Investor Brain

Saturday, February 20, 2010

One Client, One Quote

WHEN CHARLES SCHWAB IN LATE JANUARY WENT to a single, lower fee for online stock trading, we figured other changes were on the way. We were right. Fidelity ended its tiered pricing structure a few days later, and E*Trade followed suit just a few days after that.

As we discussed on Barrons.com Jan. 28 ("Has A New Price War Broken Out in Online Trading?” ), Schwab’s (http://www.schwab.com) peers and competitors interpreted the pricing change as a positive, putting the fees more in line with the rest of the world (at $8.95, the commission is in the middle of the industry pack), rather than setting off a quick race to the bottom. The big shift is that different prices for different customers appear to be coming to an end, and for that, hallelujah.

James Burton, president of Fidelity’s (http://www.fidelity.com) retail brokerage, admits his firm’s price change, which drops all stock trades to $7.95 per transaction, was a response to Schwab (ticker: SCHW): “It’s a competitive business. We listen to our customers’ feedback and do what it takes to stay highly competitive.”

One twist from Fidelity is that customers can trade 25 iShares exchange-traded funds free. This suite of 25 BlackRock ETFs, according to Burton, covers the key U.S. asset classes: large-, mid- and small-cap, with a mix of growth, value and blend funds. There are also international and bond ETFs available. “Investors who want to use passive index products to supplement or form the core of a portfolio can now do that at no cost,” says Burton.

BlackRock’s iShares S&P 500 ETF (IVV) already has an extremely low expense ratio of nine basis points (0.09%), according to Burton. If you held $1,000 worth of IVV, that would cost you 90 cents a year in administrative and other fees, compared with the 0.5% to 3% most mutual funds charge. And then you don’t have to worry about other transaction costs, bringing the relative cost of owning or trading ETFs way down. “We’ve removed that incremental cost,” says Burton.

E*Trade (http://www.etrade.com) didn’t toss the tiered structure entirely, but eliminated the top tier of $12.99 per trade for less-active customers. Now the top commission is $9.99 per trade; active traders with more than 150 trades per quarter will pay $7.99. In addition, the firm will stop charging a quarterly account-service fee of $40 in the second quarter of 2010. E*Trade (ETFC) is also dropping a per-share charge for trades of more than 2,000 shares.

Years ago TD Ameritrade made a big splash when it announced that all stock trades would carry a $9.99 commission. It was a big deal because the broker wasn’t playing the tiered-pricing game. With E*Trade hanging on to its tiered pricing structure—albeit a reduced one—the industry can’t quite say a final good-bye to this idea. Which is too bad.

LIGHTSPEED LAUNCHES WEB TRADER Lightspeed (http://www.lightspeed.com), which has focused on active retail traders as well as proprietary trading groups, hedge funds and algorithmic “black box” firms, noted with interest that about 30% of its new clients in 2009 came from traditional online brokers. Some of these new customers, the online broker says, previously were intimidated by Lightspeed’s extremely customizable software-based trading application. Now the firm hopes to make it even easier for them to join up.

Stephen Ehrlich, Lightspeed’s CEO, says most of the new customers “graduate” to Lightspeed’s platform, but many have asked for a Web-based application. “They’re just about ready to make that jump, but to get ready they want to use the Web-based platform, use the demo of the software platform and then make the move,” he notes. “Our Web Trader will remove that intimidation and help the customer coming from a traditional broker make the switch,” says Ehrlich.

The Web Trader went live on Feb. 2. Customers can trade stocks and options on the Web Trader but must use the Lightspeed software application to trade futures. Lightspeed charges 0.395 cents per share for stock trades, and 50 cents per contract for options transactions, with no minimum.

One drawback I see is that customers must choose one platform or the other, and can use only one at a time. So once you begin using the software platform, you can’t go back and use the Web application. Ehrlich notes the Web platform is version 1.0 and Lightspeed will continue to work on it, making it more powerful. I hope it will be interchangeable with the software platform in time as well.

SCOTTRADE’S FOREIGN FORAY

Customers of Scottrade (http://www.scottrade.com) can now place orders online for approximately 3,700 international securities, including many Canadian stocks. The securities include American depositary receipts along with U.S.-traded foreign stocks from approximately 20 countries on six continents.

In addition, Scottrade added an International Investing filter to its stock screener, which can be found in the Quotes & Research section of the site. The online Knowledge Center now includes research materials about ADRs. The section includes information about different types of foreign securities at Scottrade, how to trade them and how to read the symbols.

Commissions are $7 per transaction for stocks priced over $1 a share. All transactions are completed in U.S. dollars, including dividend distributions.

IS THAT STOCK FAIRLY PRICED?

Market Topographer (http://www.markettopographer.com), launched in mid-January, attempts to provide the answer. The site combines fundamental and behavioral analysis, focusing on a company’s relative risk profile, its trading multiple, and whether expectations embedded in its share price are achievable.

Free during an evaluation period, the platform is driven by a financial model with 20 years of data, analyzing 12 core risk-assessment characteristics. The suite of tools is designed to be agnostic and avoids buy and sell signals. You’ll find comparisons between two stocks, with the price broken down into a variety of components, such as expected earnings growth and dividends paid.

