/quote), the nation’s largest online brokerage, owns Schwab Capital Markets, a market-making firm. Both Schwab and Datek say that they treat customers fairly and that their corporate structures do not constitute a conflict of interest.
The debate focuses on whether market makers owned by brokerage firms sell stock from their own portfolios to unwitting customers who could get a lower price through another exchange or market maker. In early 2000, a California investor won a $100,000 arbitration award against Datek after accusing it of holding his order until its price could be met on Island, potentially bypassing opportunities to execute the trade at a better price elsewhere.
Michael Dunn, a Datek spokesman, declined to comment on the arbitration case. He said that the firm does not charge clients for its services if it doesn’t execute a trade within 60 seconds, and that it routes orders without bias.
Marta von Loewenfeldt, a Schwab spokeswoman, said Schwab “holds all market centers, even the ones we own, to the highest standards; the new rules will make us be even more aware of these issues.”
Ameritrade’s advertisements guarantee that it will provide a trade confirmation within 10 seconds of an order on any stock that is included in the Standard & Poor’s 100 index. “Quality execution has always been important to clients, and one way they measure it is by speed,” said J. Peter Ricketts, president of the private client division of Ameritrade.
Speed, however, is not the only component that may be important to investors. Market centers may be trading the same stocks at different prices, or may be able to accommodate orders only up to a certain size.
“The relationship between speed and best price may be an inverse one,” said Brett Redfearn, a senior vice president of the American Stock Exchange.