Wall Street Warms Up to Day-Trading Brokerages

Several leading U.S. investment houses have held discussions in recent weeks with day-trading brokerages and software firms about buying into the smaller companies, sources say--suggesting a major shift in Wall Street’s view of the much-maligned day-trading practice.

The large firms, which include Merrill Lynch & Co., Salomon Smith Barney Inc. and Lehman Bros. Holdings Inc., appear to be primarily interested in gaining access to the firms’ sophisticated trade-execution software rather than jumping into the retail day-trading business, sources say.

In many cases, the talks have centered on the large brokerages buying stakes in the trading firms, though outright purchases also have been discussed, according to the sources.

Some talks between Wall Street firms and day-trading outfits have gone on for several months, but it is unclear whether any deals will be completed.

Nonetheless, the mere existence of discussions reflects a dramatic turnaround in mainstream Wall Street’s attitude toward day trading, in which individual investors trade on extremely fast-paced systems purely for short-term gains.

“A number of major Wall Street firms have realized that the future of retail [brokerage], like it or not, lies in some aspect in day trading,” said Bill Singer, a New York-based securities attorney representing several day-trading firms.

Singer said clients have notified him of discussions with Salomon Smith Barney and Spear, Leeds & Kellogg, a large New York-based trading firm.

The two firms declined to comment as did Merrill Lynch and Lehman Bros.

Some of the white-shoe firms have been sharply critical of day traders in the past, essentially labeling them as bandits who undermine the stock market with their furious trading.

But mainstream firms also have become attracted to day-trading shops’ sophisticated software now that alternative electronic trading systems have emerged to challenge the traditional markets of the New York Stock Exchange and Nasdaq.

“The securities industry has a long history of eventually accepting and grudgingly appreciating those who were once outcasts if those outcasts can offer valuable services to investors,” said one source. “If you’ve got benefits to offer, you’re not going to be an outcast for long.”

So-called electronic communications networks, or ECNs, are computerized order-matching systems in which buyers and sellers meet directly rather than going through Wall Street dealers. These networks are taking an increasing share of trading volume and are used heavily by day traders.

Some major Wall Street brokerages have already taken minority stakes in ECNs to guarantee a foothold in whatever systems prove successful in the long run.

“It’s the dating game,” said one source.

Some day-trading firms have themselves developed software that could be attractive to other brokerages and institutional investors such as mutual funds. Some shops have focused on “smart agent” software that scans a variety of trading systems to find the best price available for buying or selling a particular stock.

But the discussions between the majors and the day-trading firms also may indicate that the Street’s giants believe that retail day-trading shops have long-term viability despite high-profile complaints by regulators against some firms.

Another major player may concur with that view. Two weeks ago, Japan’s Softbank Corp., a pioneering Internet investor, purchased a minority position in Tradescape.com, a day-trading software company.

Even so, state and federal regulators are pressing ahead in their scrutiny of the day-trading industry. Some firms have been accused of misleading small investors about the risks of day trading and intentionally skirting certain securities rules, such as those limiting how much money customers can borrow to trade.

Massachusetts regulators last week sought to revoke the license of day-trading firm Landmark Securities Corp. to operate in that state, charging that Landmark engaged in illegal lending activity and accepted customers for whom day trading was too risky.

It marked the sixth complaint brought by Massachusetts against day-trading firms since October. The day before, the regulatory unit of the National Assn. of Securities Dealers fined another day-trading firm $25,000 for violating trading rules.