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September 1, 2010

The Retail King

By James Ramage

In a converted 1960s shopping mall in Omaha, Neb., sits one of the most powerful retail brokerage order providers, with what many consider the industry's most sophisticated routing system.

TD Ameritrade's order routing business resides in a two-story, 500,000-square-foot space that once housed a Younkers department store. The group that seeks best execution is headed by Chris Nagy, whose office window faces several outlying desks in a sea of workstations under a dreary fluorescent-light glow.


See Chart: Retail Kings

See Chart: Where the Flow Goes

See Sidebar: Flash Trading's Big Fan


At its peak, the space contained 1,500 desks, the foundation of Ameritrade's call center. Today, about half of those workstations sit empty. Their former occupants have relocated to a newer, more colorful and stylish workspace at Ameritrade's Old Mill campus west of downtown Omaha. In a couple of years, Nagy, Ameritrade's head of order strategy and co-head of government relations, will join them in a brand new 12-story office that's under construction.


Considerable Influence

But nothing of his current office space or its surroundings matters to Nagy, or speaks to his intimate knowledge of how the markets work. What matters is the mission he's undertaken: advocate for the retail investor. He's given himself and his group the task of securing the best possible prices and trading experience for each of Ameritrade's 8 million customers.

But on Wall Street, advocacy alone does not confer royalty. Volume does. And behind Nagy and his group, Ameritrade directs more order flow to wholesalers than anyone else in the retail brokerage space, according to Sandler O'Neill + Partners, an investment bank and a research boutique.

Ameritrade said it represents:

*10 percent of all volume in options cleared through the Options Clearing Corp.

*More than 50 percent of all retail options volume

*7 percent of total equities volume at both the New York Stock Exchange and Nasdaq

*40 percent of all over-the-counter equities volume

What's more, Nagy's potential to redirect Ameritrade's order flow gives him considerable influence with his trading partners. He uses his de facto position as the voice of the retail investor to lean on market centers--wholesalers and exchanges alike--in order to ensure that their execution policies are consistent with keeping the markets as fair and transparent as possible for retail investors.

Nagy also speaks on panels, such as his recent appearance before the CFTC-SEC Advisory Commission to discuss the events of May 6, more commonly known as the "flash crash." And he writes comment letters to regulators, such as two recent dispatches to the Securities and Exchange Commission on flash orders and the consolidated audit trail.

For this, he enjoys almost rock-star status on Wall Street. He is visible. He speaks publicly with confidence. But he carries himself without a rock star's outward display of vanity or flash. And yet still, it's common for wholesale market makers and regulators to hang on Nagy's every word.

"I'm just an average guy," he said. "But I know that every person can make a difference. So, to the degree that I can make a difference in this market--make things fairer and better for everyone--that's what really drives me. It's a wonderful opportunity."

Don't be fooled. The "average guy" rolls up his sleeves and gets neck-deep in Ameritrade's routing strategy. To that end, Nagy and his order routing group pore over execution results and market conditions. They want to see evidence of price improvement. They want to know how speed factored into last week's best-execution results.

Chris Nagy, TD Ameritrade

In their best execution reviews, Ameritrade commonly compares its execution results with those of its competitors, said Gary Sjostedt, a director of order routing sales and strategy at Ameritrade. The group compares competitors' routing reports. They'll look at price-improvement levels and spikes, and graph those out.

The group also checks their route-away reports and limit executions. They'll peruse inquiries filed by their clients. They'll compare the public markets' numbers to gauge the impact of their clients' orders. They'll look at market opening protocols to see if their clients' orders were in any way disadvantaged in any particular names.

The routing strategy group also dials up the wholesalers and exchanges daily to discuss execution results. No issue is too minute to discuss, said Ovidio Montemayor, a director of trading services at Ameritrade.

"Every little issue, such as a delayed opening on the NYSE on a certain stock [is discussed]," Montemayor said. "We ask, 'How did that work out? What did you see at the close?' It's very thorough."

And they'll consider any industry news and recent regulations that may affect routing. In fact, regulations have had a tremendous impact on the retail business. The adoption of Rule 605 of Regulation NMS was the most significant. It requires market centers to publish monthly reports that detail execution-quality data. Brokers such as Ameritrade use these reports to compare execution quality across market centers when determining where to route.


Bifurcating Flow

Nagy was also instrumental in building what some consider the most complex order router at any retail broker. He led the routing group in developing the Ameritrade Order Management (AOM)--as the router is called--between 2001 and 2002. He also was the prime force behind adding many of the router's most powerful features after Ameritrade merged with online broker Datek in 2002.

To begin with, the order routing group Nagy heads endowed AOM with the ability to separate marketable and non-marketable order flow. Next, they added a feature that can separate market and limit order flow in equities, Nagy said. Later, the routing group gave AOM the capacity to handle good-till-cancel orders and immediate-or-cancel orders, and the ability to peg orders, as well as to pull orders back.

Separating market and limit order flow has been significant for Ameritrade. The firm began the practice several years ago. Then, it still sent its market orders to wholesalers, but it began sending its limit orders to the exchanges--to take advantage of their rebates from maker-taker pricing. In share volume, Ameritrade has an almost equal number of market and limit orders, according to the firm.

In splitting its order flow, Ameritrade could improve its revenues by taking advantage of maker-taker pricing at the exchanges and still get paid for sending order flow to the wholesalers. Nagy, though, would not disclose the revenues Ameritrade registers from the make rebates it earns from exchanges, or the payment for order flow it receives from wholesalers.

The practice has also translated into a tremendous amount of volume that wholesalers no longer see. But there is little they can do about it, said Stephen Kay, who oversees broker-dealers client relations at Knight, which has a giant market-making business.

