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The business of day trading
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December 25, 1998: 11:10 a.m. ET
Day trading firms unite as technology costs squeeze some out of market
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NEW YORK (CNNfn) - For four years, Block Trading of Houston ran with the big boys.
The day trading firm, at the start of this year, ranked among the industry's largest players, boasting a network of more than 20 offices nationwide and a growing staff of more than 50 employees.
It also won the Houston 100 award, handed out by the University of Houston Small Business Development Center, for the fastest- growing company in the city from 1994 through 1996 -- claiming the coveted prize with its staggering 7,900 percent revenue growth rate.
But that was before new securities regulations sent shock waves through the industry; before the consolidation wave swept over the broker-dealer business, and before the expense of developing new software technology dealt a devastating blow to Block Trading's bottom line.
"It's one of those very simple things where if you are not trying to come up with innovative new trading tools it's very difficult (to remain in business)," said Jeff Burke, co-founder and one-time president of the firm.
(Burke said he quit the firm earlier this year after bringing what he saw as "accounting irregularities" to the attention of other executives. He now works for a day trading firm associated with Summit Trading in Houston. Block's other co-founder, Chris Block, did not return phone calls seeking comment.)
Differences of opinion abound over what finally toppled Block Trading, ranging from Burke's alleged accounting irregularities to the predatory acquisition practices of its rivals. But Burke said most employees associated with the firm attribute its downfall to the costs of keeping technologically competitive.
The company, he said, spent roughly $100,000 a month developing a still-unfinished trading software system from January through around October, when it could spend no more.
Now cloaked in the safety blanket of Chapter 11 bankruptcy protection, Block Trading is struggling to stay alive. It's success will largely depend on how well it is able to adapt to the changing regulatory and cost-cutting environment that has redefined the industry.
"Trading ... as we pioneered it, is completely different today than four or five years ago," Burke said. "You can't even compare what we did then with what we do now. The inefficiencies we used to attempt to exploit have been essentially taken out of the market."
(Block Trading also is under investigation for possible state and security law violations at its Boston office. Among other things, the company is accused of distributing misleading marketing materials and leaving neophyte investors under-supervised.)
The firm's closure came just weeks after a smaller rival, Philip A. Dina Securities of Englewood., N.J., reportedly closed its doors.
Those tracking the industry say more are likely to follow as the colossal cost of doing business forces the smaller, and poorly financed, players out of the market.
A state of flux
Nine privately held day trading brokerages control the bulk of the 60 to 70 office facilities that exist nationwide. A smattering of independents own the rest.
The largest competitors are Heartland Securities, Momentum Securities Management Co., Broadway Trading LLC, On-Line Investment Services, Landmark Securities, Andover Brokerage, and All-Tech Investment Group.
"There are far fewer entities involved in this business now because of consolidation into and affiliation with these (big-name) offices," said James H. Lee, president of the Electronic Traders Association and head of Momentum Securities. "As new and as explosive as (the day-trading industry) is, it seems to be maturing in terms of consolidation."
Lee noted the industry had little choice.
"There has been enormous spending on technology and these companies need to (develop) it collectively (to foot the bill)," he said.
Proprietary software systems, which put information and automated trading capabilities at the clients' fingertips, "is the driver of the business," he said. "It's what separates the firms."
Lee estimates Momentum alone has spent more than $5.5 million since its inception in 1995 on software development and order routing infrastructure.
"That's nothing next to what Goldman Sachs spends, but for a new company being funded internally or from partners' contributions, that's an enormous amount," he said. "Next to employees (salaries), that's our single biggest expense."
Momentum brought on Block Trading's largest independent office in Irvine, Calif., as an affiliate this fall along with several smaller offices, and now provides broker-dealer services for 11 offices nationwide.
Charting their growth
It's tough to quantify the growth of the day-trading industry, since few hard facts exist. But anecdotal references to its rapid growth rate abound.
Eric Maschler, for example, the chief executive officer of Heartland Securities in New York, said his firm currently employs 220 registered representatives and has 55 individual clients who use the company's computer software technology to trade for their own accounts.
The firm, created earlier this year through the spin-off of Datek Securities' day trading operations, had just five employees when Maschler was brought on three years ago.
Maschler wouldn't disclose financial information, but said the company is "doing really well."
Lee, of Momentum Securities, tells a similar tale.
"Over the last few years, volume associated with day trading has steadily increased and I think it's peaking," he said.
According to estimates, Lee said day trades make up between 12.5 percent and 15 percent of the Nasdaq exchange's daily dollar volume. That's up from an estimated 7 percent to 8 percent last year.
"It's never been higher," he said.
Money makers
Brokerage firms make money by charging a fee for each trade. Some also charge clients entering the business up to $5,000 for training on how to use their software systems.
All-Tech Securities, for example, charges clients $25 per transaction. Large institutional investors pay a cent-per-share fee.
Summit Trading charges anywhere from $10 to $16 per transaction, based on volume. Burke said trading 1,000 shares of Intel (INTC) through Summit would cost a client far less than the larger traditional brokerage houses, which might take a commission fee of $125 to $375.
"We don't sell our customers' orders and then get a kickback for it," said Harvey Houtkin, head of All-Tech Securities and the widely credited "father of electronic trading."
Houtkin said the 10-year-old firm places 6,000 to 8,0000 trades a day at its 23 offices across the country. The company now is looking overseas for future growth opportunities, he said, including Germany, Israel, Japan and Canada.
Assuming its business plan passes muster with the securities regulators in those countries, Houtkin said, he hopes to bring All-Tech abroad sometime next year.
He noted, too, that All-Tech tried to go public during the summer but said "the general brokerage community didn't make (the firm's) life easy."
Now that an initial public offering is off the table and business growth is again the top priority, Houtkin said trading volume has doubled since the summer.
With interest in day traders, Houtkin said he believes day trading firms are at the early stages of a long-term growth streak.
"Wall Street is the ultimate game," he said. "People absolutely crave this and love what they are doing. The general population doesn't understand this. People love nothing more than their money -- maybe their children. It's a way of keeping score." 
-- by staff writer Shelly K. Schwartz
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