The
NYSE member firms thought they had a sweet deal, but the monopoly carried
within it the seeds of the system’s destruction.
Bulls make money,
bears make money, pigs get slaughtered. So goes the Wall Street truism,
and so it was that greed, over-reaching and craven, killed the closest
license to print money allowed by law. What happened is that the biggest
mutual funds got sick of paying huge commissions and started demanding
discounts. Instead of giving it to them, the brokers started to cheat
each other by allowing “end-around” trading in which institutional trades
bypassed the floor of the NYSE. Brokerages helped create an unofficial
“third market” channel and began cutting deals on trading commissions,
awarding “give-ups” or discounts to larger customers such as mutual funds.
The NYSE and the brokerage industry also tried to outlaw such discounts
and any erosion of the fixed commissions this alternative channel created,
but they couldn’t get the SEC to go along.
That didn’t stop
the brokers from trying. In 1973, the exchange actually asked the SEC
for a commission rate increase of 10 to 15 percent. The Napalm scent
of deregulation was in the air, but the brokers, blinded by their greed,
could smell nothing more than their own self-importance. Amazingly,
the SEC approved the rate increase, but only on the condition that the
exchange agree to phase in deregulated commissions, a process to be completed
no later than April 30, 1975.
And that’s where
the paranoia comes in. The paranoia belonged to a corrupt and suspicious
President Nixon, who was by 1973 so overwhelmed by his Watergate problems,
that he had no energy to protect his pals on Wall Street. He was beyond
the help of contributions. In 1971, minions of Nixon were caught attempting
to bug the offices of the Democratic National Committee in the Watergate
apartment complex not fare from the White House. The investigation of
this burglary and Nixon’s attempt to obstruct justice brought on his
downfall.
On August 8, 1974,
President Nixon resigned in disgrace. An emboldened Congress, now controlled
by democrats intoxicated by the heady rush of reform, drafted legislation
to outlaw fixed brokerage commissions.
Warnings of calamity
issued from the full-commission brokers, who feared that the traditional
means by which business was done would be destroyed. Investment advisor
Peter Bernstein wrote, “all the known parameters of the stock market
are bursting apart.”
He was right. The
world of investing was being turned upside down. Acknowledging the battle
was lost, the NYSE agreed to a one-year transition period culminating
in the end, effective May 1, 1975, of fixed commissions forever.
Geography
is destiny. The promised upheaval of May Day created one of the conditions
necessary for Chuck to succeed. The other condition was satisfied by
the accident of the company taking root in California, and not just anywhere
in California, but in northern California. It is hard to think of a
locale more hospitable to a start-up like Schwab then San Francisco.
Schwab benefited
from its San Francisco location in three main ways. First, it was almost
as far geographically from Wall Street as you can get and still be in
the contiguous United States. Had Schwab tried to establish the company
in New York City, the air would have been sucked out of the company before
it began. More likely, Schwab would never have considered starting a
discount brokerage in the first place. The not-invented-here mentality
of the established brokerages would have torpedoed Schwab’s chances for
raising money or attracting talent. “Wall Street has a crippling pack
mentality,” says John Gambs, who was deputy treasurer of Merrill Lynch
when Schwab recruited him to be the discount brokerage’s first CFO.
“It’s an extremely inbred and small community. I could never do any
work on the commuter train ride home because the guy next to me was from
Goldman or Hutton.”
But the second reason
supporting San Francisco as the inevitable location for a company like
Schwab is that California in general, and the Bay area in particular,
attracted misfits and rebels. Everyone was new in California; most of
the population settled there starting in the 1950s. California was particularly
appealing to people who didn’t fit in elsewhere: radicals, free thinkers,
subversives, experimenters, and people favoring alternate lifestyles
that were elsewhere considered immoral or in point of fact criminal.
Credentials were considered, like, so East Coast. Dress codes were as
casually disregarded in California as every other code.
New York was text-centered.
California nourished images in a way that Wall Street could not fathom.
Chuck quickly understood that image is what it’s all about. It’s no
accident that Hollywood, the crucible of image, is in California. The
result? Chuck’s face, larger than life, on ads, billboards, and TV.
The executives at Merrill Lynch and EF Hutton were aghast at Chuck’s
photograph on Schwab ads. The prevailing attitude among financial executives
cultivated by Yale and Dartmouth was that businessmen are allowed only
two opportunities to get their photographs in the newspaper: once when
they are married and once when they are dead.
The third reason—although
it wouldn’t be obvious for 20 years—was due to the happy accident that
Schwab would soon fall under the spell of the world-changing magic that
was being created 30 minutes to the south. Silicon Valley in a few years
was to become the greatest engine of wealth generation the world has
ever seen. The Silicon Valley companies started paying their engineers
in a new form of compensation—stock options. Within a few years, thousands
of employees clutching stock options would be walking around. They couldn’t
take their options to the bank. So they made a beeline for the nearest
stock broker. Frequently, that was Schwab.
Imagine a human
resources manager getting stock options. Kevin Wheeler, who would later
become Schwab’s Senior VP for Staffing and Workforce Development, was
a young HR manager at National Semiconductor in 1982 when he walked into
Schwab’s Silver Creek, CA branch to open an account and sell his options.
What Wheeler remembers most is the warm, fuzzy feeling that his finances
were in capable hands. The Schwab staff knew exactly what to say and
what to do. “They took something mysterious and a little threatening
and made it easy,” Wheeler says. Although Wheeler left Schwab in 2000,
that original account is still active.
