The stock brokerage industry has seen a radical change in the last few years. It is no longer restricted to professional traders sitting in front of offwhite computers all day buying and selling stocks. With the advent of technology, stock brokerage firms today have metamorphosed and are available to the masses. This blog will look at the history of brokerage firms in the US.
For centuries, stock brokerage firms have been an integral part of the securities industry. Brokers leverage many systems to help investors purchase and sell stocks and bonds in several markets.
From local coffee shops, brokerage firms have evolved into massive organizations impacting the entire financial system. The early twenty-first century also saw a proliferation of online trading, enabling retail investors to participate in the stock markets without location constraints seamlessly.
The history of brokerage firms reveals the change in the preference of the entire retail investor community. It also reflects how the democratization of stock investing, shift towards technology, and policy changes have entirely transformed the brokerage business. So, let’s dive in and look at all the events that have shaped the history of brokerage firms.
Brokerage Houses In Ancient Times
During the 11th century, the French began to regulate and trade agricultural debts on behalf of the banking community, which everyone considered the first brokerage system.
In the 1300s, major cities like Flanders and Amsterdam saw commodity traders holding meetings in houses. In the following years, many Venetian brokers started trading in government securities, thus expanding the business of brokerage firms.1
1602: Dutch East India Company
The Dutch East India Company was the first to issue equity shares of its business and offered them to the public. Officially, it was the first company to conduct its first IPO. Established on March 20, 1602, as a Government chartered company to trade with Mughals of South Asia, the Dutch East India Company was one of the earliest forms of a vertically integrated company. Its formation laid the foundation for equity trading, which is critical to the brokerage industry.
Stocks back then were in certificate form and traded through brokers on streets or coffee houses. A seller could request the broker to get his stocks listed, later disseminated through mailers or bulletin boards. Interest stock buyers could meet the broker at a designated place and pay the necessary price. The broker would then transfer the proceeds minus his brokerage fees to the seller. The share certificate would be in the broker’s custody until the sale.
1698: Jonathan’s Coffee House
In the late 1600s, companies began to borrow money, and this was when the formation of joint-stock companies started. The stockbrokers initially used the Royal Exchange as the meeting point; however, as the congregation became very large and “rowdy,” the government regulations mandated them to move out. Most of them moved to coffee houses, particularly Jonathan’s Coffee House.
Jonathan’s Coffee house, or the original London Stock Exchange, was a favorite of businessmen in the 17th century. It was started by Jonathan Miles in the City of London. It was a bustling node of commerce where John Castaing used to post the prices of commodities and stocks. After the South Sea Bubble of 1745 and a fire in 1748 in which the coffee house was gutted, it was rebuilt. In 1761, more than 100 brokers and jobbers used the place to trade securities.
1792: The Buttonwood Agreement
The Buttonwood Agreement was an essential landmark in the history of brokerages. It led to the formation of the New York Stock Exchange and the American investment community or the ‘Wall Street’. This agreement was signed between Twenty-four stockbrokers and merchants on Wall Street in New York City.
The Buttonwood Agreement was an essential landmark in the history of brokerages. It led to the formation of the New York Stock Exchange and the American investment community or the ‘Wall Street’. This agreement was signed between Twenty-four stockbrokers and merchants on Wall Street in New York City.
The policies of the Buttonwood Agreement were based on existing European trading systems during the time. The agreement’s objective was to foster trust in the method wherein the brokers and merchants would only trade among themselves and charge a predetermined commission for their services. Other exclusive terms and conditions also applied to the agreement between brokers.
The number of New York brokers had expanded by 1793, and their new center of operation shifted from under the Buttonwood tree to the Tontine Coffee House.
1799: The Manhattan Company (JP Morgan)
1799 was when the foundation of the iconic JP Morgan Asset and Wealth Management Company was laid through The Manhattan Company, founded by Aaron Burr. Traditionally established for supplying drinking water to the city’s population, the company began to use its surplus capital for banking operations as allowed under the charter.
Within a few months, The Bank of The Manhattan Company opened for business and became the second commercial bank in New York City after Hamilton’s Bank of New York. Over centuries, the firm was remodeled by American Financier John Pierpont Morgan, and it evolved into the JP Morgan that we know today as one of the largest investment banks.2
1840-1900: Communication Technologies
The Buttonwood tree and coffee houses became redundant after 1844, as investing wasn’t bound by time and place anymore. A slew of inventions in communication technology revolutionized the operations of financial institutions.3
Telegraph in 1844, the transatlantic cable in 1866, and the telephone in 1876 changed the way information was exchanged and opened new doors for new trading opportunities. Communication between markets was more immediate, which allowed for more appropriate pricing and increased market efficiency, size, and available information.
