BUSINESSWEEK ONLINE : NOVEMBER 20, 2000 ISSUE
BUSINESS WEEK E.BIZ -- NET WORTH

Rage against Online Brokers
Complaints are soaring despite repeated pledges to make customer service Job One

Morgan K. Roach thought he had made a small killing in the stock market. In August, 1999, the software programmer logged on to online broker E*Trade Group Inc. ( EGRP) and bought options worth 4,200 shares of America Online Inc. ( AOL) for an average price of $80. A few hours later, he put in an order to sell his stake for $95 a share. The result: A tidy profit of $8,510.

Except the trades never happened that way. Instead, Roach charges, E*Trade bought his shares for $8 a share more than his order called for, yielding a loss of $23,188. The screw-up was so bad that E*Trade not only froze Roach's account but his wife's IRA account, as well.

Repeated attempts to get E*Trade to correct its blunder proved futile. In December, he sued the online broker. ''The error was theirs, and they could have corrected it,'' says Roach, who on Oct. 26 won $38,226 to cover his losses and expenses. ''But E*Trade just stonewalled me.'' E*Trade says it believes the award is unwarranted because Roach's self-directed account made him personally responsible for the action.

This is no isolated case, however. In fact, complaints against Internet brokerage firms are soaring--despite repeated pledges from firms such as Ameritrade ( AMTD), Charles Schwab ( SCH), TD Waterhouse ( TWE), and E*Trade to make customer service Job One. A study released in late October by the Securities & Exchange Commission reveals that 4,258 complaints, including messed-up trades like Roach's as well as problems getting into accounts, were lodged against online brokers for the 12 months ended Sept. 30. That's almost four times the level from 1998--a rate that exceeds the number of new online brokerage accounts in the same period.

That trend not only angers customers, who claim they're collectively losing millions of dollars thanks to the problems. It also has the government up in arms, ready to step in. Even before the new report, the SEC on July 28 proposed a new rule to require brokers to make available to the public monthly reports on how well they're executing trades. Moreover, they would have to tell customers on request where their orders were routed so they can track what went wrong. ''Even though that's only one of the proposed rules,'' warns SEC spokesman John D. Heine, ''it certainly doesn't exhaust the possibilities.''

For their part, the brokerages say they are improving all the time and they deserve credit for pouring more money into bettering their infrastructures and customer-service operations. E*Trade, for instance, has reduced the amount of time it takes for a customer to get a call answered, from 77 seconds a year ago to 28 seconds today. E*Trade Chief Executive Christos M. Cotsakos admitted in a recent conference call with analysts that the company's customer service has been lacking. But he insisted: ''Over the past year, our customer-service staff has gotten more experienced.''

Other brokers are starting to get the message, too. Ameritrade Inc. says it halted all of its costly ad spending for five months starting in March when it became clear that it was growing faster than expected. ''We rebuilt our technology, our call centers, and added hundreds of customer associates,'' says Ameritrade President Jack R. McDonnell. Frank J. Petrilli, president and chief operating officer at TD Waterhouse Group Inc., boasts a 47% increase in spending on his infrastructure this year, to $48.1 million. That has gone into retooling the Web site to make more account data available online, as well as 12 new branches and two new call centers in the past year. ''Our hold time for each phone call is not even 10 seconds,'' says Petrilli.

Those are certainly steps in the right direction. But industry experts say they don't go far enough. Online brokers remain far too willing to sacrifice customer service, they say, in favor of capturing new customer accounts or building up their brands. ''They're learning at the public's expense, and that's not right,'' says securities expert Douglas J. Schulz, from Invest Securities Consulting of Westcliffe, Colo., who has accounts at six different firms.

Why are customer-service problems getting worse now, years after most online brokers started? Those who follow the industry attribute these problems to teething pains in a business that continues to grow rapidly. ''Anytime an industry grows this fast, you're bound to see problems,'' says Matthew L. Vetto, Internet financial services analyst at Salomon Smith Barney. ''But the brokers have now acknowledged their problems and are making efforts to deal with them by spending on technology for voice recognition automated service and hiring heavily to build customer service.''

Problem is, it's all too little, too late for customers--or the government. The latest SEC filings show most online brokers still spend far more on building brand and acquiring new customers than on improving customer-service operations. Ameritrade, for instance, spent $26.3 million in the first nine months of its fiscal 2000, or 102% more than last year, on customer-service related items. But some $157 million went into advertising in the same period, up 343% from the previous year.

