Stories of Entrepreneurship in Financial Sector

Over the past few years, Joe Nocera, a journalist for the The New York Times, has written one op-ed after another exposing the NCAA for what it is- a business juggernaut with cartel-like attributes. After reading another well argued piece on the NCAA’s crusade to rule with a heavy, unjust fist, I went to the internet to see what else Nocera decided to highlight. Maybe I could find something in book form, and maybe something before the google era (pre-2004).

I stumbled upon A Piece of the Action: How the Middle Class Joined the Money Class — a book he first published in 1993. I did not look closely, but the book was not in the style I knew well. It was not acting as a ray of light, exposing a dark corner of society, but instead turned out to be a story about the entrepreneurial efforts of the financial sector- the so called “money revolution.” In a way, it is a story about how the middle class started to care about the stock market.

But in the foreword, writing twenty years later, with the hindsight of every fund that went up, and then so dramatically down, he adds cold water to the once aspirational, now defunct thought that access to cheap credit would bring great democracy to our country. “I sure wish our piece of the action had turned out a little better for us, ” he writes towards the end of the foreword. He did not know how crippling debt would become, and gives the impression that by writing about how it all began, glorifies something that was destructive, but it is still- whether good or bad- an incredibly engaging story. And then the book begins.

Charles Merrill, 1954 (New York Times)

In APOTA, Nocera weaves the story of how a few men found innovative ways to help democratize the way American consumers invest. One of these outliers was Charlie Merrill, who was able to make two very prescient assumptions: for Wall Street to grow it had to expand its investor base and small retail chains were here to stay. Before Merrill, small investors were turned away, and Wall Street saw chain stores as a fad, but obviously, they were mistaken. While other lending institutions ignored places like Safeway, Merrill become their largest single stockholder. He then became very rich.

He also created trust with the consumer in a way stockbrokers traditionally did not. Americans were weary of bad advice and brokers propping up bad stocks, in order to raise their commissions. Merrill identified this problem, and was the first to pay his brokers a salary. “A salaried broker would be better able to guide clients to long-term investments without having to worry about the need to generate periodic trades. And the customer, listening to his brokers advice, would know that it wasn’t motivated by the prospect of commissions.” Merrill never wavered from this strategy.

In order to grow the market of investors, Merrill also realized people needed to understand how the market worked (at least somewhat). In 1948, they published a 6,000-word ad in The New York Times titled, “What everybody ought to know about this stock and bond business.” In 1955, the firm published 11 million pieces of literature, and held a popular investment workshop for women only. Their outreach knew no bounds and included tents at country fairs, and a booth at Grand Central. Nocera adds, “It ran a brokerage on wheels. Once it even gave away stock in a contest sponsored by Wheaties.” At the time of his death in 1956, Merrill had built the largest brokerage house, with nearly 20% of the “odd lot” trades on New York Stock Exchange (an odd lot are trades that are less than 100 shares). The firm also had almost a half a million customers that were acquired through a robust multi-channel marketing efforts that included some of the first financial sector TV ads.

A re-occurring theme in each tale of innovation is building trust with the customer. In order to grow, and reach the greatest possible audience, the financial institution had to keep the pillars of convenience and price close. During the course of the book, just when it appears that no other banking or investment product can be cooked or cut differently, another entrepreneur brought a fresh approach.

During the 70s, when Merrill Lynch taped the hands of new brokers to their phones to emphasize the importance making sales calls, Charles Schwab ’s firm took an opposite approach, partly due to Schwab’s distaste for the act of selling. While at Merrill they focused on the active role of “Always Be Closing- ABCs”- Schwab brokers were told to wait patiently by the phone, and only touch it, if somebody made a call. And when they did call, “they were under explicit instruction not to offer advice or suggestion.” He did this for two reasons. One so that they could charge less. If you were not offering advice, you did not need to hire experienced brokers, because all they were doing was relaying picks by the customer to the trader. Second- there was a SEC regulation called the “know-your-customer rule.” The rule stated that the broker must know some income information about who they were selling to- let’s say-whether the person was on fixed income or not. In order to circumvent the regulation, and avoid lawsuits, Schwab intended that his brokers know as little about the customer as possible. Here is the disruption- Americans were willing to pay a lower price even if the service was not as good. It reminds me of an anecdote about Wal-Mart about how the aisles are not necessarily always in order, items can almost be tough to find, but the prices are at the rock-bottom, and now their annual is more than many countries GDP. Like the system Schwab created, Americans would be willing to do a little more work, if the price was better than anywhere else. They may have to do their own research on the right trades, but they would not be charged an arm and a leg to place the trade, and this is how the middle class became the money class.

