A.B. Watley Group Inc.

40 Wall Street
New York, New York 10005
U.S.A.
Telephone: (212) 422-1664
Toll Free: (888) 229-2853
Fax: (212) 634-9924
Web site: http://www.abwatley.com

Public Company
Incorporated: 1958 as A.B. Watley, Inc.
Employees: 144
Sales: $42.75 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: AB WG
NAIC: 51121 Software Publishers; 52312 Securities Brokerage

A.B. Watley Group Inc. is a Wall Street securities brokerage firm that provides retail and corporate customers with direct-access electronic trading capabilities by means of its proprietary technology. As a direct-access broker, the company, instead of merely taking orders and executing them, offers its customers direct connections to the NASDAQ exchange by means of market makers or electronic communications networks. With the decline in business stemming from the end of the Wall Street bull market in 2000, A.B. Watley’s losses mounted, and it began seeking to license its financial services technology as an added source of revenue.

Online Trading Pioneer: 1997-98

A.B. Watley, Inc. was founded in 1958 and functioned as a traditional brokerage firm until January 1997, when all the capital stock was purchased by Internet Financial Services, Inc. This company was founded in May 1996 by Steven and Robert Malin, primarily to serve the investors known as day traders: individuals or institutional clients such as professional money managers who sought to profit from small price movements in active stocks, making as many as 100 trades a day and usually closing out their positions at day’s end. The day-trading industry dates from 1988, when federally imposed rules were changed to allow individual investors to execute trades more easily on the NASDAQ exchange. The execution of such trades was enhanced in 1996, when new rules allowed the creation and operation of electronic communication networks, which permitted anyone with a connection to such a network to see all the bids and offers posted into the system for any NASDAQ-traded security. Internet Financial Services was one of many firms that sprang up in the mid-1990s with the intention of tapping this market by offering customers instant access to and information about stocks traded on the NASDAQ exchange.

The purchase of A.B. Watley gave Internet Financial Services a client list and a license to trade on the NASDAQ exchange since Watley, a registered broker-dealer, was a member of the National Association of Securities Dealers, Inc. Internet Financial Services began offering online trading to its customers over the Internet in March 1997. On its corporate web site it provided trading access and research and portfolio services. Its UltimateTrader proprietary software, according to Edward H. Baker of Financial World, turned “customers’ computers into fullblown trading stations” at a cost of $300 a month plus per-trade charges. UltimateTrader was not intended for the occasional investor but for the hyperactive trader who might make ten or 20 trades a day, perhaps all on the same stock. “Its most revolutionary feature,” Baker wrote, “is its ability to show traders exactly where the market is: who’s bidding how much, who’s asking how much, and at what prices trades are being made when. When you put in a bid on this system, you actually become part of that market.” The system only reached its full potential, however, with securities listed on the NASDAQ exchange, since the New York and American exchanges still relied on floor trading.

UltimateTrader users were not actually buying and selling directly on the NASDAQ exchange, although what they saw was the same as the firm’s own personnel were seeing on their own computers. The order appeared on the NASDAQ system as being placed by A.B. Watley, the subsidiary that functioned as Internet Financial Services’ trading arm, or by a market maker of the customer’s choosing. A confirmation of the trade appeared within one second, and the client’s account was automatically deducted in the event of a purchase. The company’s subsequent technology upgrades allowed customers direct access to exchanges and electronic communication networks.

Day-Trader’s Mainstay: 1999-2000

Internet Financial Services accumulated $4.53 million in revenues in fiscal 1997 (the year ended September 30, 1997) and sustained a loss of $1.06 million. Its revenues doubled to $9.12 million in fiscal 1998, and its net loss dropped to $632,410. Among its 1998 expenses was the initiation of an advertising campaign expected to cost about $5 million. The following year Internet Financial Services became, in April, the first brokerage firm specializing in day trading to go public. It raised $12.7 million by selling about a quarter of its outstanding shares of common stock at $7 a share. The company changed its name to A.B. Watley Group Inc. in September 1999. Benefiting from the NASDAQ bull market, the stock quickly rose to $23 a share before retreating to about $11 a share. A.B. Watley’s revenues more than doubled in fiscal 1999, rising to $20.99 million. It sustained a net loss of $801,602.

