Wholly Owned Subsidiary of Reuters Group PLC
Incorporated: 1967 as Institutional Networks Corp.
Sales: £525 million (US$845.25 million) (1999)
NAIC: 52312 Securities Brokerages; 52321 Securities & Commodities Exchanges; 52393 Investment Advice
Instinet Corporation operates the largest of a number of privately owned electronic communications networks (ECNs) that act as alternatives to traditional stock exchanges. Officially a broker-dealer, it is a member of many exchanges in North America, Europe, and Asia. Known for its low trading costs, Instinet allows clients to enter orders onscreen and trade anonymously with fund managers, market makers, and exchange specialists nearly 24 hours a day in more than 40 markets around the world. It also offers a variety of advanced electronic research and analytic services to its clients.
Institutional Networks: 1967-85
Instinet was founded by Jerome M. Pustilnik and Herbert R. Behrens and was incorporated in 1967 as Institutional Networks Corp. The founders aimed to compete with the New York Stock Exchange by means of computer links between major institutions such as banks, mutual funds, and insurance companies, with no delays or intervening specialists. Through this Instinet system, which was operating by 1970, the company provided computer services and a communications network for the automated buying and selling of equity securities on an anonymous, confidential basis. It also acted as a securities information processor, supplying professional-level market data systems containing last sale, quote, and size information. Institutional Networks received income from commissions on the trades and from the rental of the Instinet terminals located in the offices of its clients.
By early 1971 Institutional Networks had more than 30 clients, including the Chase Manhattan, First National City, Morgan Guaranty, Manufacturers Hanover, Wells Fargo, Bank of America, and Bank of New York banks, United States Trust Company, and the Prudential, Metropolitan Life, All-State, and Aetna Life insurance companies. Other clients were mutual funds, self-administered trusts that corporations operated for their employees, and “third-market makers” who did not trade on exchange floors. An Institutional Networks subsidiary, INC Trading Corp., was, in 1983, a member of the Boston, Cincinnati, and Pacific stock exchanges and was also a member of the National Association of Securities Dealers, the operator of NASDAQ.
Institutional Networks lost money every year until 1981, although its revenue nearly tripled between 1978 and 1980, from $548,000 to $1.59 million. In 1983 Instinet still had no more than 110 institutional clients. “Pension-plan sponsors thought of market makers and specialists almost like sharks,” one of the original designers of the system later told Institutional Investor in 1987. “They didn’t want the buy side against them, even thought the trades were supposedly anonymous.” (A market maker buys and sells stocks on exchanges, earning a fee from the difference, or spread, between bid and ask prices.)
In 1983 William Lupien, who succeeded Pustilnik as president, and some partners invested $5 million in the company in return for slightly more than 20 percent of the stock. Lupien decided to market the system wholesale through market makers, specialists, and broker-dealers of over-the-counter stocks as well as institutional investors. By the fall of 1984 the Instinet system was carrying bids and offers on 3,500 stocks on every exchange in the United States, and by the following spring it was connecting some 500 broker-dealers—including 19 of the 20 largest—specialists, and financial institutions. In 1984 four big U.S. brokerage houses purchased 14 percent of Institutional Networks for $11.2 million, including warrants to buy another 11 percent of the company.
Instinet’s clients could call up a stock on a video terminal screen and check the price quotes, market by market. If the client decided to make a trade in an unlisted stock, it was carried out instantly; if in a listed stock, there was a 30-second delay while the information was transmitted to other broker-dealers. Large institutional trades were carried out through a terminal-conducted negotiation between buyer and seller.
Institutional Networks was renamed Instinet in 1985. By late 1986 its subsidiary, INC Trading Corp., had added the American, Midwest, and Philadelphia stock exchanges and the Chicago Board Options Exchange to its membership roster, and over-the-counter trading accounted for 20 percent of its average daily volume of 2.7 million shares in 1985. Revenues grew rapidly, reaching $16.4 million in 1986, but expenses increased faster, and Instinet lost money during 1983-86—a record $3.7 million in 1986.
Growing Reuters Subsidiary: 1987-94
One company that saw a bright future for Instinet was the British news-gathering agency Reuters, which in 1985 had negotiated an agreement to offer in all countries outside North America Instinet’s automated trading system for U.S. equities, American Depositary Receipts, and options. Reuters also purchased six percent of Instinet’s stock. In November 1986 Reuters Holdings PLC announced it would seek to buy all Instinet shares it did not already own, an offer valued at $102 million. Instinet joined the London Stock Exchange that year.
Reuters held a 49 percent interest in May 1987, when Instinet shareholders approved a proposed merger with Reuters, under which Instinet became a subsidiary of the British company but remained based in New York City. Lupien resigned as chairman and chief executive officer shortly before the end of 1987. A Reuters spokesman attributed his resignation, and that of Murray Finebaum, president and chief operating officer, to “differences of management style,” according to a Wall Street Journal reporter. The spokesman added that the departing executives “were not particularly happy to be part of a management structure required for a large company such as Reuters.” Michael Sanderson succeeded Lupien as chief executive officer.
After the 1987 Wall Street crash, even more institutions gravitated to the system as a way of cutting costs. “Too many money managers found themselves chasing too few pension dollars and focused on the cost of their business, especially the cost of trading,” an Instinet executive told Michael Peltz of Institutional Investor in 1995. Still, proprietary trading systems such as Instinet accounted for only a few percentage points of trading volume. To stimulate further growth, Instinet, in December 1987, introduced Crossing Network, an after-hours trading system that matched buy and sell orders at the day’s closing price. Participants were divided into four categories kept separate by personnel and computer linkup to assure each client that its traders would not be dealing with other traders—such as market makers and specialists, for example—who might have superior information.
