Charles Schwab: How One Company Beat Wall Street and Reinvented the Brokerage Industry is the first full-length book about Schwab by an independent writer. In the book, author John Kador describes a company that is still fighting the “us versus them” battle that might have been appropriate years ago — but might not be today. Schwab still sees itself as the little guy, the David fighting the Goliath of Wall Street. Hasn't anyone told Schwab to check its size? It has become the 800-pound gorilla of the self-directed retail brokerage.
Schwab didn't want the book written; well, at least not by Kador, a former speechwriter and publicist. “Initially, no one at the company would to talk to me,” says Kador. “People at Schwab are incredibly protective of their company, and their loyalty to Chuck Schwab is absolute.” The company even put its employees on notice that talking to Kador would be treated as a compliance violation under the SEC's material disclosure rules. Stonewalled at every turn, Kador showed up at the coffee shops where Schwab people hung out. He crashed Schwab parties. He sought out former employees. He wanted Schwab executives to know he was not going away. Eventually, Schwab agreed to the following deal: Kador would not contact current employees if Schwab made former employees available for interviews. “It was a good compromise,” Kador says. “Former employees, some of whom were active only a few weeks earlier, could be much more candid,” he says. Kador eventually interviewed more than 200 ex-employees, including three former Schwab presidents and members of the board.
For all of the company's stonewalling, the book concludes that Schwab is in fact an excellent firm and that Chuck Schwab himself is an honest businessman with legions of admirers. Kador praises Schwab's ethics-driven culture and notes that the company has been untouched by the industry scandals and conflicts of interest that are headlining the financial news. Kador's main criticism is that the 65-year-old Mr. Schwab has not laid out a succession strategy and seems unable to articulate a mission for the company that bears his name and will be his legacy. “Schwab is an example of a successful company that is having trouble figuring out what it wants to be when it grows up,” Kador says.
Herewith are two excerpts from the book:
Wall Street didn't always hate Charles Schwab. In the first few months after May 1, 1975, when fixed brokerage commissions were finally eliminated, the little discount broker in San Francisco wasn't even on Wall Street's radar. Then the full service brokers dismissed Schwab as a “bucket shop” staffed by losers who couldn't make it on Wall Street. They ridiculed Chuck Schwab for appearing in newspaper ads. But as more and more customers of full service brokers defected to Schwab, the mainline brokerages began to take notice. Too many of their customers were taking the advice their analysts generated but then executed their trades at Schwab to save money.
Losing commissions was one thing, but Schwab's holier-than-thou attitude really grated. Schwab people made it known that they weren't just cheaper than Wall Street, they weren't just more efficient, they were — and this really rankled — morally superior. Schwab refused to offer advice. It didn't do any cold selling. And it paid its brokers a salary to avoid the conflicts of interest the company said fouled the full service (“full commission,” insisted Chuck Schwab) brokers on the East Coast.
For the next two decades, Wall Street watched in frustration as Schwab's market share and credibility grew. It let Schwab define the market for serving self-directed retail investors. It let Schwab take the lead in back office technology. Helplessly, Wall Street watched as Schwab revolutionized the buying and selling of mutual funds. And it sat back as Schwab created the leading platform for Internet trading. By the time Wall Street finally tried to jump on board, Chuck Schwab was one of the world's richest CEOs and Schwab's market capitalization exceeded that of Merrill Lynch.
But then the stock market melted down and with it Schwab's fortunes plummeted. Schwab is a shadow of its former self, down from 20,000 people in 1999 to less than half that today. “Let's face it. Schwab is not the threat they once were, so the animosity is defused,” says Rachel Barnard, a stock analyst at Morningstar in Chicago. “As Schwab abandons cheap, self-directed trades for individual investors, they are beginning to look more like the traditional brokerages they once attacked. At any rate, Wall Street has more on its mind than Schwab right now,” she says.
Next to the succession issue, Schwab's other pieces of unfinished business almost pale in significance. The company has no lack of challenges, but four issues stand out as most pressing. All require Schwab to confront its deep-rooted precedents; all call for Schwab to enter into new relationships with its clients and partners; and all demand structural changes to the company.
