Interactive Brokers Group Inc (IBKR) 2007 Q2 法說會逐字稿

Good day everyone and welcome to the Interactive Brokers Group, Inc. second quarter 2007 conference call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to [Alexander Isle], Chief Financial Officer of Electronic Brokerage. Please go ahead, sir.

Thank you for joining us today for our second quarterly conference call as a public company. As you may have noticed, since our initial earnings report we listened to requests from our investors and we have made available additional information that our investors find useful. This includes historical quarterly financials and operating data which can be found in our SEC filings and on our website. We will continue to provide similar information in the future.

After remarks reviewing our performance by Thomas Peterffy, CEO and Chairman of the Board, and Paul Brody, CFO of the Group and the Director, we will be happy to answer your questions.

At this time I would like to remind everyone that today's call may include forward-looking statements. These statements represent the Company's beliefs regarding future events that by their nature are uncertain and outside of the Company's control. The Company's actual results and financial condition may differ possibly materially from what is indicated in these forward-looking statements. For a discussion of some of the risks and factors that could affect the Company's future results please see the description of risk factors in our filings made with the Securities and Exchange Commission. I will also direct you to read the forward-looking disclaimers in our quarterly earnings release.

Now I would like to turn the call over to Thomas Peterffy.

Welcome everybody. As you have seen in our published results in the second quarter we have enjoyed unparalleled growth in our brokerage business. Our pretax brokerage income grew over 51% from the same period last year, and brokerage now constitutes about one-quarter of our business.

Our success is propelling us forward in building out our prime brokerage capability. We expect to see continuing strong growth in our brokerage business.

The market making business also showed growth over the same period last year, but it was marred by the Altana event in Germany. This entailed the price manipulation of a stock that has announced a significant distribution, and it resulted in widespread losses across the market making community.

Subsequent to this event TP Holdings, through which I hold my ownership of the Company, purchased the Company's claims for the amount of the loss, which was $37 million. I own about 75% of the Company, so it was a lesser expense to me.

Many of you have asked why I bought the claim. I did so because I am certainly extremely upset about the situation, that somebody would cook up a manipulation like this, and actually hope to get away with it. This may not be an easy case to pursue, and spending a lot of money on legal fees may not necessarily prove to be a good investment that would be prudent for a public company to make. As an individual, I'm in a much better position to go after this public company [that did this].

This is $1 billion heist in broad daylight, and it is possible that all I will get out of going after them is material for a financial thriller. But if nobody does after this kind of illegal behavior that will encourage fanatical people to keep looking for other holes where market structure peculiarities, in combination with price manipulation, could result in a big win. I would like to emphasize that as a result of the sale of this claim the event has no monetary impact on the Company -- zero.

In the second quarter we focused on identifying and cutting back our low margin business where we felt that competitors are piggybacking on our technological capabilities. In brokerage we eliminated certain institutional customers who they're paying for order flow. In some cases these customers are simply trying to gain the system, collecting order flow payments on [groceries, scratches and wash tail]. Our best execution algorithm are more strict than what other executing brokers use, and accordingly we're not willing to match payment for order flow rates provided by some of our competitors.

Some of the eliminated customers are broker-dealers who were using our executing -- who were using us for executing complex orders that they will be otherwise unable to execute, and therefore unable to offer to their customers in competition with us.

In market making we reduced the size of our quote in certain products and changed our systems to provide less liquidity. We are now providing less liquidity in the face of suddenly rising demand until the urgency subsides. We have done this for two reasons. One, it is our defense against traders who are front running corporate news on inside information. And two, and more important, we find that more and more often they are institutional customers competing with us on our quotes.

Even the current market structure at most exchanges institutional customers have priority over market makers of the same price. They pay no exchange fees, and they receive payment for order flow. It is a situation where we make the price and they do the trades, and they get paid for it. We want to reduce their ability to compete with us on our prices, and we do that by moving away more quickly.

You'll note that our volume has decreased. These are the reasons that it has decreased. Please note that these are temporary measures. We have taken these measures until options trading incentives take hold. Currently 16% of the national volume trades incentive classes. Our experience is that while the national volume in these classes has expanded by 40%, our volume expanded by 101%, and our profit per contract declined by 31%.

