Online Brokers 2000: The Full-Service Firms Move In

There's nothing like a big infusion of new competition to prod companies to improve their games. That's what happened last summer when Wall Street giant Merrill Lynch (MER Quote) announced that it was jumping into the online broker business in an about-face from a year of disparaging the trend.

Merrill wasn't the first of the major full-service firms to get into online discount brokerage. Morgan Stanley Dean Witter(MWD Quote), through its discount unit Discover, as well as Prudential and PaineWebber(PWJ Quote) had online trading sites up and running before Merrill's. But Merrill's entry was a milestone in the industry's development. After all, up until the June announcement, the brokerage behemoth had been warning customers in an ad campaign not to trust the no-frills online brokers with their money. Merrill's capitulation signaled that the online brokerage business had arrived: It was more than just a net craze -- and was becoming something that every retail broker would have to offer.

So far, the old line brokers have not grabbed huge market share. During the fourth quarter, the top 10 online brokers still held 96% of the market, according to Salomon Smith Barney, a unit of Citicorp(C Quote). Merrill and Morgan Stanley Dean Witter only ranked in League B in TheStreet.com's Online Broker 2000 survey. That means that fewer than 312 of the more than 10,000 readers who participated identified these firms as their primary broker. (For complete results, see earlier stories .)

Online Broker Survey 2000 In Today's Package Full Service Brokers Join In Confirmations, Portfolio Tracking... Complex Trades, Commissions, News Calendar of Stories Message Boards

Still, the challenge by full-service brokers has prompted the online pioneers to upgrade their offerings. Over the next year, companies such as Charles Schwab (SCH Quote), E*Trade (EGRP Quote) and National Discount Brokers/ndb.com (NDB Quote) will respond to the new competition by adding their own full-service-oriented products such as increased banking services, initial public offerings from their own investment banks and investing advice -- from an adviser or through customized research reports.

If the incumbents don't try to match the full-service firms, they could lose customers, according to the TheStreet.com's Online Broker Survey 2000. Of the investors who responded, 21% said their full-service firms had started offering online trading, and of that group, slightly more than half said they would start using the service. Of all respondents, 31% said they would consider opening an account at a full-service firm that offers online trading, while 47% said that they wouldn't consider it.

So online brokers from Schwab to FleetBoston's (FLB Quote) Quick & Reilly are looking to offer the amenities that discount brokers had always shunned.

For example, discounter Quick & Reilly lowered its online commissions in March to one standard rate, even when a broker assists with the trade. (Not all discount brokers have phased out actual brokers.) Schwab recently agreed to buy high-end financial firm U.S. Trust (UTC Quote); Schwab said earlier this year that it hopes the acquisition will help it cut annual attrition rates of 6% by one-third within two years as it's able to roll out services like estate planning to its increasingly wealthy customer base.

Even as they add the new services, however, the discounters continue to wield price as their main advantage. Merrill and Morgan Stanley, for instance, both charge $29.95 per online trade, while many online brokers like Ameritrade (AMTD Quote) charge $8 to $13. Higher-end Schwab recently introduced $14.95 trades for more active traders.

But the big brokers are showing some flexibility on pricing now, too. Merrill and Morgan Stanley also offer an all-inclusive wrap account in which customers can trade as much as they want by paying a fee based on total assets of from 1% at Merrill to 2.25% at Morgan Stanley, depending on the size of the account.

The online upstarts also retain another edge. They're young and technologically savvy. Merrill and its cohorts, by contrast, seems a little Old Economy to some investors.

Broker Comm. per trade Acct. Min. Wrap accts. Broker advice Free research Merrill Lynch ML Direct $29.95 20k NA No $100k minimum ML Unlimited Advantage NA No $1,500 minimum fee for unlimited trades 1% on assets up to $1 mln Yes Yes MSDW MSDW Online $29.95 2k NA no $100k minimum iChoice No 50k $1,000 minimum. Fee for unlimited trades 1.25%-2.25% Yes Yes Schwab Schwab One $29.95, or $14.95 for active traders 5k* no no $100k minimum *Schwab imposes quarterly fees of $15 unless account is over 20k

Take David Holmgren, who teaches high school math and physics in Williamstown, Mass. "Schwab was excellent," Holmgren wrote in his survey. "I moved to Merrill Lynch because it offered online trading with broker help, plus expanded financial offerings." But what he has found are accounts that are only updated once daily and a broker who isn't up on hot technology stocks.

"I've gone through three [brokers] looking for one that is up on the current trends," he wrote.

Yet even with these disadvantages, Merrill has a hold on him. Though its price per trade is the same as Schwab's, the traditional firm also offers in-house research and financial advice. Schwab offers research from other brokerage houses and is building up to providing financial advice.

"Schwab needs to have competitive pricing and expanded financial services, and I'll go back," Holmgren wrote.

If nothing else, Merrill's online business may help it keep customers in-house who are looking to try their hands at online trading. Lee Edwards, a 52-year-old computer programming manager for Bank of America in Seattle, says he had one foot out the door when Merrill launched ML Direct in November.

"If Merrill Lynch hadn't started offering online trading, I would have moved to Schwab. Reliability and 'honor' are critical, so I would never use the $5 services," Edwards wrote.

Last fall is when Morgan Stanley Dean Witter stepped up its online efforts, too. It folded in its discount brokerage unit, Discover, renaming it Morgan Stanley Dean Witter Online and raising the price to $29.95 a trade from the $15 it charged previously. Customers of the former Discover get to pay $15 until Sept. 30, 2000.

In the survey, Merrill ranked fourth among the League B brokers. Morgan Stanley was right behind.

Prudential, PaineWebber, Salomon Smith Barney, Goldman Sachs (GS Quote) and J.P. Morgan (JPM Quote) all now have some sort of online trading available or in the works. But so far, they haven't received enough usage -- at least from TSC readers -- to get evaluated in this TSC survey.

If the Online Broker 2000 customers are an indication of Merrill's prospects in online trading, the leading online brokers will have to stay on their toes. The winning League A brokerage, Datek, got middling grades for customer service and breadth of offerings. About 54% of the Merrill clients, by contrast, gave its customer service the highest rating, "excellent." And on breadth of product offering, Merrill came in with an "excellent" rating from 48% of respondents.

These results show why, when Merrill said last June that it was going to embrace the Internet, the online brokers trembled. And their stocks, already backing off highflying valuations, have consistently slipped.

Despite screaming high transaction volumes and numerous analyst upgrades, online brokerage stocks still have lagged. That, analysts say, has been due to full-service brokerages coming into the game, bringing the clicks-and-mortar strategy that has been so successful for Schwab to a broader audience.

So much for Merrill's slow start.