Check out the free trial, because it appears to me that this will be an expensive site once the publisher starts charging.

Published in Barron’s 2/15/2010

Saturday, January 16, 2010

New Investor Tax Rules on the Way

Adapting to new rules for cost-basis tax reporting.

THE INTERNAL REVENUE SERVICE IN mid-December issued proposed regulations on cost-basis tax reporting. Under the measure, brokers would be required to report to the government the cost of equities sold by their customers in 2011. For 2012, they’ll have to report similar information about mutual-fund sales and, in 2013, options and fixed-income cost bases. At present, the cost basis of transactions is communicated only to clients, who are responsible for reporting it to the IRS. The comment period on the proposal ends on Feb. 8.

Investors who use online brokers have long complained to us that they have trouble getting accurate cost-basis information from the firms. So will the industry be ready in time to comply with the measure?

Even though the deadline for options is a little further off, figuring transaction costs there will be a particular challenge.

The new IRS rules will change the dynamics between investor and financial institution, says Cameron Routh, senior vice president of strategic products at Scivantage (http://www.scivantage.com). His company’s Maxit enterprise application provides real-time cost-basis and tax-based investment decision support to help financial advisors and individual investors minimize tax liabilities and increase after-tax performance. Several online brokers we cover have installed Maxit in their back offices, including TradeKing, Options- House and Just2Trade.com.

“Not only is the firm going to be reporting your cost basis to you, but they’ll also be reporting it to the IRS,” says Routh. “Some [investors] might blame the broker for reporting private info; firms are going to have to educate their customers.”

Every firm eventually will introduce its own solution. Scivantage, obviously, is encouraging its online brokerage customers to get an early jump by installing the technology that would let them meet the IRS requirements now. Routh believes that getting on top of cost-basis reporting will help retail investors, and improve the investment experience by offering pre-trade tax analysis, portfolio analysis, tax tools and other applications, to leverage cost-basis tracking.

Scivantage’s Maxit competes with Gainskeeper (http://www.gainskeeper.com), which is offered to investors through online brokers including Firstrade, Zecco and optionsXpress. Gainskeeper is also available directly to investors, who can import their transactions and run the necessary reports. Maxit doesn’t have a retail version for traders, but we wouldn’t be surprised to see one in the next year.

Frequent traders already have to report wash sales themselves. These transactions are triggered when one sells a holding at a loss, and purchases it (or something that is substantially the same, like a similar ETF) again within 30 days. The loss on the sale is disallowed, though you can add it to the cost basis of the new purchase. The changes in the IRS rules place a new burden on online brokers to track and report wash sales, including a detailed list showing each sale on a single line. Some active traders generate thousands of wash sales per year.

The complications of wash sales can lead to accounting nightmares if you have to make all the calculations on your own. Some online brokers report wash sales if you make the transactions on their Website, but the wash-sale rules apply even if, for example, you sell a stock at E*Trade and then buy one that is considered substantially the same at Charles Schwab.

Traders who opt to change their accounting method from cash basis to mark-to-market aren’t subject to wash-sale rules. But they open themselves up to a great deal of additional scrutiny. Mark-to-market traders are few in number and require heavy-duty tax software that can’t be found in the usual mass-market products. We recommend Armencomp’s TradeLog MTM (http://www.armencomp.com/gtttradelog/) for these hyperactive traders.

WE’VE GOTTEN A STEADY STREAM of reader e-mails responding to our recent plea for input about online brokers for our coming annual review. We’re still open to any thoughts you can offer.

If you’ve been using an online brokerage account over the past year, please drop us a line at electronicinvestor@yahoo.com . Thanks.

Published in Barron’s, January 11, 2010. 

Tuesday, July 14, 2009

SEC Chair says staff will "explore transparency issues" regarding Dark Pools

An excerpt from SEC Chair Mary Schapiro’s testimony before the United States House of Representatives Committee on Financial Services
Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises.  Her remarks are entitled, “SEC Oversight: Current State and Agenda,” and were delivered Tuesday, July 14, 2009. 

"In addition, our staff has begun exploring transparency issues related to markets known as dark pools. Dark pools are defined in various ways, but generally refer to automated trading systems that do not display quotes in the public quote stream. We have heard concerns that dark pools may lead to a lack of transparency, may result in the development of significant private markets that exclude public investors (through the use of “indications-of-interest” that function similar to public quotes except with implicit pricing), and may potentially impair the public price discovery function if they divert a significant amount of marketable order flow away from the more traditional and transparent markets. Given the potential risks posed by dark pools, the Commission will take a serious look at what regulatory actions may be warranted to respond to the potential investor protection and market integrity concerns that dark pools may raise.”

I’m pleased to see that the SEC will be checking out dark pools with a focus on transparency.  My main concern about these pools is that their existence removes a great deal of liquidity from publicly displayed venues, which may be resulting in incorrect pricing. 

Good luck, SEC and Chairman Schapiro. 

Full testimony at http://www.house.gov/apps/list/hearing/financialsvcs_dem/sec_testimony.pdf