Saturday, June 30, 2012

Clearing Firm's Exit Will Cost Brokers

Penson Worldwide recently wound down its business at a surprisingly rapid rate. Its successor, Apex, is trying to raise rates on some online firms.

Penson Worldwide, a big clearing firm that drew lots of unwanted attention to itself a year ago by disclosing it held millions of dollars worth of potentially illiquid bonds issued by a horse-racing track operator tied to one of its directors, has wound down its business with surprising speed in the past few weeks. Much of it has been transferred to a new outfit, Apex Clearing, which has angered some brokers by seeking more capital to offset their risk taking.

In recent weeks, the situation apparently became untenable at Penson, which handled transactions for several hundred online brokers and hedge funds. In its quarterly report to the Securities and Exchange Commission in mid-May, Penson said it was pursuing a number of “strategic restructuring initiatives” to improve its financial liquidity and increase its regulatory capital. A couple of weeks later, on May 31, Penson formed a partnership with options-market maker Peak6 Investments, the parent of electronic broker OptionsHouse, creating Apex. Penson still owns clearing operations in Canada as well as some futures-clearing business, but all of its U.S.-based business now belongs to this new entity. Penson stock (ticker: PNSN) traded last week at 17 cents a share, down from $3.12 a year ago.

Apex began operating on June 6. Trades previously cleared through Penson were transferred to the new entity. About one million customer accounts and a number of exchange memberships migrated from Penson to Apex without apparent problems. Clearing firms like Penson process trades electronically for broker clients and make sure funds are properly segregated.

The firm’s swift departure suggested that regulators had stepped in to avoid a bigger problem. “This whole deal has Finra’s [Financial Industry Regulatory Authority] fingerprints all over it,” says one executive. Finra is the largest independent regulator for securities firms operating in the U.S., and its mission is to protect investors by ensuring the integrity of the brokerage business. A Finra official acknowledged the agency’s “heightened scrutiny” of Penson in recent months as well as its intention to monitor the transition to Apex.

The first news of problems at Penson came about a year ago. The firm disclosed in a routine filing that it had certain receivables whose collateral had reduced liquidity. Among them: $42.6 million in bonds issued by a Texas horse-racing track, run by Call Now, an early investor in Penson. Call Now CEO Thomas R. Johnson was a Penson director. He left the board shortly thereafter.

PENSON WAS EXPANDING aggressively, according to several sources. The growth was funded by debt that increasingly strained Penson’s finances, they said. It also was allowing its clients to take on too much risk, says one of the sources. Penson referred any comment to the Apex team.

Announcing Apex’s start, Brad Goldberg, Peak6’s president, said in a release: “This transaction resolves an urgent need in the marketplace today to maintain stability and continuity for Apex Clearing’s customers.”

Brokers apparently started looking for an exit after last year’s news broke. “If there had been an easy alternative, their customers would have left last year,” says one observer. Switching clearing firms can be a prolonged process, given the technology and sensitive client knowledge involved. Brokers don’t want their customers to experience any sort of disruption.

Peak6 partner Danny Rosenthal is the CEO of the new firm, and he says that Apex will focus on building stability while using capital more efficiently. Apex will exit from some businesses, such as clearing foreign equities, which were a drain on capital. Rosenthal also notes that Apex will leverage Peak6’s focus on automation.

Although brokers were generally pleased that Apex will be a more stable operator with a good management team, some were worried about the role of OptionsHouse, the Peak6 unit that competes with many electronic brokerages. They don’t want the broker to gain any advantage. Rosenthal assures us that there are firewalls in place to prevent one piece of Peak6 from influencing another.

More controversial is Apex’s new deposit plan for brokers. Goldberg explains that Apex has developed a formula asking correspondent firms to increase their deposits based on the types of trades that they handle. “All of our correspondents are coming up to a formula-driven level,” notes Goldberg. Some smaller brokers complain they are being asked to put up as much as 5 to 10 times more than previously.

Some online brokers were fighting back last week. TradeKing and Zecco, which are slated to merge, were granted a temporary restraining order against Apex’s increased capital requirements. TradeKing said it had been asked to lift its deposit from $100,000 to $13.1 million, while Zecco said its required deposit was raised from under $100,000 to over $9 million.

