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DECEMBER 24, 2001

Trading Places

It's 10 a.m. Do you know where your sell order is being executed?

thin rule
Reviewed by Theresa W. Carey


Edited by Randall W. Forsyth

Just in time for your yearend reflections, the SEC has implemented rules intended to provide an overview of how brokers handle clients' orders.

SEC Exchange Act Rule 11AC1-5 requires market centers -- market makers and securities exchanges -- to report monthly on the speed, price and size of their orders. Rule 11AC1-6 mandates that broker/dealers report quarterly on order- routing practices for U.S. equities (New York Stock Exchange, Nasdaq, American Stock Exchange) and exchange-listed options. A key goal is to eventually build a database that will determine where investors get the most for their trading dollars.

Statistics for the third quarter, published in compliance with Rule 1-6, paint a revealing picture of each brokerage. Among the figures provided are those for the major market centers (for instance, exchanges, specialists, market makers and electronic communications networks, or ECNs) that receive 5% or more of a brokerage's orders; payment for order flow arrangements, and percentage of orders by type (market, limit and "other," including short sales).

The orders the SEC is most interested in are those considered "non-directed," which are placed when an investor just hits the "trade" button without telling the brokerage to use a particular exchange or ECN. The SEC wants to see how the brokerage handles orders when it's given free rein.

Brokerages are required to post this information publicly, though that doesn't mean the link is prominent on their Websites. For instance, to find Charles Schwab's report at http://www.schwab.com/, you must scroll to the bottom of its home page and locate the "SEC Disclosure" link under "Company Information." At Wall Street Access (http://www.wallstreetaccess.com/), you'll have to click on "Trader Education and Resources" and then find "Order Routing" at the bottom of the menu. And the story is much the same at all 15 online brokers whose Websites we examined.

One fact leaps out, as Salomon Smith Barney's Guy Moszkowski notes in a report: Brokerages with market-making divisions concentrate their order routing internally. Schwab sent 96% of its Nasdaq orders to Schwab Capital Markets, while Morgan Stanley kept 84% of its trades inhouse. Brokers that don't have internal market makers naturally spread the orders around, but payment for order flow appears to be a factor in their decisions on where to place a trade. Datek sends 89% of its Nasdaq orders to its wholly-owned Island ECN subsidiary.

Moszkowski analyzed 11 major brokers. He found that, on average, 44% of their Nasdaq orders during the third quarter were market orders, 39% were limit orders and the remaining 17% were "other."

Certain brokerages produced order mixes that differed significantly from the average. Only 16% of the trades placed with Datek were market orders, while Merrill Lynch customers favored market orders 71% of the time.

Market centers have been publishing their Rule 1-5 statistics for three months now, with numbers available for August-October. Reports are available for individual ticker symbols. Two problems: First, with the current system, making comparisons isn't easy. Second, the sheer volume of information is too staggering to be easily digested. For the NYSE alone, there are approximately 50 megabytes of data per month to examine. That's an enormous pile of information, and one we're still sorting through.

A key question: Will these disclosures affect investors' decisions on which broker to use? Write us at electronicinvestor@lycos.com about how important it is to know the destination of your trades.

Analyzing risk: early this year, we looked at PortfolioScience ("Beats Dramamine," January 8) which analyzes a portfolio and calculates the dollar amount by which it is likely to fluctuate daily, weekly, monthly or yearly. The calculations let users determine the greatest sources of risk in their holdings, based on historic volatility.

We noted that the site fell prey to that old bugaboo: the hassle of having to enter data. You can still use the PortfolioScience engine free if you don't mind entering numbers, as long as your portfolio has fewer than 50 positions.

However, if you're tracking your portfolio using Excel, or are using an online broker that allows you to download your data in the Excel format, you can subscribe to the personal version of the PortfolioScience Excel add-in for $19.95 per month and avoid having to input data. The institutional version is a heavy-duty enhancement to the free tools available to institutional subscribers and includes covariance analysis, correlation matrices, and beta calculations.

[Portfolio Science screen shot]
PortfolioScience helps investors to analyze the risks in their portfolios.

The add-in tacks an extra menu onto Excel that connects your spreadsheet to the PortfolioScience servers. You specify your holdings and their ticker symbols, and then indicate which analytical function you want to use. The request is sent to the Portfolio- Science servers, where the calculations take place. Then the results are reported back to your spreadsheet. Having the work done offsite avoids the need to download historical data onto your computer. Certain calculations, such as figuring the correlations between 10 or more stocks, would make some PCs bog down in a mathematical quagmire.

Says Ittai Korin, founder and president of PortfolioScience: "Some of our clients have portfolios with 500 to 1,000 symbols or more, so the power of having the calculation engine operate remotely lets you harness computing power you couldn't access before."

The Excel add-in lets you insert a calculation into a spreadsheet, to instantly update your spreadsheet when your portfolio changes, or let you do "what-if " analysis. Korin says PortfolioScience is popular with hedge-fund managers. One reason: It lets them correlate the performance of baskets of securities with that of indexes.

AmeriTrade's takeover of national Discount Brokers is complete, and by now all former NDB customers should have new account numbers and PIN codes.

The deal has led to a few additions and a few deletions in services offered. The "Same Side, Same Day" commission is gone; it had allowed a trader to make multiple transactions on the same side (all buys or sells, in other words) on the same day, for a single commission. Also gone are some portfolio-analysis functions.

But the folks at AmeriTrade have added several new methods of viewing stock quotes, including the ECN Book Quotes Tab and enhanced charting capabilities. They've also left the order-entry screen open, making it easy to execute a trade, and have added the ability to route orders through AmeriTrade's proprietary "TradeScout" system.

[Natl Discount screen shot]
Since taking over National Discount Brokers, Ameritrade has added and deleted some online services.

Portfolios with more than $5,000 in assets are assigned an account executive, and holders can switch to one of AmeriTrade's other offerings in its Private Client division, if desired.

The completion of the NDB takeover gives AmeriTrade three levels of service in the Private Client division: AmeriTrade Brokerage on the low end, AmeriTrade Plus in the mid-range, and AmeriTrade Pro (formerly direct access brokerage TradeCast) for frequent traders.


E-mail comments to editors@barrons.com




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