Brokers Wage a Price War on Commissions

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A sign marks the entrance of the E*Trade Financial office in Chicago, Ill.

The hot question to ask your broker these days is not which stock to buy, but how much it will cost to make the trade. Across America discount brokers are slashing commissions in an all-out fight to grab new customers.

Well, not quite all-out. The big holdout on price cuts is TD Ameritrade. But industry watchers say they'll be the next to act. "I think a move is imminent for TD Ameritrade," says David Lo, director of investment services at J.D. Power & Associates. "[Their trading fees] are higher than everyone else so they almost have to do something."

The price war began last month when brokers began aggressively cutting commissions on stock trades to grab the attention — and business — of many self-directed investors and independent financial advisers who had fled large brokerage firms during the economic and stock market meltdowns.

Online brokers were soon seeing their business pick up. "There has definitely been a surge in the past 12 to 18 months," says Fred Tomczyk, chief executive of TD Ameritrade. "We've had very good growth trends." In TD Ameritrade's fiscal first quarter that ended on Dec. 31, 2009, net new assets rose to $8.7 billion from $7.8 billion a year earlier, according to Kim Hillyer, the company's senior manager of communications.

But the quest to grow market share quickly led brokers to begin slashing prices.

Charles Schwab Corp. launched the opening shot when it chopped commissions on online equity trades by about 30% to $8.95 from $12.95 a pop for individual investors, and, more importantly, streamlined the fee so that it applied across the board regardless of how frequently someone trades, how many assets the investor holds, or how many shares a person buys. In the past, customers with more than $1 million in assets and those who completed more than 120 trades a year got the lower rate, while less wealthy, less active clients were hit with higher fees. Also, under the new rules, anyone trading blocks of more than 1,000 shares will no longer be hit with additional fees.

Fidelity fired a salvo two weeks later, when it cut trade commissions to a flat fee of $7.95 from previous rates that ranged from $8 to $19.95 depending on trading volume and asset size. E*Trade, best known for its popular talking baby ads, joined the battle in early February when it trimmed equity-trading fees for low-volume investors to $9.99 from $12.99, although it still maintained a premium deal of $7.99 per trade for higher-volume customers. Scottrade stayed put, as it already offers flat $7 trading fees.

The ball is now in TD Ameritrade's court, a firm that has been gaining market share in recent years, with its flat $9.99 fee. In 2009, TD Ameritrade's daily average revenue [producing] trades rose 17% while Schwab's fell 2%, said Michael Hecht, an analyst at JMP Securities, in a recent note. "We were the one shop that had simple, straightforward, transparent pricing — one price point for all clients and there's no gimmick to it," says Tomczyk. "Clients don't like it when think they have one price and wind up getting nickeled and dimed to death. We set a price point and that's what the price is."

But with rivals now offering a similar flat-rate policy — and at a lower rate — TD Ameritrade is likely feeling pressure to at least match its competitors' rates to maintain market share. "If TD Ameritrade starts to lose customers because of [pricing], obviously there's going to be some sensitivity to lowering their commission rates," says Joel Jeffrey, a vice president and analyst at Keefe, Bruyette & Woods.

History has shown pricing can make a significant difference. In the 2004 price war, Schwab gained 5 percentage points of market share when it cut trading fees to $19.95 from $29.95.

For now, TD Ameritrade's Tomczyk is keeping his commission plans close to the vest. "We will definitely be monitoring this," he says. "We don't like losing, and if we need to respond, we'll respond." Tomczyk adds that his firm would even take some hits to profits to hold the line. "It's about growth in the long term and being competitive first and foremost," he says. "If that means your profits get squeezed [in the short term], your profits get squeezed."

The squeeze is already on at some firms. Schwab's lower commission announced in January, for example, will reduce revenue by $15 million to $20 million in the first quarter, and cut earnings by about 4 cents a share, or about 6%, in full year 2010, according to Richard Repetto, an analyst at Sandler O'Neill. Repetto estimates the company would need to see a 30% increase in daily average revenue trades to offset the lower pricing.

E*TRADE's lower pricing will reduce retail brokerage earnings by about 10% and overall earnings by 1 cent a share in fiscal 2011, according to Hecht.

At TD Ameritrade, every $1 that's trimmed from commission rates will lower the company's 2011 earnings by 7 cents a share, or about 5%, estimates Matt Fischer, an analyst at Credit Agricole Securities (USA) Inc. However, this decline could be offset by an increase in business and market share.