TradeKing CEO Don Montanaro, told Barron’s: “We run a very safe business and felt that $100,000 was plenty.” Zecco CEO Mike Raneri added that “the temporary restraining order is intended to let us maintain our current businesses with our customers and our prospective customers.”

Montanaro hopes to resolve the issues, but says, “We are certainly exploring all of our options when it comes to clearing, including the path of self-clearing.”

Brokers that don’t pony up within 30 days could face dire consequences. The head of another small firm that clears at Apex says that his choices are to come up with the huge deposit, or pay half of it within 30 days and change the terms of the clearing agreement, which he estimated would mean a tripling of fees. The third choice: move to another clearing firm within 90 days. But his firm would be unable to open new accounts during the switch.

Of the TradeKing and Zecco actions, Rosenthal says Apex’s new system is intended to provide stability and longevity for the new firm. “There’s no malice for particular customers in our request to increase their deposits with us, but there are some taking on more risk than we’re comfortable with.” He adds, “We’re still talking, and there are a lot of ways to resolve this.”

The outcome has ramifications in the cost-sensitive online broker market. In our most recent broker ranking ("Online Investors Cut the Cord,” March 12), 14 firms listed Penson as their clearing firm. (Click here for a list.)

With the TradeKing-Zecco merger, the number drops to 13. We’ll monitor to see if it falls further. It’s clear capital levels to support risk-taking are going up.

Published in Barron’s, June 25, 2012. 

Posted by twcarey on 06/30 at 11:45 AM
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Saturday, June 16, 2012

What's the News in Online Trading?

A financial video outfit gives TD Ameritrade customers free access to previously paid-only site. A new online broker, aimed at basket trading of stocks, moves out of its beta test.

Two unusual electronic-trading specialists took important steps to prepare for their future in recent days.

Tastytrade, a video financial network dreamed up by thinkorswim brokerage founder Tom Sosnoff, linked up with TD Ameritrade, allowing the big firm’s customers free access to the previously paid-only site. Motif Investing, a new online brokerage founded by Microsoft alumni, launched out of its beta test mode. Other than drawing attention at the same time, these two firms have little in common.

SOSNOFF’S MISSION IN LIFE is to show traders how to make money by focusing on probabilities and strategies that can shift the odds in their favor. He believes that traditional financial-news organizations mostly sell fear of failure, while his fledgling outfit emphasizes opportunity. “We make crazy fun of fear,” says Sosnoff.

Now about a year old, tastytrade’s mostly witty content streams live over the firm’s Website and is also available via iTunes, Apple TV, and Roku. It provides about six hours a day of programming and plans to add much more. Its biggest offering, “Get Tasted,” runs four hours each day. Sosnoff and Chicago Board of Trade veteran Tony Battista co-host the show, which featured an appearance by The Electronic Investor in mid-May. (If you’ve got 21 minutes to kill you can see my appearance at

Because Sosnoff and Battista highlight the probability of a trade turning profitable, they talk a lot about the time value of a trade, too. “I’ve been doing a lot of ranting recently because I’ve been on a kick about the analysts and writers not putting definition around their predictions,” Sosnoff says. “We want to tell people what the odds are of a price event happening. We are right there with our viewers while they’re trading.”

Coming soon: a show aimed at middle- and high-school students, called “Chasing Warren.” The co-hosts are 12 years old, and understand options trading. I expect to learn a few new tricks from them.

Sosnoff, who sold his sophisticated online brokerage to TD Ameritrade, recently adopted a new pricing strategy that relies in part on the big broker. TD Ameritrade customers can watch all of the tastytrade content free through May 2014 on either its Trade Architect or thinkorswim trading platform. Everyone else has to pay $90 a month. That’s a big shift from the previous policy of charging $90 a year. TD Ameritrade customers can hardly afford not to check out tastytrade.

MOTIF INVESTING ( posted its own recent news. The broker has updated the concept of basket trading of stocks. CEO and co-founder Hardeep Walia says that the big idea behind the firm is allowing investors to trade on their own big ideas. Other brokers allow clients to trade baskets of stocks—there’s ING Direct, which operates under the name, as well as FOLIOfn (, but Motif’s approach differs.