By 1990 the Instinet network was beginning to make an impact on trading in Europe. A member of the International Stock Exchange, Instinet UK catered to British market makers and institutional investors and, in May 1990, added selected leading European stocks to its trading network.
In 1991 Instinet introduced Market Match, a new electronic equities trading system that used a volume-weighted-average system. This pricing method was based on the dollar value of a stock’s daily trading volume divided by the number of shares traded that day on the consolidated tape and NASDAQ. The service was aimed at individual investors as well as managers of large index funds, marking the first time an electronic trading system had targeted retail investors, although such individuals did not have direct access.
It was the increasing power of institutional investors, however, that fueled Instinet’s growth. By late 1995 the network had 5,200 terminals around the world and was reportedly handling 70 to 80 million shares a day. It accounted for about 20 percent of NASDAQ’s daily trading volume and an amazing 60 percent of the trades in NASDAQ’s 100 largest stocks. Revenues rose from $57 million in 1991 to $279 million in 1994. Much of this business came from customers who preferred the anonymity of the electronic system to trading through NASDAQ’s 500 or so market makers, who mostly transacted their business by telephone before entering the trades into the exchange’s SelectNet computers. Moreover, Instinet posted completed trades immediately, while there was a 90-second delay on NASDAQ screens. Furthermore, Instinet had a bottom-line advantage; a 1994 survey found Instinet to be the cheapest means of executing trades.
Instinet also offered related products, not only after-hours trading but also an order management system and a research and analytic package. Its New York and London offices included personnel called “facilitators” who helped new customers learn to use the system and notified clients when stocks in which they had shown an interest became active. Instinet bought members of the Paris, Frankfurt, and Zurich stock exchanges in 1993, and also acquired Thamesway, a broker with sizeable operations in Asia. Trading outside the United States was accounting for only 15 percent of the company’s revenues, however.
To serve our clients in equity trading, Instinet sets the standard as the premier global provider of unique agency brokerage services.
Responding to Competition: 1995-99
Instinet’s revenues reached $327.1 million in 1995. It was the third largest U.S. market—busier than the American Stock Exchange—and accounted for 18 percent of the trades of over-the-counter stocks. Douglas Atkin succeeded Sanderson as chief executive officer in 1998. By this time Instinet was a member of 17 exchanges and had eight offices worldwide. During Atkin’s six years in charge of international operations, revenues outside the United States had grown three times as fast as sales within the country, where Instinet was facing pressure from competitive electronic systems such as Island, Terranova, and Trade Book, some of them even faster and cheaper. In September 1999 Island outstripped Instinet, for the first time, in quantity of NASDAQ trades. Fears that Instinet was losing its long-secure market led to a sudden 15 percent drop in Reuters stock in October 1999.
To drum up more business, Instinet signed a 1999 agreement to allow E*Trade Group Inc.—the nation’s second largest Internet broker—to trade on its system for 2½ hours after the New York Stock Exchange and NASDAQ closed at 4 p.m. Instinet was conducting about 12 percent of its trades before and after regular market hours. The company had recently won approval from the Securities and Exchange Commission to serve as a broker-dealer to individual investors.
In 1999 Instinet took a 16.4 percent stake in Archipelago Holdings LLC, a smaller electronic communications network that was applying to become a full-fledged stock exchange and thereby compete with the New York Stock Exchange. Atkin said that Instinet would likely eventually shift some business from the New York Stock Exchange and NASDAQ to Archipelago. Earlier in the year, Instinet had joined with some of the same financial services companies that invested in Archipelago to acquire Tradepoint Financial Networks PLC, a struggling British electronic stock exchange registered to trade British stocks in the United States. Instinet also took an 11.4 percent share in W.R. Hambrecht + Co., a San Francisco-based operator of online auctions for initial public offerings (IPO) of stock.
The Hambrecht acquisition indicated that Instinet intended to enter the IPO trading market. It was also expected, during the first half of 2000, to begin offering trading to retail investors, with related services such as mutual funds, credit cards, and mortgages, and also to begin handling trades in bonds and other fixed-income securities. The retail operation was not expected to compete with online deep discounters such as E*Trade on commission costs but rather to serve, at a premium price, active and professional traders willing to pay for performance. Reuters was also said to be considering a possible initial public offering for Instinet.
Instinet’s revenue increased from £446 million (US$740.3 million) in 1998 to £525 million (US$845.25 million) in 1999. U.S. equities accounted for nearly 80 percent of total revenue in 1999, but international revenue grew by 39 percent. Its operating income fell from £155 million (US$257.28 million) to £129 million (US$207.69 million), however.
Instinet Australia Limited); Instinet Canada Ltd.; Instinet France SA; Instinet Japan Limited; Instinet Pacific Limited (Hong Kong); InstinetGmbH (Germany); Instinet(Schweiz) AG (Switzerland); InstinetUK Limited (U.K.).
Bloomberg LP; Datek Securities Inc.
- Company is incorporated as Institutional Networks Corp.
- The Instinet system is operating by this year.
- Institutional Networks is profitable for the first time.
- Broker-dealers as well as institutions now use Instinet.
- Instinet becomes a subsidiary of Reuters Holdings PLC.
- Instinet trades make up 18 percent of NASDAQ’s volume.
- About 12 percent of its trades are outside market hours.
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——, “Instinet to Invest in an ECN,” Wall Street Journal, July 28, 1999, pp. C1. C15.
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