1914: The Launch Of Merrill Lynch
On January 6, 1914, Charles E. Merrill founded the company Charles E. Merrill & Co. After a few months, he was joined by his friend, Edmund C. Lynch, thus officially forming the Merill Lynch Company.18
In a few years, the company focused on investment banking; hence it spun off its retail brokerage business to E. A. Pierce & Co in 1930. led by Edward A. Pierce, Edmund Lynch, and Winthrop Smith, E.A. Pierce was the largest brokerage in the US. It introduced IBM machines for the business’ record-keeping and controlled a private network of over 23,000 miles of telegraph wires for placing orders.
Despite this, by 1938, E. A Pierce began to struggle financially due to low capitalization and eventually merged back into Merill Lynch in April 1940.
1934: The Securities Exchange Act
President Roosevelt’s administration enacted a new set of laws five years after the 1929 market crash regulating trades within the stock market to curb financial crises in the future.
As many believed that reckless practices were responsible for the crash, in 1934, the Securities Exchange Act created a new regulatory body called the Securities and Exchange Commission (SEC).4
The primary objective of this body was to promote accuracy, transparency, and fair practices and stop financial fraud within the securities markets.4
1946: The Launch Of Fidelity
Launched in 1946, Fidelity is one of the largest financial services companies in the world. Edward C. Johnson II founded the Fidelity Management and Research Company, now Fidelity Investments, to serve as an investment advisor to the Fidelity Fund. Fidelity Investments operates as a major brokerage firm and has investor centers in over 140 locations throughout the US.5
1966-1970: The Struggle With Technology Adoption
A series of events in the late 1960s transformed the securities industry. Trading volume rose sharply, with the number of transactions on the New York Exchange jumping from five million per day in 1965 to twelve million per day in 1968.6
Historian Wyatt C. Wells in his work, Business History Review, mentioned that this expansion was too overwhelming for the physical system that brokers used for transferring and record-keeping of the securities.7 They began to resort to computers; however, these devices were quite expensive and demanded heavy maintenance and advanced management. Consequently, many brokerage firms couldn’t keep up with a sudden increase in the pace of transactions and faltered.
The only digital trading system that the brokers used in 1969 was electronic communications networks (ECNs), which helped display the bid and ask prices for stocks in-house.8
As a result, trading volume saw a sharp decline between 1969 and 1970, adversely impacting the brokerage revenue. By the end of 1970, these factors pushed about a sixth of American brokerages to shut shops.
1975 May Day: No Set Fees; Entry Of The Discount Broker
Until May 1, 1975, the traditional 2% fixed commissions posed a big challenge for the financial industry.9 The Federal Trade Commission, led by Chairman Paul Dixon, had been pressuring the SEC since 1968 to outlaw the fixed-rate commission as an anticompetitive practice. Finally, in 1975, the SEC deregulated its 183-year-old fixed commission rates as the high costs of trades deterred more significant public participation.
1975 was also when discount brokers like Charles Schwab and TD Waterhouse entered the markets. As a result, public participation in the stock market reached record levels., with nearly 25% more consumers directly or indirectly owning stocks within the first five years alone. Within the next few years, commissions averaging over $0.80 per share in the early 1970s plunged to just about $0.04.
1982: NAICO-NET Trading System
By the late 1980s, the financial industry realized the importance of the internet and public computer.10 While most brokerages were already familiar with ECNs; several stock brokerage firms began to either develop software or purchase software companies so that stock traders could provide stock price information quickly and match buyers with sellers easily with massive cost savings.
By 1982, NAICO-NET, the first full-service electronic consumer equity trading system, was launched by North American Holding Corp. located in East Hartford, CT. This system was used for trading stocks, mutual funds, and commodities using an online PC. This implies that the system was ANSI or terminal-based, but IBM PCs could connect to it using a simple application connecting traders globally.11
Pershing Corp. (Donaldson Lufkin & Jenrette) directly received the online trades for high-speed clearing. NAICO-NET could connect trades so quickly that the spread—the difference between the buy and ask prices—went down significantly. The spread was where most brokers made their money, so keeping the spread thin was not appealing to brokerage firms. The cost of running NAICO-NET was not a selling point, either. The software licensing fee was prohibitively expensive.