When you trade a basket of stocks, you invest a particular dollar amount in a bunch of stocks simultaneously. The basket can be weighted using a variety of methods, such as the market capitalization of the companies in which you’re investing. You’ll wind up with a varying number of shares of each of the stocks, usually including some fractions of shares. That allows investors or traders to spread out their risk.

Walia, who worked previously at Microsoft, believes that mutual funds and even exchange-traded funds create costs that leach away potential profits. Motif is set up so that you can create your own ETF designed around a particular idea. For example, one of the newly launched motifs is called “Lots of Likes,” and focuses on companies that have a wide following on Facebook and Twitter. You can search the available motifs by clicking on “Explore Motifs,” and selecting from industries, type of idea, one-year returns, or daily percentage price change. There are more than 50 motifs in the current catalog, and each is described in detail if you click on “How We Built This.”

These motifs are made up of as many as 30 stocks, drawn from an internally developed index of up to 100 stocks per industry. Customers can change the weighting within a motif using slider bars, then take a look at a graph that shows how the motif performed against the overall market. The revisions you make to a motif, such as substituting one company for another, or changing the weighting of a stock, are reflected in real time. “Try doing that with an ETF,” laughs Walia.

Opening an account is a multi-day process, including setting up an Automated Clearing House service for transferring cash. Trades are placed in dollar amounts with a minimum of $250 per transaction. When you buy a motif, a market order is generated and you spread that dollar amount among the stocks in the motif, and end up owning fractional shares of each company.

Chief compliance officer Connie Kuhl, an E*Trade alumna, explains that Motif holds the remaining fractional shares. “We have a set of smart algorithms that keeps the costs of trading down,” says Kuhl.

Commissions are $9.95 for each motif, whether you use it as originally designed or customized; placing a trade for an individual stock such as closing one position within a motif, is $4.95. This pricing compares favorably with subscriptions charged by FOLIOfn and ShareBulding for trading stock baskets. Motif is allowing customers to trade without commission for June.

The Website is nicely laid out, and very simple to use. Walia says that the firm will add the ability to harvest tax losses later this year for $4.95 per motif; a function to rebalance motifs will also be available but the pricing hasn’t been set. Though there is not yet a native mobile app, it’s very easy to use via mobile browser on an iPad.

I do have some reservations about this idea, though I believe it will appeal to investors—not traders—who would like more control over their investment than an ETF allows. The biggest problem, as I see it, is the inability to offset your costs of trading using options, since it’s rare to buy enough shares of one stock to be able to trade a derivatives contract. One advantage of trading ETFs is that most have options available. Motif might be a good place to invest a fraction of your portfolio, though the product line is too narrow to consider it for a large portion.

Options fan and video star Sosnoff offers his own review: “If you can’t lower your cost basis or you can’t reduce your capital requirements then it doesn’t make any sense in today’s world. This would have been a great product in 1990.” Don’t look for Walia on tastytrade anytime soon. 

Published in Barron’s, June 11, 2012. 

Posted by twcarey on 06/16 at 01:12 AM
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Saturday, June 02, 2012

Two Facebook Followers Unite

Pioneers in social networking for traders, online brokers TradeKing and Zecco hook up to take on the establishment.

When they met in eighth grade, in the principal’s office, Don Montanaro and Michael Raneri didn’t know they’d be friends for decades, much less business partners. The latter part came true on May 15, when their online brokerages, TradeKing and Zecco, agreed to merge.

Montanaro’s TradeKing and Raneri’s Zecco were early adopters of Facebook-like social networking for traders. TradeKing ( runs the Trader Network, where users can share ideas; Zecco ( has a similar community called ZeccoShare. The newly merged firm would have a combined client base of approximately 500,000 accounts with several billion dollars in client assets. Terms of the merger, including the combined group’s location and leadership, weren’t disclosed.

The plan is to unify the two entities under one brand and put the resulting firm on a single, best-of-both-worlds platform. The surviving brand, or possibly a new one, will be announced after the merger gets regulatory approval, which is expected in the next 30 to 60 days. The two firms already share a price point—both charge a low $4.95 commission on stock trades. Aside from low prices and social networking, TradeKing has focused on options and has a pretty rich educational site.