The first challenge is to finally find a revenue stream that is not as cyclical as trading commissions. Schwab knows that the bulk of this revenue will come by serving the growing population of wealthy investors. And the only way to do that is with a robust advice offering. The company that said it would never tell customers what stocks to buy did just that in May 2002 when it announced Schwab Equity Ratings, a computer-assisted stock picking service. Schwab computers will select stocks — giving them grades of A through F, indicating whether Schwab expects the stocks to outperform or underperform the market.
The second challenge is international. It is not at all clear that the Schwab model is exportable overseas. The intimate relationships he established with individual investors in the U.S. have eluded Chuck in his forays into England, Germany, Japan, Australia, and even Canada. The company must decide if it will make a serious push to re-establish itself in the markets it has recently abandoned. The board, with the exception of former Secretary of State George Schultz, is weak in international expertise and Chuck is clearly uncomfortable in foreign settings. Apart from the Latin American market it serves out of its Miami branch, Schwab's international presence in the next five years will not be significant.
The third challenge is integrating selected banking services into the Schwab portfolio as part of any overall investment/money-management strategy. The company has applied for a national bank charter to serve online customers. If approved by federal regulators, the bank will be Federal Deposit Insurance Corp.-insured and will have all the services offered by most banks, including automated teller machine (ATM) cards, checking accounts, and overdraft protection. The impetus for this strategy is to provide a better overall experience to Schwab's affluent clients who need a more integrated offering of both brokerage and cash-management services. Whatever happens, Schwab will be playing catch-up in the banking area.
The fourth challenge facing Schwab is the crisis of confidence confronting the entire financial services industry. Investors are spooked. The failures of the industry's compliance efforts suggest that the U.S. financial markets are deeply flawed. The watchdogs responsible for keeping the industry honest have lost all credibility themselves. Chuck has long railed at analysts who shape stock recommendations to woo investment-banking customers, auditors who bend the rules to curry favor with corporate clients, and government regulators too timid or politicized to keep track of the frenzy.
His most pessimistic projections pale against the reality of Enron, Andersen Consulting, Global Crossing, and other companies that have systemically defrauded the investing public and threaten to alienate investors from the markets.
The future belongs to companies that have earned credibility. In this area Schwab shines. For all its problems, Schwab still retains the confidence of customers and investors. They believe not only that Schwab is a company whose accounting practices are safely within the bounds of the law, but that it is an organization where people look facts in the eye, speak plainly, and avoid promoting initiatives they haven't yet achieved. It's an organization that is constitutionally incapable of exaggerating. Schwab is a company, in short, that puts its credibility ahead of anything else. Awakening from a decade of mind-numbing credulity, investors are on a search-and-destroy mission against companies who display contempt for the principles of fiduciary responsibility and disclosure. The good news is that Schwab is well positioned to weather the storm and once again take its place as the moral center for the securities industry.
A Category of One
In 1998, Chuck made a video. The narrator asked Chuck what he wanted the business pundits to say about his company in two hundred years. His response was very uplifting. He said that this “little company on the West Coast” had started a revolution that allowed people who had never had access to financial markets to make a happier and more secure future for themselves, “that we had demystified a vital part of the system for the majority of Americans.” On that score, the little company that Chuck started, and to which tens of thousands of men and women have devoted their hearts and minds, is a success. Chuck's cause — “to build the most useful and ethical financial services company in the world” — is complete.
Schwab's final challenge loops back to the fundamental question of the company's unique value proposition and what it stands for. What are we? We're not deep discount; we're not full commission, Chuck must occasionally muse. He must also acknowledge that it's easier for revolutionaries to define themselves by what they are not rather than by what they are. Schwab's answer — “We're a category of one” — resolves one question, but begs another.
“A category of one.” For Charles Schwab & Co. it continues to work. But it's an increasingly lonely place to be.
Excerpted by permission from Charles Schwab: How One Company beat Wall Street and Reinvented the Brokerage Industry, by John Kador