Profitless Prosperity

From all outward appearances, Manhattan's Wall Street, Chicago's La Salle Street, San Francisco's Montgomery Street and other financial districts should be cheerful places. Since the beginning of the year, the Dow Jones industrial average has repeatedly bounced to near-record levels, propelled largely by recurrent talk of peace in Viet Nam. Though stock prices remained relatively flat after last week's news of a tentative settlement between Hanoi and Washington, many market analysts still hope that the Dow will quickly pierce the magic 1,000 mark once a Viet Nam cease-fire is actually signed. In fact, though, worried frowns are prevalent among officers of many of the 3,740 U.S. stock-brokerage firms. They have made money for many clients, but precious little for themselves.

While profits of most other businesses have been booming (see following story), average monthly earnings of brokerage firms from January through August dropped 20% below a year earlier. Some of the best-known firms have suffered even more. In the most recent quarter, Weeden & Co.'s earnings fell 61%, and Hayden Stone barely broke even. Salomon Bros. net for fiscal 1972 (ended Sept. 30) was down 33%. In the past ten months, 33 brokerage firms have failed and another 18 are being watched closely by the New York Stock Exchange lest they fall below minimum capital requirements. So far this year 221 other brokerages have disappeared through mergers or simply closed their doors. Most galling of all, perhaps, stock in such well-known securities firms as Merrill Lynch, Dean Witter, Bache & Co. and Reynolds Securities are all selling at about half their 1972 highs.

The troubles so far scarcely compare with the bloodbath of 1969-70. Safeguards exist now that did not then:

> Brokerage houses have automated most of their backshop operations, breaking the paperwork jams that tangled the industry then. For example, stock certificates, which had to be sorted and hand-delivered from one brokerage house to another after each transaction, have largely been replaced by electronic entries in computers.

> Many firms now raise permanent capital by selling their own stock to investors. In 1970, most were dependent on capital contributed by partners, who could and sometimes did pull out their money at the first sign of trouble, thus precipitating the very crisis they feared.

> Most important to investors, the Government in 1970 set up the Securities Investor Protection Corp. to pay off customers of brokers who go bust. S.I.P.C., which insures investments up to $50,000, already has paid out $9.8 million to investors who otherwise would have lost their money.

The standard excuse for the present difficulties is low volume. In reality, trading on the New York Stock Exchange, the nation's dominant market, has been running ahead of a year ago (see chart). Explanation: the brokerages have not themselves been instituting the vigorous cost-cutting programs they acclaim for companies whose stocks they recommend to clients for purchase. Many firms last year opened new branch offices and expanded their sales staffs. As a result, officials of the New York Exchange estimate, member brokers break even only when daily volume averages a high 14 million to 15 million shares, v. 12 million only two years ago.

Brokers have also been suffering from their own haughty disregard of small investors. For years, many discouraged business from individuals who wanted to buy a few shares and courted "institutions" that buy or sell in huge blocks, such as mutual funds, pension funds and bank trust departments. That approach made sense when all commissions were fixed. Executing a 10,000-share trade cost a broker proportionally no more than handling a 100-share trade, but the commission typically would be almost 58 times as large.

Last year, however, the New York Exchange, under pressure from Washington, ordered brokers to negotiate commissions on trades worth more than $500,000--that is, the brokers could charge only what the customers were willing to pay. Last spring the minimum was lowered to $300,000. Cutthroat competition on big trades will cost the industry around $80 million in commissions this year. Meanwhile, the industry has been all too successful in turning away small investors, who still pay fixed commissions. A decade ago, small investors accounted for two-thirds of all trades on the Big Board, but they figure in only one-third of all transactions today.

Some firms are now making major efforts to win back the individual investor. Merrill Lynch, for example, is sinking millions yearly into bullish ads on TV aimed at luring the small investor's dollar out of savings accounts and the like. It is possible that the brokers will be bailed out temporarily, through no great acumen of their own; a Viet Nam cease-fire could indeed start the surge in trading volume and renewed public interest in the market that they need. For the longer run, though, brokers must emulate the close watching of market trends and transaction costs that they urge on the managements of the companies whose stocks they appraise.

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