Montanaro, the co-founder and CEO of Florida-based TradeKing, was introduced to Raneri, now San Francisco-based Zecco’s CEO, by their middle-school principal shortly after Montanaro’s family moved to Connecticut. (No, they didn’t get in trouble together.) “We were best buddies all through high school, and Mike was my intro into Quick & Reilly after I finished law school,” Montanaro recalls. Quick & Reilly was an early discount broker and branched into online trading in the mid-1990s. “Mike had a 10-year run at Schwab after Q&R, so we’ve been colleagues and competitors for years. Now we’re partners at the right time to really be winners in this space.”

TradeKing’s original social component drew some skepticism from this column. The concept, however, appears to have caught on with a few million investors and traders on a variety of platforms, so it now looks like a great idea. Raneri and Montanaro think of the “Big Five” online brokers—Schwab, Fidelity, E*Trade, TD Ameritrade and Scottrade—as an oligopoly that is slow to respond to customer demands.

Montanaro says, “There’s a need for a nimble alternative that approaches customers with modern respect and embraces transparency. One that is willing to have a conversation in the open with its clients, asking, ‘What do you like, what don’t you like, and how can we get better?’ “

Apparently, the size of the two firms separately prevents them from being worthy competitors to the established oligopoly. “With this merger, we can stop being distracted by one another,” notes Montanaro.

Raneri expects to see “crowdsourcing,” or online discussions, among both firms’ clientele, to improve the experience for their merged customer base. “Social media and social networks made us stand out a little bit from the larger competitors. That transparency is going to help us here, so our customers can tell us what they like best about TradeKing and best about Zecco.”

When considering which pieces will be included on the merged platform, both agree that Zecco’s mobile apps are better than those offered by TradeKing. TradeKing’s options tools are a huge step above those on Zecco’s platform, plus TradeKing launched a bond platform that will be part of the merged unit. Zecco’s foreign-exchange capabilities will also be made available, though it will continue to involve a separate account and log-in.

Raneri says, “The combination will be the best of the best and very easily rival what the larger brokers offer in terms of technology. We plan to shine when it comes to customer service.”

Montanaro, reflecting on the time when they both worked for Quick & Reilly, recalls that their firm, though small, built a thriving business with superior customer service. In the early days of discount brokerages, there was a lot of overlap in product offerings and pricing, but Q&R’s trademark was service. “We’ve carried that forward with TradeKing,” Montanaro says, “That drives all of our decision-making and will continue to make a difference going forward.”

One former brokerage exec wonders what the combined firm’s new name will be, and hopes that the firm can come up with something new. “They will have to come up with a whole new name, in my opinion,” he says. “Zecco is a horrible name, and TradeKing is OK but not great. I am curious about the profitability and revenues of each firm as well as who is going to run the company—and where is it going to be located.”

A current competitor believes the merger will help because they were too small separately. But, he warns, saying they are going to challenge E*Trade “is crazy.”

In Barron’s online brokerage survey, we have consistently ranked TradeKing higher than Zecco over the years, mainly because the former’s options tools are superior. Zecco has come up with a number of plug-ins that keep its trading ticket ubiquitous, allowing customers to trade from any Website, including Facebook. Raneri says, “We’re the only broker that trades directly on Facebook right now.” Zecco runs a weekly contest on its Facebook page that rewards the winner with a $500 prize. One wonders whether that promotion will survive the merger.

WITH THIS SOCIAL-NETWORKING marriage set, the online brokerage industry is still recovering from the raucous debut of the king of all social media, Facebook. TD Ameritrade ( reports that 22% of all stock orders on May 18, the day of the initial public offering, involved Facebook. At TradeKing, 30% of the orders were for Facebook, and 90% of those were “Buy” orders.

Montanaro says, “We’ve never seen this concentration in one symbol on any day in our 6½-year history. We had lots of fresh new funds coming into accounts in recent weeks in anticipation of [the IPO], so we knew we had serious pent-up demand for the stock.”

The next challenge for the online brokerage industry is the start of options trading in Facebook stock, which is scheduled to begin May 29. Let’s hope the CBOE has less trouble initiating trading than Nasdaq did.

Posted by twcarey on 06/02 at 03:09 PM
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