Small Discount Brokerage Firm Chases Success in Small Parcels

Charles M. Spear was recently at a party when a woman approached him and asked if he was the man who runs Spear Financial Services in Glendale, a small discount stock brokerage that also sells annuities and other insurance products.

Spear, chairman of the company, confirmed that he was. Then the woman told him that her husband had invested his life savings in Spear Financial’s stock at $6 a share. Today, the stock sells for $3.

“She said she thought it might be good for me to look her in the eye,” Spear recalled. “I haven’t done very much for them.”

It’s not wise investment strategy to put your life savings into any one stock, and Spear surely would like to see Spear Financial’s stock go higher--he owns about 8% of the shares himself. But Spear, a stocky, 46-year-old Cleveland native, makes no apologies for his company’s performance.

After starting the firm in 1983, he built Spear Financial’s revenues to $14.1 million by 1987, when the company earned $1.7 million. But in the aftermath of the 1987 stock market crash, when small investors were scared away, Spear’s sales were knocked down to $11.5 million in 1988, producing a $1.1-million loss. Now the company is again profitable and Spear predicts that its sales will climb to $20 million this year.

Still, few would confuse the bearded Spear with that other Charles of discount brokerage, Charles Schwab, whose Charles Schwab Corp. is the nation’s biggest discount broker. Schwab maintains 1.2 million active accounts versus 25,000 at Spear, has 2,200 employees to Spear’s 200 and revenue in 1988 that totaled $392 million.

Schwab also spent nearly $12 million on advertising last year to draw more clients; Spear spent about $500,000. But Spear isn’t convinced that advertising is as cost-effective in getting new customers as simply buying other brokerages with established customers. To keep growing, Spear has gone shopping, buying even tinier discount firms in California--such as Chris Harris Securities, First Los Angeles Discount Securities and Kall & Co.--often at prices of less than $100,000.

What makes Spear’s brokerage services stand out? “I don’t have anything special,” he said. Spear Financial tries to offer strong service, he said, but then all companies try to do that. His minimum commission on a stock trade is $38, just under Schwab’s $39. But Quick & Reilly, another discounter, has a $35 minimum, and Kennedy, Cabot & Co. in Beverly Hills charges just $20 on some trades.

But Spear does not see brokerage services as his key to success. Selling insurance-related investments and other financial products, such as mutual funds, through banks and savings and loans is where Spear sees his future growth.

Some banks and S & Ls can sell annuities and other insurance products directly, but often they simply refer customers, in exchange for a fee, to another firm that specializes in such products. Spear owns just such a firm, James Mitchell & Co., which he purchased a year ago.

In the Mitchell deal, Spear assumed or paid off $2.2 million of Mitchell’s debt, and will pay Mitchell himself a yet-to-be-decided amount of Spear stock based on Mitchell’s performance. (Spear said Mitchell likely will end up owning a bigger stake in the company than he does.)

The annuities that Mitchell sells are issued by an insurance company, which then pays a fee to Mitchell. Mitchell in turn splits its fee with the bank or S & L. Mitchell and the financial institution can each earn a few hundred dollars for each transaction, depending on the size of the annuity or other investment sold.

Annuities are contracts in which a person makes an up-front lump payment with a guarantee of receiving payments in the future, usually at retirement. Yields earned by the annuity in the meantime are typically tax-deferred.

The insurance business provides higher profit margins (about 15 cents per sales dollar before taxes) than a discount brokerage and has stronger growth prospects, Spear said. For example, last year, Mitchell had pretax earnings of $333,000 while Spear’s brokerage business had a pretax loss of $1.85 million. And in the first six months of this year, Mitchell accounted for $5.6 million, or 55%, of Spear Financial’s $10.1 million in total revenue, which yielded a modest overall net profit of $43,569 for the company.

Spear figures that the discount brokerage business will usually show a profit, but the Mitchell insurance business “will outpace the growth of anything else I’ve got around here.”

Move Praised

Spear director Donald Weeden, who led the fight for deregulating brokerage commissions in the mid-1970s, praised Spear’s move into insurance because it is tied to banks and S & Ls. Those institutions are likely to be more deregulated in the coming decade, which will prompt them to look for new investment products to sell.

“More and more banks will want to get into that business and will find Jim Mitchell is probably as good as any vehicle,” Weeden said.

Spear formed his company to offer brokerage services only to investors with personal computers, enabling them to trade electronically, and was one of the first to do so. The business grew very slowly--prompting Spear to become a traditional discount broker for investors with or without computers--but now Schwab, Fidelity Investments and other big investment firms offer the same computer service.

In 1985, Spear also introduced a service enabling individual investors to trade certain stocks 24 hours a day. Such off-exchange “third-market” trading is mainly reserved for large institutional investors. But the New York Stock Exchange soon forced Spear to abandon his service, and Spear acknowledged that it drew few customers anyway.