Goodbye Wall Street, hello Omaha

Kiplinger's Personal Finance Magazine, Oct, 1998 by Steven T. Goldberg

The computers are linked via the firm's Web site to investors' computers. They route customers' orders instantaneously to computers at other firms that fill Nasdaq trades, or directly to the New York or American stock exchanges. Most orders are filled automatically, without human intervention. Trade confirmations route back through the Omaha computer bank to investors' PCs.

"We're at the beginning of a revolution," says Ameritrade chairman Joe Ricketts, "that will be more significant than the Industrial Revolution." The 57-year-old Ricketts founded the firm in 1975. But for years it was a relatively sleepy outfit, and until recently it was in danger of being bypassed by other firms sprouting on the Internet.

Then Ricketts, according to a colleague, "bet the company." In March 1997 Ameritrade made an initial public offering of its stock. Much of what was raised was spent in six months on a $34.5-million advertising blitz. The company bought commercials on Monday Night Football and Seinfeld, and placed glossy ads in magazines (including this one), partly to lasso new customers but also to create a buzz.

The ads were atypical. Peter Horst, the Ameritrade official who orchestrated much of the media campaign, says the ads "make it fun" to invest. They are populated with happy people who say things like "I bought a major Hollywood studio for $8" or "I got into Club Med for $8," or "I dumped my Playboy for $8."

Ameritrade got the buzz it sought. All of a sudden it had a recognizable brand name. Phone calls about opening accounts flooded its switchboard. In nine months, 181,000 accounts were opened--doubling the firm's customer base. In the three months ending June 26, average daily trading volume rose to 21,412 shares, more than triple the number a year earlier.

Without the increased trade volume sparked by the ad campaign, says Robert Slezak, Ameritrade's chief financial officer, the company lacked the efficiencies to turn a profit at its newly lowered prices of $8 per trade ($13 for a limit order). Also essential are cheap office space and telephone reps, most of them licensed brokers, who are paid about $12 per hour.

But commissions are just one source of Ameritrade's revenue. Almost as much--$7.80 per trade--is interest income. In addition to charging for trades, Ameritrade lends money to customers who borrow to leverage their investments. More than $600 million is on loan in margin accounts at rates as high as 9.25%. "They're paying the freight for the rest of the customers," says Kurt Halvorson, who runs Ameritrade's back office.

Moreover, Ameritrade has more than $1 billion in cash deposits and generally pays just 3% interest to its investors. While a money-market fund with about a 5% interest rate is available, accountholders have to know to ask. You can't place a trade at Ameritrade or at most other online brokerages without having cash already in your account.

Ameritrade also makes about $2.24 per trade from what's known as "payment for order flow." This means that Ameritrade, like many brokers, sells Nasdaq orders for a penny or so per share to a market maker, who actually executes it. (The New York and American stock exchanges employ different trading systems that don't allow for payment for order flow, although brokerages often route trades for these stocks to smaller, regional exchanges that do pay for order flow.) Some critics say that this practice discourages online brokers from looking for the best market maker to execute your trade. When you buy a stock, it might be for 24 15/16 per share rather than 24 7/8, the critics say.