21st Century Finance

Almost lost amid the hubbub over the AOL–Time merger was Charles Schwab & Co.’s $1.3 billion purchase of U.S. Trust. The deal was similar to AOL-Time, both because Schwab today does most of its business online, and because Schwab paid a hefty premium for the old-style fund manager and investment advisor.

The early analysis of this deal by CNBC and others emphasized Schwab’s hefty premium, openly questioning whether the online brokerage business is all it’s cracked up to be.

The instant analysis was all wet. The fact is we’re seeing a split and a maturing in the online brokerage business, the first really big electronic commerce industry.

Before going further, let me get some disclosure out of the way. I’ve kept my self-employment IRA at Schwab since a decade before the web was spun, and now execute my trades at their web site. I tell my friends I have a “bookie” named “Charlie,” and when I get a tip I take a flyer with him – his “vigorish” (commission) is just $30 on each end of the deal. I should also say one of those trades was the purchase of 100 Schwab shares.

On one end of the new business are firms like Datek. Their principals launched the Island, a hugely successful electronic clearing network (ECN), and they’re now happily engaged in building a big transaction processing business. (On the consumer side, they’re pushing ECN-like tools into the broader market.)

On the other end is Schwab, which sees assets under management as the key to future success. At the end of last year, Schwab had $349 billion under management, double the figure of a year earlier. (Between Schwab and Datek are firms like E*Trade, which wants to associate with a branch network, and has built a big transaction business besides.)

Over my career, I’ve been pumping all the law allows on my “bookie,” and I’ve now got a sizable stake. Somewhere in the jump from four figures to six, your mindset changes. You become prudent, you place bets all across the map – foreign stocks, domestic stocks, bonds, and mutual funds. One day you wake up and you can afford – no, you require – full-time professional management.

Thus, Schwab’s U.S. Trust purchase. In one move, Schwab moves directly against Merrill Lynch and the other big brokers, giving its own customers an upgrade path as their money turns to wealth. Schwab has the trust of 3.3 million account holders, their little investments are turning into real moola, and now they don’t have to leave. Over the next year you figure Schwab’s computer geeks will make U.S. Trust web-savvy, that Schwab will process all U.S. Trust’s trades, and that its marketers will create lots of different options for buying U.S. Trust’s services.

The game is fluid. Recent research by Cyber Dialogue indicates that the online world reduces the brand loyalty people feel about financial service companies. So let’s end with this key question: Is the online brokerage business about trading, or is it about assets? Watch Schwab, Datek and E*Trade carefully over the next few years. Their fates will furnish the answer.