The same goes for E*Trade, which in the nine months ended in June hiked marketing-related investments by 84% from a year ago, to $422.2 million. Spending on technology to improve customer service rose at a slower rate, 79%, to $366.5 million.

Indeed, the customer-service problem is largely a reflection of too few dollars spent to make the trading systems handle the load of customers they've tried so hard to attract. Truc Hoang, of Westlake, Ohio, for instance, is suing E*Trade, claiming she lost money last February because E*Trade's site went down, delaying her trades and causing the block of stock she wanted to buy to become $10,000 more expensive. When the trades were finally executed, too late, she lost $40,000, says her attorney, David Webster, who hopes to turn the case into a $20 million class action suit.

Shabby treatment. The problems extend beyond site performance issues that delay trades or execute them at the wrong time. More and more customers are unhappy that they cannot contact a broker when they need to. And when they do get through, they find that the representatives don't know enough to answer queries. ''They're putting inexperienced people on phones in charge of complaints, which gets unhappy customers even more frustrated,'' grouses Schulz.

Take Ali Lee Khadivi's case. A software designer from San Jose, Calif., Khadivi says he placed an order to buy 1,000 shares of Perot Systems Corp. in February, 1999, at $71. Shortly afterward, Khadivi decided ''it wasn't such a good buy,'' so he canceled the order. E*Trade executed it anyway. Khadivi called as soon as he saw the trade and several times later, but was bounced around and didn't get a clear response. ''They treated me like I was someone stupid and like I didn't know what I was doing,'' he says.

Worse yet, the stock plunged, E*Trade sold his holdings, and then tried to settle by offering him $1,500. Khadivi says he declined the offer, and soon after, E*Trade liquidated his account. ''They then reported me to a credit bureau and a collection agency,'' he says. At that point, he sued E*Trade and after 14 months won the case when the National Association of Securities Dealers ordered the online broker to shell out $61,203. E*Trade declined to comment, but said at the time that although it disagrees with the judgment, it would comply.

Online brokerage firms claim they're already spending a lot of money on technology to prevent these problems. Indeed, Charles Schwab & Co.'s third-quarter earnings report shows that capital expenditures reached record levels. ''Marketing levels were down, and it appeared that it was spending on its underlying infrastructure and equipment to enhance efficiencies,'' says Gregory W. Smith, online brokerage analyst at Chase Hambrecht & Quist.

How much more brokers can afford remains in doubt, however. The customer-service woes come at the worst possible time for online brokerages, which are reeling from the impact of a shaky stock market. Overall, online trading volume fell more than 20% in the second quarter and an estimated 13% in the third quarter. As a result, the stock prices of most online brokerages have tumbled in the past year and are now mired around their historic lows. E*Trade has seen its shares drop more than 80% from its peak of $72 in 1999. Ameritrade, at $15 a share, is off 36% for the year. TD Waterhouse Group has lost 45% of its value since its launch last year.

The problem is that at the same time customers are clamoring for better service, investors are demanding profitability first and foremost. To get there, online brokers must spend a lot to get new revenue streams from other types of financial services, hoping to become a one-stop shop for consumers.

E*Trade, for instance, is diversifying its revenue streams into insurance and banking by acquiring other companies like Telebanc Financial. ''E*Trade has put a lot of coals in the fire--the near-term costs are high, but the potential for future returns could be good,'' says Salomon's Vetto. Ameritrade, meanwhile, has joined with MBNA Corp. ( KRB) to issue credit cards and has allied with NetBank for banking. And discount broker Schwab is now moving upstream, hoping to mine wealthy clients with its acquisition of U.S. Trust Corp.

Still, none of that will pay off if online brokerages don't fix the problems in their core businesses. For customers and their advocates, the prescription is clear: ''They've got to slow down opening new accounts,'' says Schulz. ''It's unfair to clients, and it's not sound business practice.''

Indeed, customer dissatisfaction can be particularly damaging for Internet companies. Customers can quickly spread the word--good or bad--to hundreds or even thousands of others with a click of the mouse. Even E*Trade's Cotsakos admitted in a recent analysts' conference call, ''The best marketing tool is high-quality service.'' Now, he and other online brokers must start using it.

By PALLAVI GOGOI

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