There are many more price point incentive classes and market participants with inferior technology are less able to compete with us. Trading in pennies is our answer to the ever mentioned issue. The SEC considers the penny pilot a success. They have asked the exchanges to expand the pilot to include enough of the next 50 higher volume classes to cover 35% of the national volume by September 28 of this year.

The remaining classes will be added on March 28 of next year. At that time 63 classes with the highest volumes will be trading in pennies. That will constitute approximately 58% of the U.S. national volume. In addition to expanding to new products and exchanges internationally, preparing for more trading in pennies in the U.S. is going to be our focus in the immediate future.

I would like to now hand it over to Paul Brody to discuss financials.

Thanks everyone for dialing in. I will review our summary results and then I will discuss the segments before we take questions.

We had a very strong quarter in the Electronic Brokerage business and a sound quarter in market making. In addition to our GAAP results we have presented non-GAAP operating earning which exclude non-recurring items, because we believe these items are not indicative of Interactive Brokers Group's operating results. I will describe these in somewhat more detail.

As Thomas discussed, the Altana loss and the sale of the related claims were unusual events that are non-recurring in nature. While the loss is treated as a GAAP loss, the payment to the Company for the sale of the claims is not treated as GAAP income because it was made by an affiliate of Interactive Brokers Group, and is instead treated as a capital contribution. However, regardless of this accounting treatment, the sale offset the loss, and the event had no monetary impact on the Company, therefore both events are excluded from our operating results.

In addition, we recognized a net gain or approximately $11 million, including interest, from the recovery of income taxes previously overpaid to the UK Inland Revenue. This is a transfer of our operations from the UK to Switzerland, income for a three-year period beginning in 2002 was not taxable in the UK, but was instead taxable in Switzerland. The recovery amount reflects the net of amounts receivable from the UK Inland Revenue and payable to the Swiss tax authorities for these periods. This non-recurring item is also excluded from operating results.

With reference to our financial statements both of these items affected the Market Making segment. Together with the corresponding adjustment to income taxes, excluding these items, increased pro forma diluted earnings per share for the quarter by $0.05.

Turning to our operating data. In market making trade volume was up 47% compared to the second quarter of 2006, although contract and share volumes were down, indicating a smaller average trade size. In Electronic Brokerage total customer DARTs were up 14% from the second quarter of '06, and clear customer DARTs were up 13% from the same period. Between the segments on a GAAP basis market making represented 71% of pretax income, and brokerage represented 27%, with the remaining 2% in corporate and eliminations. On an operating basis excluding non-recurring items, market making accounted for 76% and brokerage 22% of pretax income, with the remainder again in corporate and elimination. These proportions compared to 82% for market making and 18% for brokerage in the second quarter of '06.

Net revenues for the quarter were $294.7 million on a GAAP basis and $337 -- $330.7 million on an operating basis, up 1% and 14% respectively quarter over quarter. And by quarter over quarter I refer to the second quarter of '07 versus the second quarter of '06.

Trading gains were $150.3 million on a GAAP and $187.3 million on an operating basis, down 15% and up 6% respectively from the same period in 2006. Position and execution fees were $60.3 million, up 32%. And net interest income was $61.5 million, up 29%.

Noninterest expenses were $130.2 million, up 3% quarter over quarter. Compensation expenses were $28.9 million, up 7% quarter over quarter. As a percentage of net revenue on an operating basis total noninterest expenses were 39.4%. And out of this number, execution and clearly expense accounted for 24.6%, and compensation expense accounted for 8.7%.

Pretax income was $164.5 million on a GAAP basis and $200.5 million on an operating basis, which was level with the same squatter last year on a GAAP basis, and 22% higher than the same period last year on an operating basis.

Our overall GAAP pretax profit margin was 55.8%, while our operating pretax profit margin was 60.6% as compared to 56.5% in the second quarter of '06, and 57.5% in the first quarter of '07. On a GAAP basis the pro forma diluted earnings per share were $0.28, and on an operating basis the pro forma diluted earnings per share were $0.33.

At June 30 '07 our total headcount was 555, an increase of 11.9% from June 30 '06 and 2.8% increase from March 31, '07.