Theresa W. Carey of Barron’s gave UltimateTrader high marks in March 1999, when the financial weekly rated A.B. Watley seventh among 22 online brokers for such qualities as trade execution, reliability, and range of services. “Ultimate Trader,” she wrote, “was one of the first to exploit the Internet while avoiding the drag of the World Wide Web (a/k/a the World Wide Wait).” Watley Vice-President Anthony Huston told her that the firm was targeting the elite, high-end day trader. “We’re going after the top 2 to 5 percent of the market,” he said, “those with the time to learn and understand the software; above-average assets; above-average understanding of the markets; comfortable with new technologies; and a willingness to pay for data and trade-related services.”

A.B. Watley also was offering client support between 8 a.m. and 8 p.m., with a staff that reached 45 in 2000. Its range of services through third-party relationships included unlimited check-writing, Visa credit cards, and access to more than 5,000 mutual funds. For institutional investors, a sales and trading desk facilitated and/or executed large-block transactions in about 500 thinly traded equity securities for clients who wanted such off-exchange transactions to remain anonymous. A.B. Watley earned about 22 percent of its fiscal 1999 revenue and 19 percent of its fiscal 2000 revenue from the activities of this desk.

In September 1999 A.B. Watley announced the creation of UltimateTrader Free. Available to clients who maintained an average cash balance with the firm of $20,000, it provided NASDAQ Level II real-time stock market quotes at no cost rather than the usual $20 to $50 a month, depending on the provider. It also included the usual extras, such as updated charts, positions, and buying power, and portfolio monitoring. Without this plan, there was a monthly fee ranging up to $200, depending on the number of trades placed. The company’s commission per trade varied from $12.95 to $23.95, depending on level of service and trade frequency. Some 71 percent of A.B. Watley’s fiscal 1999 revenues came from UltimateTrader charges. Another 3 percent came from Watley Trader, a recently introduced web-based rather than software-based version of the UltimateTrader platform. The introduction cut the firm’s expenses because Watley Trader was cheaper to operate than UltimateTrader, according to a company spokesman.

A.B. Watley more than doubled its revenues in fiscal 2000. Of total revenues of $42.75 million, commissions accounted for 77 percent; principal transactions for 13 percent; data service revenues for 5 percent; and interest and other income for 5 percent. Expenses rose even faster, however, and the company sustained a net loss of $9.85 million. It had about 11,000 retail customers at this time. In October 2000 A.B. Watley was replacing its Windows NT servers for its platform with Sun Microsystems servers, which the company said would be more scalable and reliable for users. Huston—now the company’s president—said the firm had spent about $25 million since 1996 on technology developed in-house. This included the UltimateTrader II version of the company’s platform, introduced in fiscal 2000. UltimateTrader II was said, by December 2000, to have already saved the firm $14.4 million per year because it was developed in-house and eliminated the need to pay fees to vendors.

A.B. Watley began marketing its direct-access technology in August 2000. Three months later, it licensed a service for active traders to E*Trade Group, Inc., with the potential, the company said, of reaping $3 million a month in revenue for the firm for three years. The bear market that began earlier in the year had seriously affected trading volume on Wall Street, but the number of full-time day traders was said to have held steady, at about 50,000, and they were said to have raised their activity by 55 percent, to an average 44 trades per day, according to a Bear Stearns & Co. Inc. analyst. Steven Malin maintained that A.B. Watley was the only firm able to provide a web-based system for active traders that could be scaled up for use by hundreds of thousands of traders. License fees were seen as a necessary means of raising revenue for Watley, which laid off 28 employees—20 percent of its workforce—in February 2001.