1885-1996: The Upsurge Of Online Brokerage
TradePlus was one of the first brokerages to adopt online stock trading, and in 1985, it offered an online retail trading platform on America Online and Compuserve. In 1991 TradePlus’s co-founder William Porter formed a new subsidiary called E*Trade Securities, Inc.11
In 1995, TD Ameritrade acquired K. Aufhauser & Company, Inc. and its WealthWeb, a platform that had started offering online stock trading in 1994. Charles Schwab emerged as another strong online stock trading provider in the late 1990s. They started offering online trading activity in 1995, with total asset management worth $181.7 billion.
Scottrade.com launched its online portal in 1996 and gained a lot of popularity in 1998 when it offered online trades with a low commission rate of $7 per trade.
1989: Morgan Granted Equity Underwriting Powers
1985 Chase Manhattan Bank introduced a Spectrum home banking service that offered three tiers of service: core banking, financial planning, and investing.2
In 1989, after the Glass-Steagall banking laws separated commercial and investment banks’ activities, US Federal Reserve granted J.P. Morgan & Co. the right to underwrite and deal in corporate debt securities. After a year, JP Morgan became the first US bank holding company to offer its clients a full range of securities services.
2010-2013: Mobile Trading And The Robo-Advisor
The past decade witnessed unprecedented advancements in technology, and two of them were the rise of smartphones and Robo Advisory. According to Gartner, global mobile device sales to consumers were over 1.6 billion units in 2010, indicating a 31.8% rise from 2009.12 Talking only of smartphones, their sales to consumers climbed 72.1% from 2009. This ushered in a change in the user experience and the rise of mobile investing.
E*Trade Financial Corp revealed that the share of its 3 million mobile trading customers climbed from 6.5% in 2012 to 8.4% in 2013, while Fidelity Investments saw a 63% jump in trading from mobile and tablets.13 Robo advisors were the other significant change that the brokerage firms witnessed after the stock market crash in 2007-2008. In 2010, Jon Stein launched Betterment, and Robo-advisors shot to prominence. After this, WealthFront, Future Advisor, and Personal Capital joined the tribe.
Such firms charged lower fees, offered more flexibility in trading, and had intelligent automation driving them. Most Robo-advisors leverage passive indexing strategies and provide advanced services like tax planning, retirement planning, and portfolio rebalancing.
Many feared that the advent of Robo advisors would push traditional brokerage firms out of the market, but that didn’t happen. Every human being’s financial situation is different, and algorithms have limitations of not customizing things beyond an extent.
2020: Covid-19 And Brokerage Firms
The pandemic has contributed to the rise in interest among retail investors. Due to additional cash and ample time at hand during a lockdown, millions embraced stock investing. According to Deloitte, In January 2021 alone, close to six million Americans downloaded a retail brokerage trading app, whereas over 10 million opened a new brokerage account in 2020.14
After working remotely for over a year, the broker-dealer’s self-regulatory body requested the Financial Industry Regulatory Authority (FINRA) for remote supervision instead of a physical one. They also asked the authority for increased adoption of digital signatures and more online licensing examinations.15
2020: Charles Schwab Acquires Ameritrade
In October 2020, Charles Schwab acquired TD Ameritrade in a deal worth $22 billion. The objective of the acquisition was to form one of the biggest online brokerages with nearly $6 trillion in client assets from 28 million brokerage accounts. Schwab aimed to integrate TD Ameritrade’s award-winning thinkorswim® and thinkpipes® trading platforms, educational resources, and tools into retail offerings.16
The Bottom Line
Over the decades, advancement in the brokerage industry has brought more investors into the markets. With the technological progress of each passing day, the stock brokerage firms brace for more developments.
The tools and opportunities available to the modern-day retail customer were unthinkable in the 17th and 18th centuries. This has made the investor so empowered that it has impacted the dominance of stockbrokers and related industries.
Wakefield Research predicts that there will be more consolidation among smaller players in the stock brokerage industry, and only a few big ones will rule.17 This phenomenon might also create barriers for new entrants. Wakefield also stated that the brokerages are likely to focus more on customer service and technology adoption instead of fees.
Sources: 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18