Our balance sheet remains highly liquid. Our long-term debt to equity at June 30 of '07 was 10.2%. And our equity capital in the form of redeemable members interest at June 30, 07 was $3 billion.

I will turn now to the segment results and start with market making. As you can see in our operating data, although trading volumes were up a substantial 47% over the second quarter of '06, contract and share volumes declined. This in part reflects our reduction in quote sizes for the reasons Thomas expressed earlier, as well as trading in pennies.

GAAP trading gains for the second quarter of '07 were $143.8 million, down 17.3% quarter over quarter. Operating trading gains, excluding non-recurring items, were $180.8 million, up 4% for the second quarter of '06 and down 6.6% sequentially.

GAAP net interest income from market making, which accounted for 72% of total net interest income, showed continued strong growth coming in at $44.2 million, an increase of 29.6% quarter over quarter. This is driven by the continuing integration of our market making systems with our securities lending system.

GAAP net revenues were $189.4 million, down 10.6% from the second quarter of '06, while operating net revenues increased 6.4% to $225.4 million from the second quarter of '06. Lower trading volume pushed down the variable cost of execution in clearing trades, our largest expense category, by 9.7% from the second quarter of '06 to $49.1 million.

GAAP pretax income for market making was $116.5 million, down 13.4% quarter over quarter, while pretax income on an operating basis was $152.5 million, an increase of 13.4% from the second quarter of '06, and a decline of 1% sequentially. Clearly the reduction in variable expenses in the period improved upon the topline trading days.

Turning to Electronic Brokerage, our brokerage operations have continued robust growth, which is reflected in all of the primary metrics for this business. Customer accounts grew by 19% over the total June 30, '06 and by 5% for the current quarter. Trade volume is the primary driver for the brokerage business, and total customer DARTs grew to $236,000, or 14%, over the second quarter of '06. In fact, as Thomas mentioned, this figure includes the elimination of certain institutional customers to whom we made payments for order flow. The more relevant measure is cleared customer DARTs which grew to $189,000, or 13%, quarter over quarter, and roughly even with the first quarter of 2007.

In addition, average commission per DART increased 17% to $4.86 over the second quarter of '06. We believe this reflects our success in attracting larger professional customers.

Customer equity grew to $7.4 billion, up 45% from the second quarter of '06 and up 7% sequentially. Revenue from commissions and execution fees was $60.3 million, an increase of 31.7% quarter over quarter and 7.1% sequentially. Average net revenue per account on an annualized basis increased 11% to a little under $4,700 from the second quarter of '06.

Net interest income rose to $20.5 million, up 61.4% from the second quarter of '06 and up 12.6% sequentially. Interest income in our brokerage business is primarily a function of customer cash and margin loan balances. Our goal is to provide the best interest rates to our customers as part of our suite of professional trading tools. All of our interest rates are set at published spreads from benchmark rates, and we believe they are the most favorable in the industry.

Net revenues in brokerage were $100.8 million for the quarter, up 32.3% from the second quarter of '06 and up 6.7% sequentially. As with our Market Making segment, execution and clearing fees account for the majority, approximately 58%, of our noninterest expenses in brokerage. These variable costs were $32.2 million for the quarter, up 13.4% quarter over quarter. However, we benefited from the reduction in volume due to discontinuing certain institutional customers mentioned earlier. As a result, execution and clearing fees, which include payments for order flow, dropped by 13.2% compared to the first quarter of 2007.

Pretax income from Electronic Brokerage was $44.8 million for the second quarter, up 51.9% quarter over quarter and up 29.1% sequentially.

That concludes the financial summary, and we will now entertain questions.

(OPERATOR INSTRUCTIONS). [Brian Tolerine], LPL Financial Services.

Congratulations on the good quarter. I appreciate that Mr. Peterffy has a little bit deeper pockets than the normal person, but I assume you can't buy a $37 million loss every quarter from the Company. I understand that you have put some governors on the volume to try to protect yourself. If those governors were in place during this insider trading scheme, do you have any idea how -- instead of a $37 million loss would it have only been a $10 million, or a $5 million, or a $20 million? Can you give any gauge on that, the success that this lower liquidity I think that Mr. Thomas Peterffy described it as, how that would have helped?

