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Datek Online Holdings Corp. is the holding company for Datek Online Brokerage Services Corp., one of the nation's busiest online brokers, which is known for low rates and speed of execution. Its other subsidiaries include a clearinghouse for trades and a developer and marketer of software for brokerage and trading firms, while an affiliate has created an electronic communications network for the same purpose. Throughout the 1990s the company was the subject of repeated regulatory and criminal investigations resulting from its trading practices. In an effort to shed its unsavory reputation and prepare the way for an expected initial public offering, in the late 1990s the firm sold its day trading unit and secured the resignation of its chairman and chief executive officer, Jeffrey A. Citron, who, however, remained its chief stockholder.
Brokerage House and Nascent Trading Operation: 1970-90
Datek Securities was founded in 1970 by Aaron Elbogen and George Weinberger, who opened a small office in Brooklyn to sell stocks and underwrite minor issues. By 1978, when the company incorporated, it had moved its quarters to Iselin, New Jersey. In 1975 and 1982 the company was censured and fined for technical rule violations by the National Association of Securities Dealers (NASD), a self-regulatory group established for trading stocks on the over-the-counter (OTC) market.
Datek established a trading operation in 1987 in New York City's financial district headed by Sheldon Maschler, an aggressive and abrasive broker who had been associated with Robert E. Brennan, a promoter of penny stocks who was eventually barred from the brokerage industry. (Brennan was later charged by the state of New Jersey with using Datek as an intermediary in the manipulation of the prices of four stocks that several brokerage firms controlled by Brennan were trading among themselves.) One of Maschler's first hires was Citron, the 17-year-old son of a friend, who started as a clerk. He was soon joined by Joshua Levine, a high-school dropout billed as a programming genius.
In 1989 Levine and Citron began to investigate faster, cheaper means of buying and selling stocks. Working in the basement of Maschler's Staten Island home, where Datek moved its four-man trading operation in 1990, Levine and Citron created Watcher, a software program that allowed day traders--so-called because most of their transactions were intended to be completed within a single day&mdashø monitor more than one computer screen at a time and exploit the Small Order Execution System (SOES), an electronic system established by NASD to facilitate trading of OTC stocks by small investors. Watcher allowed Datek to take advantage of a weakness in the system--relatively slow updating of price quotes--in order to make money by taking a position on the margin.
Day-Trading Powerhouse: 1991-98
By 1991 Citron, by his own account, had earned $1 million. Datek earned about $2 million that year from its trading operation. The company was censured and fined by NASD in July 1988 and January 1991 for violations of fair-practice rules. Datek and Maschler were fined $10,000 and $50,000, respectively, in August 1991, and were suspended from using the SOES systems for ten and 35 days, respectively, for abusing the system. In August 1992 NASD suspended Datek and Maschler from the OTC market for three months for misuse of the system. The organization charged that Maschler had, in late 1991, executed large orders of a security by bundling them into smaller orders, thereby violating the regulation that the system was to be used only for the individual investment decisions of small investors.
In 1993 Maschler was censured by a NASD committee for 'profane and indecorous language.' A NASD executive conceded, in a May 24, 1993 Wall Street Journal article, that Wall Street traders 'don't necessarily speak the queen's English' but added that Maschler's language 'transcended anything that could be remotely considered proper even in those circles.' The committee fined Datek and Maschler $5,000 each and suspended Maschler for one business day. Another NASD complaint against Maschler was overturned by the Securities and Exchange Commission (SEC), which ruled that the panel was biased against him.
Datek earned $3.8 million from its trading operation in 1992. Citron and Levine left the company that year in order to form an array of enterprises intended to serve Datek with new technologies. In 1993 Citron also purchased a brokerage firm that operated from Datek's offices and established another brokerage firm, also headquartered in Datek's offices, that he subsequently sold to Levine. Both also were partners with Maschler, who was supervising about 40 traders huddled in front of computer screens. By the end of 1996 Datek had 500 traders, many of them freshly out of Ivy League schools but already making as much as $750,000 a year. They were employing the SOES system for large trades, buying stocks and then selling them again within seconds.
Datek earned more than $75 million in 1995 and nearly $95 million on revenues of about $190 million in 1996--or about 50 cents on the dollar. While rivals continued to call Datek a 'rogue trader' and 'SOES bandit,' they were imitating the firm's own practices by this time. They, as well as Datek, were using software programs, such as Watcher and Monster Key, developed by Citron and Levine. The two also developed Island ECN, which in 1997 became one of four electronic communications networks authorized by the SEC to handle quotes for the NASDAQ's more than 5,000 stocks (and which in July 1998 was accounting for about 15 percent of all NASDAQ trades).
In 1996 Citron and Levine (and Maschler, according to one account; Peter Stern, according to another) had formed Smith Wall Associates to develop and license trading software. Maschler, who left Datek in 1996, was fined $675,000 and suspended from trading for one year in December of that year. Citron was fined $20,000 and suspended for 20 days in 1996.
