Inside Out: How Efficient Operations Propelled Wedbush Morgan
July 20, 2009
Wedbush Morgan Securities is a classic example of how West Coast thinking can recast Wall Street.
At the dawn of this decade, most firms providing clearing services to broker-dealers charged high single-digit dollars per trade or more. Then, in 2002, Wedbush began to charge a fraction of a cent per share to its high-frequency trading customers. The concept matched the per-share pricing models of the electronic exchanges and electronic communication networks those customers favored.
Banking on the increasingly automated clearing and settlement process it was creating, the firm reasoned that low fees would ramp up volume and profits would follow.
Wedbush, a multi-faceted investment bank and brokerage, set out to reorganize and streamline the clearing process, handling them electronically and with as little human intervention as possible. Manual processes would be eliminated, risks reduced. And speed gained.
Transferring data was key. One core function Wedbush outsources, for instance, is trade processing. That is handled by Thomson Reuters' Beta Systems. But Wedbush set out to make that more efficient, too.
At the time, Beta's reconciliation process created thousands of pages of reports to review for items such as trade breaks. Wedbush first worked with Beta to find ways to summarize those reports--on paper--more efficiently. Then, as the volume of its trades grew, the firm shifted to exchanging files in electronic format with Beta. To speed up the process further, Wedbush worked out an agreement to receive trade-related data such as the final price and number of shares involved directly from the National Securities Clearing Corp., the industry utility that centrally settles trades. Before, the data would first go to Beta.
"The more middlemen you take out of operations, the more you reduce costs and risks. And when those processes are in-house, we know exactly what we need and can get just the right answer to solve problems," says Jeff Bell, its head of clearing.
The focus on efficiency was radical. In the 1990s and at the start of this century, the New York Stock Exchange still ruled the roost. Brokers enriched themselves on wide spreads providing fat fees. Fully disclosed clearing firms, which historically have been concentrated in the New York area, made their money by managing the books and records for broker-dealer correspondents, putting their own capital at risk in the trade reconciliation process and generating the related trade confirmations and statements.
Wedbush's lower fees and efficient, electronic processes attracted early customers that also expected to capitalize on increasingly electronic market centers.
They included so-called blackbox proprietary trading firms, such as Tradebot and Getco. These firms, now known for high-frequency trading, used computer algorithms to execute huge volumes of orders over Nasdaq--then the only fully electronic exchange.
So it was no surprise that David Cummings, who ran Tradebot, chose Wedbush to clear trades over BATS Trading, an electronic network he began in January 2006 that offered extremely aggressive pricing to broker-dealer customers. By the time it was approved to become an exchange last fall, BATS had captured upwards of 12% of executions in Nasdaq- and NYSE-listed stocks.
Cummings and later Joe Ratterman, who replaced Cummings as president and CEO in June 2007, have railed against the more established exchanges in their letters to customers over the years. They frequently criticized what they saw as excessive fees. BATS' extremely aggressive pricing model, largely due to its low clearing fees, is credited with pressuring Nasdaq and other exchanges to sharply cut their execution fees. Nasdaq's fee and rebates were respectively $0.0030 and $0.0020 when BATS started, and since then it has progressively narrowed that spread by raising the rebate or lessening the fee. In fact, the latest rebate on its fee schedule for the highest volume customers is actually more than the fee.
