Commentary: Why E Brokers Are Broker And Broker

Barely a year ago, online brokers looked poised to take over Wall Street. Discounters E*Trade, Ameritrade, and Datek were sending shivers down the spines of hidebound mammoths like Merrill Lynch & Co. Their cheap trades drew in a growing legion of retail investors. These upstarts suddenly seemed on track to become as highly valued as Wall Street veterans. By last March, E*Trade Group's $9.4 billion market capitalization topped that of Bear Stearns Cos.

Not anymore. These days, it's the online brokers who are trembling. On Jan. 8, Ameritrade Holding Corp. laid off 350 employees, 14% of its workforce, after announcing an expected first-quarter loss of 12 cents to 14 cents per share, vs. analysts' estimates of 5 cents. A week earlier, J.P. Morgan Chase & Co. halved its Morgan Online staff to 150. A similar fate may await most pure online brokers. "It wouldn't surprise me to see all of these guys announce layoffs," says Jaime Punishill, a senior analyst at consultants Forrester Research Inc.

BRAINLESS BULLS? What went wrong? Consider a familiar Wall Street motto: Don't confuse a bull market with brains. Online brokers and cheap trades were in vogue when markets were rising. But now, investors who thought they knew it all are finding that they needed advice all along. Many are too scared to make their own trades and are high-tailing it out of the markets. Or they are scrambling to find a good adviser. The trend is punishing discount brokers, who need transactions to survive and have little advice to give. "The current [online broker] model is inadequate for the pressures they are facing now," says Eric J. Rajendra, global head of e-financial services at consultant A.T. Kearney.

Of course, traditional brokers have also suffered severe blows from the turbulent stock market. But with deep pockets, they are poised to wreak revenge. They're set to bury or buy any online broker that insists on slogging it out as a transaction-oriented business. So the online crowd needs partners to build up competitive research and advisory services quickly. E*Trade, for example, tied up with Ernst & Young last year. The pure online discount broker is dead. "There will be a time when the term `Internet brokerage' is no longer relevant," predicts Julio Gmez, chairman of online researcher Gmez Inc.

A devastating shakeout among the nation's 140 or so online brokers lies ahead. "We think you need five to ten," says Henry McVey, financial-services analyst at Morgan Stanley Dean Witter.

Analysts figure that online brokers are geared up to handle a total of 1.2 million trades a day. But since the stock market started its lengthy decline last spring, online brokers' daily trades have dropped 30%, to 834,000, according to investment bank Robertson Stephens Inc.

The pain is particularly acute for discount online brokers, since they are such young companies. The end of dot-com euphoria combined with the rapidly rising cost of acquiring new clients online is putting a serious dent in their revenue growth and in their ability to raise funding to expand. "It's a double whammy," says Richard H. Repetto, online brokerage analyst at Putnam Lovell Securities Inc.

LAST LAUGH. But Wall Street itself is also learning some harsh lessons from its forays into the online world. J.P. Morgan laid off marketing personnel partly because it discovered that while Morgan Online helps its private bankers, even its comprehensive online advice offerings aren't a surefire draw for droves of millionaire Net-savvy clients. A recent Forrester Research study shows that despite aggressive marketing, only 4% of 3,500 millionaires have visited J.P. Morgan's Web site, vs. 28% who have seen E*Trade.

Nevertheless, traditional Wall Street firms may have the last laugh. Their broader Net offerings make it increasingly difficult for the online crowd to steal clients away. And, like it or not, the Net has become a mandatory component of financial advice. Hence, J.P. Morgan, Merrill Lynch, Morgan Stanley Dean Witter, Goldman Sachs, and Credit Suisse First Boston are all investing heavily in sophisticated online offerings.

Short of a huge boom in stock trading, the online brokers' woes are set to endure. That means if they can't beat Wall Street's Old Economy firms, they'll have to join them.

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