| 25 June 2010

Hell froze over on Monday. Merrill Lynch launched an online brokerage for self-directed investors. The firm, which is now part of Bank of America (BAC), is known for serving its affluent clients through a network of 15,000 financial advisers. With $2.2 trillion in client assets at stake, the company has consistently avoided any efforts that might at all muddy the waters with those relationships. 

The Broker Blogger himself can recall sitting in Merrill's executive dining room for breakfast one morning, head honchos across the table listening politely to my pitch for new online services. We sat at a table that, by my colleague's estimate, was worth more than my house. We were served eggs and bacon by a team of white-gloved servants while large oil-painted founders and past-presidents hung on the wall and stared down at our half-open laptops with obvious contempt.

Every point we made in our pitch was met with the same counter-point: how will this go over with our (then) 14,000 financial advisers? Will this improve their relationship with their clients? No matter how ingenious the pitch we played, the refrain was the same: yes, but did we mention we have 14,000 financial advisers? Explain what this does for them, please.

We left that meeting with full stomachs, empty pocketbooks and a lot of unsigned deal papers. But we didn't feel defeated so much as educated. Because the fact is, this consistency of purpose worked for Merrill Lynch and it worked well. For many, many years. The fact that Merrill got itself into trouble which led to its controversial acquisition by Bank of America had more to do with management's lapse in concentration. In other words, Merrill's core model still worked, it was the efforts that pushed Merrill beyond this basic approach, which we can only imagine were brought on by breakfast meetings more successful than ours, that led to their stumble.

Here's what we know: most investors hold multiple accounts. As a general rule, one account will tend to be more active than the others. The competition in the world of online brokers used to be, up until about 6-12 months ago, for activity. Online brokers, for their part, were focused on DARTs (daily average revenue trades) as a measure of success. More active accounts led to more commissions which led to more revenue.

The Charles Schwab Corporation (SCHW), which launched in 1974, was an early leader in developing an alternative model for self-directed investors. Some would argue that their efforts helped create new market for self-directed brokerage services; they were growing the market, not poaching clients from the likes of Merrill. The proliferation of the self-directed 401(k) and the rapid boom and bust cycles in the markets, like those we saw in the early 2000s, fueled the demand for online broker platforms, more sophisticated tools and education.

But Schwab in particular, and TD Ameritrade (AMTD) to a lesser extent, saw the writing on the wall in the last couple of years and began moving away from a dependence on trading activity and started moving toward a strategy that focused on fee-generating services and asset growth. In other words, where once they were a distant nuisance to Merrill, they are now a direct competitor.

We emphasize this fact by pointing out that a large portion of Schwab's business now comes in the form of asset management and administration fees. In fact, at $420 million the first quarter of this year it was more than double their trading revenue.  Moreover, in the fourth quarter of 2009 Schwab assets under management in advisor services ($590 billion) surpassed assets in their investor services ($583 billion) for the first time in the company's history.

We suggest that Merrill is less concerned about attracting new, smaller clients or losing single clients and more concerned about losing financial consultants and ALL of their clients to companies like Schwab and TD Ameritrade. O if not, they damn well should be. These uber-online brokers have transformed themselves into safe-havens for rogue consultants looking for a place to hang a shingle and control their own destiny. To wit: in 2009, 172 new advisor teams moved to Schwab, a whopping 40 percent increase from 2008. One need only spend a few minutes on Schwab's advisor center to see how they do this.

Which finally brings us back to Merrill Lynch and Bank of America and the new Merrill Edge. We've taken a look at the platform (see images at the end of this article). It's basically a re-branding of B of A's trading platform. Frankly, we're not sure whether to be unimpressed with its lack of sophistication or impressed with its utter simplicity. We suppose the team at Merrill did some user testing and it's plausible that they learned a thing or two about their clients and what they wanted out of a platform. It could be, for example, that these clients are simply interested in a little control, the ability to flick around their accounts on their own, maybe place a trade or two, but are less interested in complicated screening and strategy tools or java charting applications. It's more likely that it's just a typical feature-less bank brokerage effort all dolled-up with a Merrill logo. But who knows?

What we do know is that, despite the fact that BofA says they are "targeting investors with less than $250,000 in assets," the platform represents no threat to the likes of Schwab, TD Ameritrade and others who do offer a full suite of tools. So the service doesn't offer anything unique to potential new clients and we don't think it's likely to keep cash cow clients from moving some "play money" to places like optionsXpress, for example, if they wanted to. (If you're going to play, might as well play with the cool toys.)

The real question is how Merrill's financial consultants are taking the news and whether they are now more at risk of leaving. Bank of America has a statistically valid point, claiming that they have data that shows that clients with both a full service and a self-directed relationship are less likely to leave, according to this BusinessWeek article. Bt it's a point that works for Schwab as much as it works for Merrill.

More worrisome for Merrill is this notion, mentioned in that same article: "Merrill Edge may lead to more financial advisers leaving the firm because they fear the platform might cannibalize their clients." In other words, if you really want my clients to have access to a trading platform -- and worse, you want to emphasize $8.95 trades versus my $250-500 commission -- then I might as well pick up and move to Schwab.

We think the team at BofA is looking at the wrong set of data. They focused too much on the effects a trading platform would have on clients and not enough on the effects they would have on financial advisers. Apparently they didn't have breakfast with the muckety-mucks in the executive dining room at Merrill to explain their decision. If they had, they would have been asked a simple question. "So how does this benefit out financial consultants?" The answer would have been, and still is, obvious.





Screen shot 1: Merrill Edge's Trading Screen




Screen shot 2: Merrill Edge's integrated accounts view




Screen shot 3: Merrill Edge's Performance screen