Schwab wanted Americans to feel unbridled trust with his company, but unlike many entrepreneurs his innovation was not a series of light bulbs going off that connected dots that others did not see, but rather, the ability to listen to his uncle while taking his money.

In the early 70s, securities law required an out-of-state financial institution to register in state and abide by their laws, but like many entrepreneurs before him and after, Schwab ignored the laws in the name of growth. Subsequently, the Texas regulators blew the whistle, and demanded a refund to Texas investors with a 6% interest. Schwab sued, but the SEC moved to block sales of the fund, not just in Texas, but nationwide. While Schwab fought these efforts in lower district courts, the company hemorrhaged money, and he was about to go out of business until his rich, entrepreneurial-minded Uncle Bill stepped in with a $100K, and the company re-organized into a discount brokerage.

Sacramento Branch

A few years later, Schwab was in trouble again. He did not have enough capital to cover small margin calls, and needed Uncle Bill’s money again. Bill was willing to give Schwab $300K, with one condition — he needed to set up a retail branch office in Sacramento, and hire his nephew to run it. The discount brokerage business was a pick up the phone and take a call kind of business, and retail was seen as a frivolous expense, when the priority was making the call center more efficient. Schwab resisted, but Uncle Bill’s money would not arrive without the demands being met, and finally Schwab relented.

It was September 1975, and in the sleepy state capitol, Schwab opened its first branch. Almost overnight the business started to receive hundreds of more calls a day, then thousands more, and it seemed to all be related to this one tiny branch across the state capitol building. I imagine it to be like the last scene of Spotlight Movie , when after the story is published, they receive hundreds of calls from other victims. Just imagine that, but with out the sexual abuse.

The new customers calling and signing up from Sacramento, but the branch was not particularly busy. It appeared that customers trusted Schwab more because they could see a retail location. It was now not just a place they made trades over the phone, but an actual company with branches, just like the banks they entrusted with their wages.

A few months later, another man, not Uncle Bill this time, came to Schwab saying he wanted to open a Seattle branch after he invested, and Schwab said yes. Schwab customers from the Seattle area doubled, just like in Sacramento. When they went to Denver in 1977, and opened a branch there, they monitored the data more closely. Before they opened, they had about 300 Colorado customers, and within a year- the number jumped to 2,000. “From that moment on, Schwab spent every spare dollar opening new branches.”

I can’t help but think about how 92% of purchases still happen at traditional retail. While e-commerce is bigger than ever, most American consumers want to walk into a store front, try things on, and talk with an actual human being. They need to trust the company they are buying from.

Both Merrill and Schwab were successful because they helped the middle class place trades at a discounted rate. They also educated the consumer, and acted as an independent, trustworthy resource.

Nocera’s book is filled with many of these anecdotes that provide color to many subjects that appear on the surface as dull. In one of Gimlet Media’s latest podcast, Adam Davidson Adam McKay take what appears to be boring subjects and make them, “surprisingly awesome,” thus spawns the title of the show. Nocera’s book provides the content for any show that may need to spruce up subjects like credit cards, mutual funds, bonds or IRA’s. We think about a bank always having these options in one place, but that was not always the case, and through these tales of entrepreneurial coincidence and dot connection, we came out on the other end with many more options in our banking buffet. But like Nocera writes in his foreword twenty years after the publish date, this had consequences, and as our country currently stares at trillions of debt, we all wonder if it was all worth it, but this book is definitely worth your time.