Mutual Enemy - Company Business and Marketing

Industry Standard, The, Feb, 2001 by Daniel Mcginn

Wall Street is wary of ex-SEC man Steven Wallman, and for good reason. His online brokerage, targeting so-called portfolio investors, poses a fresh threat to fund managers.

There's a well-worn path leading from Washington into the private sector. After leaving a government post -- say, as a commissioner at the Securities and Exchange Commission -- many ex-officials decide it's time to cash in, usually as a lawyer, lobbyist or consultant.

Steven Wallman went a different route. In 1998, after a three-year term at the SEC, he was eager to run a startup -- and a group of entrepreneurs dangled an intriguing offer. The plan was to use wireless technology to outfit everyday investors with pagers that would receive stock market news anytime, anyplace. Brokerage firms, in turn, hoped to profit from a flood of headline-driven trades.

Wallman didn't like the scheme. "That's an interesting way to use technology to get people to invest," he says, "but I don't think it's good for them. To get a headline that says 'Department of Justice Sues MSFT' and to try to make an investment decision from it is absurd." So he went to work on his own idea, something to give people a better way to pick their stocks.

What Wallman came up with is Foliofn, an online brokerage that specializes in portfolio investing. Since the site's launch last May, the financial press has hailed it as an innovation that could transform the way average investors buy stocks. The idea has also triggered alarms in the mutual fund industry, which has approached Wallman's old employer, the SEC, to urge that Foliofn be more strictly regulated. Meanwhile, some mutual fund companies are reportedly considering similar products.

Like any brokerage, Foliofn lets investors pick their own stocks. But its real pitch is ready-made "baskets" or "folios" of stock from different indexes or industries. Want to invest in biotech? Just click the biotech folio and you've bought stock in up to 50 companies. The baskets can be endlessly customized -- you could delete or double the allocation to, say, Amgen, or create a new basket from scratch. Want a portfolio that invests only in North Dakota-based companies? Foliofn lets you build it. Investors can do this at other brokerages, too, but Foliofn offers twists that make it cheap and easy. For instance, investors can purchase fractional shares, so folks without a lot of money can divide their dollars among dozens of stocks. Traditional brokerages don't sell fractional shares, and typically charge high commissions for trades of fewer than 100 shares.

Low fees are the service's other big attraction. For $295 a year, investors can buy up to three folios of 50 stocks each. Trading is free, as long as investors buy or sell no more than twice a day and stick to a list of 2,500 U.s. stocks. For a portfolio builder who can live with those restrictions, Foliofn's fees may undercut those of even the lowest-priced online brokerages. Wallman hopes that, if he can make diversification cheap and easy, investors will limit their obsession with finding that one killer stock and instead focus on crafting sensible portfolios.

Foliofn pitches its service as an improvement on mutual funds, one that offers lower costs and more control for investors. Its investors will know which stocks they hold -- information mutual funds must disclose only twice a year -- and can buy and sell as needed to minimize capital gains taxes. A possible downside: While mutual funds have professional managers to research and select investments for their clients, folio investors are in charge of their own picks, for better or worse.

Wallman has spent his career preparing to help investors make such decisions wisely. As an MIT undergrad, he accelerated his studies and earned a master's degree from the Sloan School of Management during his final year. From MIT he went to the Boston Consulting Group and then, after Columbia Law School, to Covington & Burling, a Washington, D.C., law firm. He did some traditional lawyering, but his work in the '80s and early '90s -- for groups like the AFL-CIO, Business Roundtable and Council of Institutional Investors -- had him studying public policy issues such as corporate governance and takeover law.

In 1994 Wallman was appointed to the SEC by President Clinton. As a commissioner, he spurred the agency to pay attention to the Web and to champion the interests of small investors, whose ranks were exploding. Wallman says his big accomplishment was convincing stock exchanges to convert share pricing from fractions to decimals. The transition, he says, will reduce the spread between what buyers and sellers of stock pay. Some experts estimate the change will save investors up to $5 billion a year.

But Wallman found parts of his SEC job frustrating. In speeches to investors, he'd routinely rattle off the agency's prescription for informed investing: "Go home and study companies' financial statements, read those 10Ks, keep up with industry news and then pick your stocks." He was mouthing the party line but had doubts about its efficacy. "It made no sense -- it couldn't be done," he says. Most people "don't have time to do all that financial analysis." Meanwhile, he saw mutual funds doing things he considered less than ideal for shareholders -- like revealing their stock holdings only twice a year. He began to feel he could change things more effectively as a private-sector innovator.