Coping with the Bear Market: 2000-01

Sagging revenues and higher operating losses took a heavy toll on the value of A.B. Watley’s common stock, which reached a peak of $28.25 a share in March 2000. In an April 2001 private placement, the company sold more than two million shares at $5.50 a share for total net proceeds of $10 million. Earlier, in August 2000, an investment group had provided the company with an 18-month cash-for-shares credit line of $48 million, which A.B. Watley tapped to the extent of $2.85 million a month later. A.B. Watley purchased a struggling rival, On-Site Trading Inc., in November 2001 for about $5.6 million in stock, and it also assumed $1.8 million in On-Site’s debts. Founded in 1994, On-Site Trading had 27 offices, primarily in the East, and was supporting about 1,300 active traders.

Company Perspectives:

Our goal is to provide the highest quality trading technology and service at the lowest possible cost.

During the first nine months of fiscal 2001 ending at midyear, A.B. Watley’s revenues fell 37 percent compared with the same period in 2000. Its net loss more than tripled during this period. The company had about 12,100 retail customers at midyear, but the number of UltimateTrader clients had fallen 36 percent from midyear 2000, to 2,036. Total billed transactions were also down by 36 percent, to 750,756. In July 2001 A.B. Watley lowered its monthly flat fee for active traders and reduced the minimum balance for this program to $5,000. It also cut its standard commission per trade by as much as 75 percent. The company, in late 2001, required a $10,000 deposit to open a flat-fee UltimateTrader II account; the minimum balance needed to maintain the account was now only $2,000. Transaction fees for this program ranged from $17.95 each for 1 to 49 trades per month to $8.95 each for 750 or more trades per month. There was no monthly maintenance fee for 20 or more trades per month; below this level, the fee was $50.

In December 2001 A.B. Watley’s common stock was trading for only $2 to $3 a share. Steven Malin, the chairman and chief executive officer, owned 20 percent of the company’s common stock in June 2001. Robert Malin owned 8 percent. Linda Malin, their sister and the firm’s general counsel, owned 9 percent.

Principal Subsidiaries

A.B. Watley, Inc.

Principal Divisions

Electronic Products Division; Institutional Sales and Trading Division.

Principal Competitors

Charles Schwab & Co., Inc.; Datek Securities Corp.; E*Trade Group, Inc.; Fidelity Brokerage Services, Inc.; Quick & Reilly, Inc.; Waterhouse Securities, Inc.

Key Dates:

1997:

Steven and Robert Malin purchase securities broker A.B. Watley Inc. and begin offering online trading to its customers.

1999:

The brokerage firm becomes the first day-trading specialist to offer shares to the public.

2000:

A.B. Watley licenses direct-access technology to E*Trade Group, Inc.

2001:

The bear market has seriously eroded A.B. Watley’s revenues.

Further Reading

“A.B. Watley Intros Flat Fee,” Financial Net News, July 23,2001, p. 3.

“A.B. Watley Preps Web-Based Direct Access Platform,” Financial Net News, November 27, 2000, p. 6.

Baker, Edward H., “Video Games,” Financial World, April 15, 1997, pp. 108, 110.

Basso, Peter, “A.B. Watley Improves Direct Access,” Wall Street & Technology, October 2000, p. 28.

Carey, Theresa W., “Growing Pains,” Barron’s, March 15, 1999, pp. 30-31, 33.

—, “Online Ardor Cooling,” Barron’s, September 27, 1999, p. 66.

Gandel, Stephen, “On-line Broker Goes More B-to-B,” Crain’s New York Business, March 5, 2001, p. 42.

“Online Mergers: Yak Yak Yak, “IDD/Investment Dealers’ Digest, November 19, 2001, p. 48.

Schwartz, Nelson D., “Can’t Keep a Good Day Trader Down,” Fortune, February 19, 2001, pp. 148-50.

Smith, Geoffrey, “Day of Reckoning for Day-Trading Firms?,” Business Week, January 19, 1999, p. 88.

—Robert Halasz