The other thing, I don't understand why it is so difficult to catch these guys. It seems like somebody if is investing their money and buying some options you ought to be able to -- it ought to be pretty simple to trace it back to the person that invested the money. So maybe if you give me some insight -- I am a shareholder, I'm not an analyst. So those are my two questions. Thank you.

As far as the $37 million situation is concerned this was not an insider trading case. This was a situation in which a company paid out 74% of its volume in dividends. The way the German Exchange treats this dividend, as far as adjusting the outstanding option contract is different than how it is done in the U.S. In the U.S. all the striking prices are decreased by the amount of the dividend. In Germany you take the price after the dividend, you divide that into the price before the dividend. That gives you a multiplying factor, and you divide the strike prices by that factor and multiply the outstanding options. It is just very complicated.

At any rate, it would come to roughly the same amount with one exception. On the close somebody sold 31 million shares into the market. This was more than 50% of the float on this stock. That sale knocked the price down by roughly 25%. So therefore all the options were adjusted by this new closing price instead of what it would have been otherwise. And subsequently the next day the stock opened over 50% higher.

So this was not an insider trading situation. It was a well thought out scheme that appears to me at least to be market manipulation. It is not difficult to find out who did that trade for the exchange. It is difficult for us to find out until the exchange concludes its investigation if they believe that there was manipulation we will -- the name will be revealed to us. Otherwise we will have to find maybe some other way to figure out who did it. So this had nothing to do with insider trading.

As far as governors are concerned, it was not an issue of a governor. This -- you could not have hedged for this circumstance. And so that is the situation. In my thirty-year career I've never seen anything like this happen. I also never have seen a company that paid out 74% of its volume in a dividend. This kind of a situation can only happen in these very unusual circumstances where several of these events come together.

As far as your other question was concerned, which had to do it insider trading, was it, as to why they don't catch these people. Well, I really don't know what to say to you about that. We did have a meeting just quite recently with the SEC, a large meeting where we have suggested some modification to the insider trading rules because the fact is that it is a mystery who is -- where the insider information comes from. Ultimately it must be coming from the people who work on the transaction. Maybe not directly, probably indirectly. But it is what it is. Thank you.

(OPERATOR INSTRUCTIONS). Rich Repetto, Sandler O'Neill.

I guess first on the broker. So you stopped -- maybe I'm -- doing business with certain customers. And it appears these customers just weren't profitable then if you are paying them payment for order flow and your profit improved as a result of not doing business with them, I guess. Is that fair?

These are institutional -- these are broker-dealers who used our execution system to execute their option flow. Some of them had customers that I guess they didn't police very hard who were basically doing business just for generating payment for order flow. That is some of the authorities.

There are other brokers for who we have been executing complex orders. These are well-known online brokers who do not have the capability, but they like to offer the capability to their customers, and we're the only ones who can execute for them. So we have been doing that for some time. But we used to have additional order flow from them. They have asked us to raise the amount of monies that we were paying for that order flow. And it wouldn't have worked for us, so we decided to stop it. And therefore we also decided to not continue the complex order execution.

The end result was good for the -- I'm just trying to see is there any more of these types of customers and sort of filtering to be done in the future?

Some of these customers have come off in the course of the quarter, so the impact was not fully reflected in the quarter. And, yes, we obviously are now looking at this much more diligently, because it came to us -- we were quite unprepared for this kind of business.

Understood. I know you don't get give forward-looking statements, but it is reasonable -- these weren't onetime events and the results in the margins were recurring. It could improve, I guess is I'm trying to say.

I understand what you're trying to say.

I will go to the next question then. On the market making side you did put on -- sort of reduce the quote sizes. I was just wondering, how do you do that? Do you do that across the board or where you suspect that there is some activity or -- I'm just trying to figure out how you do that?

Right. We have focused mostly on the high [gamma] options that tend to be relatively close to expiration and not very far from the market.

So then it isn't -- it is not triggered by anything -- suspicion that --?

No, no, no. We wouldn't know how to do that. We generally reduce the amount of liquidity we are providing.

Did you feel net net the trade-off was positive, or do you think that right now you are -- I'm just trying to see -- do you think the trade-off was positive here?

