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May 31, 2002

The Merrill and Herzog Marriage: The trading industry's great power marriage has finally been consu

By John A. Byrne

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  • The Merrill and Herzog Marriage: The trading industry's great power marriage has finally been consu
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It is a marriage of great expectations. In the great game of Nasdaq trading, Merrill Lynch & Co., the nation's largest brokerage firm, and Herzog Heine Geduld, an unpretentious and independent wholesaler, may seem like an odd couple.

Merrill, a full-service firm for retail investors and institutions, did not actively court the smaller accounts and broker dealers that were Herzog's bread and butter.

Merrill and Herzog both had a different approach to trading. "Herzog traders were trained not to lose money. A Herzog trader might do size but he'd be careful about risking capital," said one respected veteran trader.

"Merrill would buy a couple of hundred thousand shares and lose some money, if necessary, to satisfy a client," added this trader. "Merrill, a much larger firm, could afford to."

Merrill internalizes and does not pay for order flow. Herzog, on the other hand, a "dealer's dealer," paid for order flow.

But Merill and Herzog - opposites in so many ways - were alike in others. Both are reputable titans in the Nasdaq dealing world. The share volume of the combined firm placed it as the number one Nasdaq market maker in the world, according to figures supplied by Nasdaq for the 12-months ending March 31. (That prize was captured for the month of April by Knight Securities, though it was neck and neck with Merrill and Herzog, which combined was ranked No. 2, executing some two and a half billion Nasdaq shares.)

Complimentary Lines

Merrill and Herzog also had complementary lines of business which did not overlap, according to analysts. The chemistry worked. On June 6, 2000, Merrill and Herzog tied the knot: Merrill Lynch acquired Herzog Heine Geduld for $920 million in stock - at the pinnacle of the online retail stock trading boom.

The attraction, clearly, was motivated in part by Merrill's desire to cash in on the boom and instantly add more volume. At the time, noted Putnam Lovell Securities, the acquisition put the largest proportion of Nasdaq's retail order flow into Merrill's hands.

But Merrill's designs were dealt a serious blow when industry retail stock trading crashed. It was down 59 percent compared to the first quarter of 2000. Still, Merrill in buying Herzog, had more than the online trading bonanza in sight.

Soon after the deal was announced, a Merrill spokesman said it would enable Merrill to internalize more of its order flow. There were other strategic reasons. Merrill, which dropped the number of stocks it made markets in soon after the order handling rules - to some 550 from 800 - reaffirmed its confidence in the OTC market making. And it was building a strong foundation for its other lines. These include the potentially lucrative equity underwriting and merger advisory businesses.