Trader’s Narrative

Zecco is a new brokerage firm started in late 2006 that offers zero commission, online trading.

Sounds too good to be true! So how do they make money? Through advertising!

For those who were around during the bubble years, this is nothing new. In fact, often, I think that the whole “web 2.0″ is nothing more than the web 1.0 with a new paint job. Take the AllAdvantage zombie which is now called Agloco. But anyway, believe it or not, during the bubble years, there were firms who offered free brokage services.

As you’ve probably guessed by now, they’ve all long kicked the can. Which says a lot about this business model. Lets see, there was FreeTradez.com which didn’t even get off the ground because they failed to comply with NASD request of financial statements.

There were others who offered free market orders but charged a small fee for limit orders. In other words, they sold order flow. A big no-no today but quite ordinary back then. After all did you really care if your broker cheated you out of $0.50 a share when the intraday ATR was $25 or more?

Among these sellers of order flow was FinancialCafe.com which later on merged with another free broker, BrokerageAmerica.com in a futile attempt to forestall its demise.

So feverish was this trend that even well entrenched brokers got nervous that they were missing out on the new new thing. Ameritrade jumped in with a short lived division called FreeTrade.com

They offered free market orders but charged $5 for limit orders (again, selling order flow). Later they changed their commission rates a few times. At one point they looked pretty similar to today’s Zecco: they offered 20 free trades a month and then a laddered rate for transactions after that.

Of course, Zecco has the luxury of really deep pockets since it is partially owned by Morten Lund one of the billionaire entrepreneurs behind Skype. So I don’t think it is going away any time soon.

Although they are using technology to reduce costs, there is only so much you can do. One cost you can’t reduce much without damaging your business is customer service. This by the way has been the Achilles heel of Interactive Brokers for many years (although they have improved remarkably in recent times).

When I started trading I paid $60+ round trip (at a discount broker!) and being a total novice, I only realized after several trades that with my small portfolio, any potential profit would be handed over to my broker. So I understand people’s need to minimize trading costs. But I really doubt Zecco is the way to go about doing that.

The other consideration is that Zecco’s “free trades” is not without limits: they are capped at 10 a day, 40 a month and after that are $3.50 each. But most Zecco accounts are smaller than $25,000 and therefore, Pattern Day Trader rules apply to them.

If you’re using Zecco to trade (not invest) you will be frustrated with the limitations that PDT regulations impose. And may even lose money if PDT rules stop you from trading. If you have $2000 here’s how you can circumvent them, get 4 times intraday margin and trade all you like!

As Mark Twain quipped, “History doesn’t repeat. It rhymes.”

Agloco is a pay to surf MLM scheme that exploded onto the interwebs late last year. It is backed by the same team as AllAdvantage which crashed and burned in the bubble years. Check out this article from Business 2.0 on AllAdvantage (pdf).

AllAdvantage had a simple proposition: pay people a fixed hourly rate for the hours they spent browsing the internet with their software and use an MLM structure to attract new users. As you’d expect, this lead to legions of bots that pretended to surf. In contrast, Agloco uses a tortuously roundabout path to go from surfing to actual payment of money.

Still, most people mistakenly see Agloco as having a simple, linear model. Consider the following a public service announcement. If you’re a shrewd trader or investor or ever sat through an economics class (awake) you have no need to read further.

For the rest, let’s break it down:

[1] First, you have to download and install Agloco’s viewbar. This software (vaporware?) has yet to be released and every time a date is given, it makes a nice whooshing sound as it passes by. For the sake of this analysis, let’s assume it is actually released.

[2]So you surf the web while running the viewbar. But you don’t get a one-to-one proportionate credit for the actual hours you spend online. No matter how much longer you spend online, you’ll only get five measly hours accrued a month. And they “reserves the right to change these rates at any time for any country”.

[3]Next, these ‘Agloco hour units’ will accumulate. At some point, who-knows-when (if ever) they will be converted to something else. Note that they “reserves the right to change the [conversion] rates at any time”. So you can find yourself on shifting ground and get much less than what you thought you’d get.

Now, here’s the knee slapper: Agloco will convert these ‘hour units’ not into cash but into shares. But Agloco is a private company in start-up mode; has no public shares to distribute; is not profitable; hasn’t even released a product; and its founders failed the first time they tried this venture (what they lack in creativity, I suppose, they make up in persistence). Furthermore, according to SEC regulations, Agloco can not distribute unregistered shares to the public. While the ability of Agloco to produce and distribute value hinges on being able to going public, it’s ironic that the least amount of attention has been paid to this point.

From Agloco’s website:

“Remember, the company is 100% owned by the Members…”

No, it is not. It is a private company owned by a very few. I can cut them some slack for aggressive promotional copy but this is a bald faced lie.

[4]Assuming it does actually go public (I would really like to see an investment banker sit through a meeting with a straight face) Agloco will then have to use its shares as currency to pay its members – that was the original point, before all these twisty turns, remember? When it begins to do so, the proverbial shit will hit the fan.

If we assume Agloco is successful, they will have to regularly pay their considerable and probably growing user base a massive amount of money. Which means selling a massive amount of shares on the market. Guess what will happen to the value of the shares when this unflagging selling takes place? Guess what will happen before the selling hits as smart traders position themselves ahead of the avalanche of sell orders?

[5]But wait, maybe I’m being too harsh here. Let us again give them the benefit of the doubt. Let’s assume that people don’t make a mad dash to cash in their shares… eventhough they’ve been slaving over a hot monitor for months. The next hurdle to the ‘members’ seeing money is for the firm to become profitable.

[6]The chances of this are very slim for obvious reasons. Even if they do become profitable, the founders will rightfully want to get a return on their risk capital before paying anyone else. Again, let’s assume not only that Agloco becomes profitable but that their board declares a cash dividend (as opposed to a sneaky stock dividend).

[7]Now here is the payoff that the ‘members’ had been waiting for. Assuming all the above, we finally get to the single mention of cash payment to users in Agloco’s website:

“As Agloco grows and the company generates positive cash flow, we will be distributing the excess cash to Members and shareholders of the company.”

At this improbable point, having jumped through hoop after hoop and assumed everything but the kitchen sink, the members are getting paid a pittance: dividend ‘cents’ on any ‘dollar’ shares owned. And that is assuming that in Agloco’s glorious ascent, hackers the world over haven’t unleashed massive ‘bots’ to mimic surfing and made it a victim of its own ’success’. Or that the SEC hasn’t nabbed the founders on charges of attempting to circumvent securities law by promising the public unregistered securities in return for membership.

If you are more jaded than I am, you may point out that at each node through this circuitous path, Agloco has built in several mechanisms to control the amount of ‘value’ they distribute – whether limits on hours, conversion rates of shares or cash, reserving the right to kick anyone out for any reason, etc. These built in ‘firewalls’ are there for the protection of the founders and the business but they can also be used quite easily to manipulate the user base to extract the most from them while reciprocating a minimum.

Having said all that, I don’t think Agloco’s a scam. It is a poorly conceived scheme that appeals to those who know very little about finance, share issuance and regulation. I really do wish Agloco would go public. How else would I get a chance to short it?

I’ve been DUGG! If you would like to make this information available to more people, follow this link to digg me up.

UPDATE: If you enjoyed this, then don’t miss: the beginning of the end for Agloco.