Still unresolved, in 1998, were other charges against Datek. The SEC had filed a civil suit charging that five persons, including Maschler as a Datek executive, had collaborated in 1993 to sell unregistered shares of stock to a fictitious foreign investor, with the proceeds placed in offshore accounts. The SEC was seeking the return of $6.5 million from this scheme. Datek itself was sued in 1997 by a petroleum company that contended the securities firm had collaborated with six foreign investors to manipulate its stock.
By 1997 Datek's profits from day trading were waning due to new NASD rules and also because so many other firms had either licensed or imitated the Citron-Levine software programs. The company was now placing its hopes for the future on Datek Online, the Internet retail brokerage operation it established in 1996. Datek Online became the first brokerage to take advantage of Island's ability to show quotes for all NASDAQ securities, thereby--it told its customers--increasing their chances of having their orders filled at the best price for all these stocks. It also undercut the competition by offering a bargain price of $9.99 per trade. By May 1998 Datek Online's roster of clients had grown eightfold in little more than a year, to 80,000, holding more than $1.5 billion in company accounts. It ranked fifth in volume of daily trades among brokerages engaged in Internet trading. Net income was about $1.5 million in 1998.
Datek Online Holdings: 1998-99
Datek Securities was restructured as Datek Online Holdings in February 1998. Datek Online Brokerage Services was the subsidiary for day trading and retail brokering. Other subsidiaries included Big Think, a software development and marketing support unit, and Datek Software Services. Island ECN remained autonomous, although 85 percent owned by Clearing, an operation to clear trades. Three other segments provided computer services: Datek Online Network Operations, Datek Online Management, and Datek's day trading unit, whose chief principals were Citron (the largest shareholder), Levine, Maschler, Elbogen, and Stern. In an apparent effort to distance the trading operation from the new company, this unit was sold a month later to Heartland Securities Corp., a money management firm headquartered in the same Iselin, New Jersey, building as Datek Online Holdings. Heartland's owners--or part-owners--were Elbogen and Erik Maschler, a son of Sheldon Maschler.
In spite of Datek Online Holdings' divestment of its controversial day trading unit, the new company was forced to postpone a planned initial public offering of its stock because of continued probes by the SEC of the divested unit's activities. Moreover, in July Vulcan Ventures Inc., a venture capital fund financed by Paul Allen, a cofounder of Microsoft Corp., canceled plans to invest as much as $100 million in Datek Online Holdings and Island ECN. The SEC, in 1999, found Datek guilty of violating federal securities law 12 times in the spring of 1998 but fined the firm only $50,000.
In May 1999 Vulcan Ventures joined with two other investors, Group Arnault, a French private holding company, and TA Associates Inc., a Boston private investment firm, to offer Datek $300 million in exchange for a minority stake in the company. The latter two put up $195 million in July, but Vulcan decided not to follow through, reportedly partly because of concerns about continuing criminal and regulatory investigations of Datek. TD Waterhouse later backed away from a proposal to take a one-eighth share in Island ECN.
By this time Datek was the fourth largest online broker in the United States, with 253,000 such accounts holding more than $6 billion in customer assets. Datek offered low-cost stock trading and promised to execute these trades in a minute or less but, unlike such full-service brokers as Charles Schwab Corporation, it did not offer research or such investment vehicles as bonds and options. Interviewed by the Wall Street Journal for a June 1999 supplement on investing, Citron said, 'At Datek we provide the same off-line services that Merrill Lynch would provide, except we don't do it in a physical location; you have to call us on the phone. But you can call us and get quite a bit of information and quite a bit of help--although we will not tell you or give you advice on what particular items to buy.'
Contrasting Schwab's clients, many of whom he characterized as 'people who really need help in investing,' Citron went on to say, 'our customers are financially literate. ... They understand the markets. They know exactly what they want to buy. ... They require more real-time tools. They require real-time quotes. They require real-time account-balance information, real-time graphing.' Citron described E*Trade Group, Inc., and Ameritrade Holding Corp. as Datek's chief competitors, rather than full-service firms such as Schwab, FMR Corp., and TD Waterhouse Group Inc.
Because of the continuing concerns about possible prosecution of Datek and its principals, Citron resigned as chairman and chief executive officer of the firm in October 1999. He continued to own about 30 percent of the firm's stock but agreed to surrender all voting and management rights to the company's board of trustees for two years. In a New York Times story, Edward J. Nicoll, Datek's former president and Citron's successor, conceded, 'There's no question we want to disassociate ourselves from the past. The company's value has been diminished as a result of the investigations.' He was hoping to resolve these issues so that Datek could fulfill, perhaps as soon as mid-2000, its plans to convert itself to a public company. Datek also sought a clean bill of health from regulatory authorities because Island ECN was asking the SEC to allow it to form North America's first private for-profit stock exchange.
Principal Subsidiaries:Big Think Corp.; Datek Online Clearing Corp.; Datek Online Management Corp.; Datek Online Network Operations Corp.; Datek Online Software Services Corp.; Datek Online Brokerage Services Corp.
Principal Competitors:Ameritrade Holding Corp.; E*Trade Group, Inc.
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