INVESTORS RUSH THE NET

By THOMAS McCARROLL

Jim Pelkey used to call his broker frantically the moment he heard breaking news about a company whose stock he wished to buy. A small investor by Wall Street's measure, Pelkey often had to try several times before getting through, hoping, in the meantime, that the stock wouldn't cool by the time his broker placed the order. For this the Cupertino, California, resident paid a commission of around $70 a trade.

But that changed after he opened an account with an electronic brokerage service called E*TRADE Securities www.etrade.com) which uses the Internet, rather than a traditional broker, to buy and sell stocks. Using E*TRADE and his personal computer, Pelkey makes his own trades anytime, without a broker. At $19.95 a transaction, he also gets free stock quotes, free market reports and even free checking. "I used to feel like a lamb being led to slaughter. Now I'm the one who feels empowered," says Pelkey.

E*TRADE, as well as Lombard Institutional Brokerage www.lombard.com and discount pioneer Charles Schwab www.schwab.com) is part of the next wave of brokerages that are shaking up the Wall Street establishment by trading stocks and bonds in cyberspace. Unlike traditional securities firms that operate out of storefronts and office buildings, this new breed connects to its customers mostly through PCs.

Elsewhere on the Net, online forums such as the Motley Fool are breaking Wall Street's monopoly on information, and rumors, about companies and their business prospects. Drawing more than 200,000 visits a month, it is the most prominent of a growing number of online sites, such as the Silicon Investor www.techstocks.com or the newsgroup misc.invest.stocks, where investors can ask questions and share knowledge.

Currently the upstart brokerages account for less than 1% of all the 640 million shares traded daily, but they also account for nearly 100% of the anxiety that the big Wall Street firms are feeling as technology reduces the complex world of securities to its barest minimum--carrying out a transaction. Wall Street's role then becomes something on the order of checkout clerk. This comes at a time when more and more investors are buying stocks. At one point less than 5% of Americans owned stocks; now more than 20% do.

As increasing numbers of investors take financial matters into their own hands, trading companies such as E*TRADE are expected to proliferate. The number of brokerage houses offering electronic trading has nearly doubled in the past year--to 22--including Jack White & Co. and National Discount Brokers. There are already 650,000 active online brokerage accounts, compared with 413,000 in 1995. By 2000, predicts Mary Doyle, senior analyst of mass-market interactive services at IDC/Link Resources, there will be 1.5 million online accounts. Says she: "The days are over when brokers called all the shots, controlled customers' accounts and charged whatever commission they saw fit. Investors are plugging in and taking charge."

Trading stocks by computer isn't exactly new. The basic technology was first used in the mid-'80s by discount brokerages such as Trade*Plus, Charles Schwab and Quick & Reilly, which borrowed the idea from their banking-industry cousins as a way of cutting down expenses. On average, they reduced fees as much as 70%. To keep customers captive, the systems relied largely on special software and in-house investment services. Then brokerage firms like Donaldson, Lufkin & Jenrette began liberating customers by offering an electronic-trading service called PC Financial Network (AOL/Prodigy: PCFN) and making it available through the commercial online services.

But even these trailblazers are being upstaged by discount brokers, like E*TRADE and rival Lombard Institutional Brokerage, that use the wide-open information superhighway to offer lower commissions and inexpensive shortcuts to any investor who has a personal computer and a modem.

No money changes hands over the Net--only the trades are transacted over the open lines. A customer must first establish an account, often with cash or securities to cover trading costs. These accounts can't be accessed through the Internet, so hackers can't penetrate them; the worst they can do is make unauthorized trades. The Internet brokers allow investors to monitor their portfolios, retrieve market data from brokerage databases and link them to other business Websites. Fidelity Investments www.fid-inv.com also lets customers play interactive games, like its Guess the Dow Contest. Says William Porter, the founder and chairman of E*TRADE, based in Palo Alto, California: "The Internet lets us leverage our business in a way that old-fashioned brokerages never thought possible."

Because cyberbrokers maintain little support staff, fewer offices and lower overhead, they can afford to lowball traditional brick-and-mortar firms. WealthWEB www.aufhauser.com) for instance, charges less than half as much in commissions as big brokers. If you were going to buy 100 shares of Wal-Mart at its recent price of $25, Merrill Lynch, for example, would charge $78 for the trade. Some cyberbrokers charge as little as $12. Small investor Raymond Pittman of San Francisco figures he has saved $2,000 to $3,000 in fees since switching from a full-service broker to Lombard Institutional.

One thing to consider when trading on the Net: you're on your own out there. Unlike full-service firms, which emphasize personal service and offer plenty of advice, electronic traders keep contact to a minimum. Many bare-bones Internet brokers do not even maintain a customer-support staff, so if you find yourself inadvertently buying 500,000 shares of Buggy Whip Inc., don't expect help to come running. And those that do have help lines often charge for the calls. Charles Schwab permits customers of its new e.Schwab Internet service one free phone call a month to a human broker. Afterward, they must pay $5 for each call. Investors should also watch out for extraordinary postage and handling costs and indirect expenses such as connection time to services, like America Online and CompuServe.

And while the Internet is vast, it is not always fast. Moving from one Website to another takes time and a little luck. "When you place an order over the Internet, you have to cross your fingers and hope that it gets there," says John Markese, president of the American Association of Individual Investors. "Sometimes, you just might be better off calling a broker by phone."

Perhaps the biggest investor error, says Jamie Kiggen, a managing director and Internet analyst at Bear Stearns, is overconfidence. "Many investors fall into the trap of thinking that technology somehow makes them invulnerable or wiser. Nothing could be further from the truth," she says.

Online trading is unchartered territory as well for regulators who are concerned about plans by companies like Spring Street Brewing, which launched the first ever initial public offering on the Internet earlier this year. The New York City-based beer company was briefly forced by the Securities and Exchange Commission to suspend trading until it hired a bank or escrow agent to handle investor money. The offering of nearly 900,000 shares at $1.85 a share was such a smashing success that Spring Street wants to start an in-house brokerage to take other companies public and trade their stocks exclusively on the Internet.

With their core-investor market aging rapidly, firms such as Merrill Lynch and Smith Barney know they have to expand into online trading to find new blood. And fast. The typical client at a full-service brokerage is 63 years old. Online investors are mostly affluent, computer-savvy males whose average age is 41. The big brokerages claim they aren't worried about the upstarts and like to point out that their traditional business is still growing. But the movement to the Internet has tremendous momentum, and Wall Street knows better than to swim against the tide.