Stephen Kay, Knight

"We've noticed it," Kay said of Ameritrade's bifurcation strategy. "It's just competition, the nature of the business. Order routers are very good at what they do, in terms of maximizing their order flow for the client."

Now, for options, Ameritrade wants to separate its market and limit orders, as well. The firm is going through the process of gaining memberships with all eight of the current options exchanges, Nagy said.

Such innovations are nothing new. Nagy's been in the securities industry for more than 25 years. But his rise to retail royalty began at the bottom and in the back offices. Similarly, his unassuming beginnings and childhood heralded little of what was to come.

Nagy was born in Flint, Mich., and grew up in Phoenix. His parents had moved to the U.S. from Hungary in 1956. They were among the 200,000 or so Hungarians who fled their homes that year during the Hungarian Revolution. Nagy's parents raised him to speak the mother tongue; he learned English when he was 5.


A Hunger for Trading

Ellie Tweed, a broker for Shearson Lehman and the mother of a college roommate, first piqued his interest in trading. Tweed taught Nagy to trade options. Hooked quickly, Nagy was soon squeezing in Union Carbide, Clorox and Philip Morris options trades into his days of chemistry classes and his nights working at a grocery store.

In short order, trading took over whatever free time he had. But it wasn't nearly enough. Nagy hungered to learn more--only not in school.

"I figured, I'm studying chemistry in school, but it doesn't really give to my passions like [trading] does," he said he remembered thinking. "This is just so fascinating. I really want to get into this business, like right now."

So Nagy decided to drop his studies at Arizona State and work for Shearson Lehman. He was told he'd need to start at the bottom. He accepted a position there as a sales assistant in equities for $16,000 a year in the mid-'80s.

He learned as many different positions as he could over his first few years to build an understanding of back-office operations. The experience would prove critical to understanding the business, Nagy said.

"I gained so much back-office experience that you could put me in any back-office role and I'd know it front to back, completely" he said. "Coming out of Harvard, you don't know how the back-office works. So, because of that, you don't know the structure of how things are going to clear, or how things are going to work in times of crises."

In 1990, he had moved on to the retail trading desk for U.S. Bancorp, in Minneapolis. By 1998, Nagy ran equities trading there and oversaw the firm's integration with Piper Jaffray. A year later, Ameritrade contacted him to see if he'd be interested in running trading for them in Omaha.


Lessons From '87

Learning the back office may have given Nagy an indispensable foundation. But it was the crash of 1987 that gave him a cause. It taught him how fear ravages the markets. It exposed him to the retail investor's vulnerability. Nagy described his firsthand experience of the crash as the defining moment in his budding career.

"It really started to set things in motion for me, for who I was to become and where I was to go," Nagy said. "The average Joe didn't stand a chance in the marketplace, compared to everyone else, because the only way the average Joe could get access in the marketplace was through the means that were provided back then, which were limited.

"And the information the average Joe had was paltry," he added. "I realized that this market wasn't really transparent, or fair. Information in the market was very hard to come by. And there, the average Joe had nothing."

Nagy has held that memory close ever since. Subsequently, he views Ameritrade's relationships with the wholesalers in terms of its own retail clients. When Ameritrade makes any suggestions to or demands of the wholesalers, it's for the benefit of the retail investor, Montemayor said.

"It's why we do what we're doing," he said. "It goes further than best execution. We're trying to improve the markets. We're doing anything we can to tweak them to get improvements in their systems, or trading hours, or new products that are coming out--we're involved in them before they come out. Everything we do pushes that client agenda down the road."

The constant communication is important, Montemayor said. It gives the wholesalers the opportunity to make adjustments and fixes with their systems when problems emerge, he added. And when Ameritrade shifts its volume to another destination, it rarely comes as a surprise; the wholesaler has plenty of advance warning, Gary Sjostedt said.


Eye on the Ball

If a technology glitch starts showing up in the data, [Sjostedt] will start addressing it with them, immediately," Montemayor added. "So, some time will go by, and you give them a chance to address it. And at times, you find, it was something with the code. They say: It'll be fixed by Monday. We can choose to route away or stay with them."

Ameritrade regularly uses about five large market centers--wholesalers and exchanges--and about two or three prominently, Nagy said. It keeps an additional five to seven in a pipeline under consideration for later use. As options headline the next priority for Ameritrade, wholesalers that trade both equities and options will be large recipients of the retail broker's flow. Currently, Citadel Execution Services and Citigroup fit this twin bill.

Nagy said that the relationship between Ameritrade and the wholesalers helps keep trading costs low for retail investors. And wholesalers will always have a place in the relationship, he added. "I want to marry retail orders with institutional liquidity, and wholesalers help us achieve this," Nagy said.

Wholesalers say they are competing for Ameritrade's order flow every day, so they can't afford to become too complacent. Ameritrade benefits from the competition, Sjostedt said, and encourages new wholesalers to participate.

"The bar is always going up," said Andy Kolinsky, president of Citadel Execution Services. "If you take your eye off the ball, you could find yourself with less order flow. We have to be analyzing, reviewing, communicating and understanding where we need to be for our clients every day of the week."

Kolinsky said he appreciates how Nagy works behind the scenes and talks to the SEC regularly in representing retail investors. He agreed that Nagy is their biggest advocate.

"There's no one who sits on more panels to push that message to the industry more than Chris," Kolinsky said. "Sometimes he is controversial. But his end goal is always for the benefit of the investing public."

And while Nagy said he appreciates the attention and respect he receives from his peers in the industry, he's well aware of the fact that Ameritrade doesn't service its customers in a vacuum. Relationships always matter.

"It's nice to have the respect," he said. "But at the same time, I never use that in a detrimental fashion, even with our market centers. While I can be very firm, you must have a good business partnership in order to succeed."


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