Net net the trade-off is neutral to positive from the point of our results, but it is certainly positive as far as not extending a helping hand to people who do not have pricing systems so they piggyback on our prices and use the market structure -- basically can build a business with our technology.

Got you. The last question has to do with what you viewed in the penny pilot test. Obviously, your results are every positive to you, but just -- I know you're the market maker I believe for the Russell option at the IOC. Again, it seems like the big volume increases have been in these indices options. And I guess my point is as it expands do you think you'll see this same -- I think it was 80% or 100 -- did you say 100 or --?

It was 101% for us, the volume increase.

Right, I would think that was skewed towards the Russell, because --?

It was skewed towards indices. But don't forget in the next 22 classes there will be five indices os we don't expect a very different picture.

You are very excited. And if you put up 100% increase in volume and a 30% contraction you're well ahead the game?

Yes, we like it.

You voted yes then with the SEC?

They didn't ask us, but we certainly were lobbying for it. Yes.

That is all I had for the moment. Thanks.

[Steve Zamachello], Third Millennium.

First of all I want to congratulate you on adding Larry Harris to your Board of Directors. Larry is a real out of the box thinker. And he also has some clout in Washington. That is a pretty unusual combination.

At the Sandler breakout session, I had asked you about is there anything you can do with technology to try and identity these traits in advance -- do something that could take and insure you. And I know like in Las Vegas they have -- they go to elaborate measures to go ahead and identity card counters, knowing they don't want to be the other side of that bet. And they look for really elaborate patterns and all kinds of things. Is there some sort of pattern recognition, unusual volume trends, things that you could do that would be early warning indicators that basically would say, we better slow down taking the other side of this guy's trade?

We just prefer to stick to our knitting and do what we are good at, and that is building technology for our brokerage platform and market making in a world where on the longer run I think everybody will be observing the rules.

I guess the answer is no, you still don't think there's anything you could do technology wise to stop getting run over.

Maybe it could be, but it is not something that we focus on.

[Robert Needless], Susquehanna Capital.

Just very big picture, after the last quarter on the call you said it was kind of a down quarter. We have those things bounce around. So this time, even adjusting for the situation in Germany, it is still relative to what you have been doing the past couple of years, the revenue growth is a lot less. What combination of factors is that if you blend in pulling back the orders from the institutional customers, and whatever else you want to throw in, is it just another down quarter or are you hitting a wall on some of your growth drivers, or what is going on?

market making is not -- it doesn't proceed in a straight line. There is more variability in market making than there is in brokerage. The reason for that is fairly simple. Every time we make a trade we make roughly the same amount of profit per contract [use]. This is very much like a commission.

But in the brokerage business after the trade the client owns the position and in the market making business we own the position. Just like the client who makes or loses money on that position, similarly we also make or lose money on that position until we are able to match it up with an opposite trade.

We are running our market making business so that our positions are very well hedged, but nevertheless we have an exposure. Our positions are subject to a limited degree of random fluctuations in price. The fact is that those random fluctuations tend in their entirety to move against us. This is because many of the traders on the opposite side of our trades are acting on good research and are well-informed about corporate or industry development.

The end result is that, while we make a fixed amount of profit on the average trade, we lose at least half of that profit on the resulting position before we are able to pass out of it, even when this takes place within a few minutes. As I have said, this loss is subject to random fluctuations, and accordingly there is an element of randomness in our market making P&L. So that is all I can tell you about that.

That's very clear. Thank you.

John Schneider, WR Hambrecht.

It is Paul and Alex. Congratulations on the quarter. I just had a quick question on how your success has been on attracting hedge funds to the prime brokerage platform in the second quarter?

It has been rather good. We had a number of prime customers in the pipeline, and we are -- we have turned on two so far. But we have at least 10 that we are our working with and hope to turn them on within the next -- I'm sorry -- I'm not supposed to talk about it. It has been good.

That's great news. Thank you very much.

Brian Tolerine, LPL Financial Services.

I appreciate you trying to explain that trade from Germany. Going to this question, the analyst just mentioned this Vegas example to ferret out cheats. If a trade has all of the earmarks of an insider trade, is there any way you could refuse to settle that trade if there is an investigation and then --? I know that could have a chilling effect, but it ought to only have a chilling effect on the cheaters or those who facilitate their trades. They wouldn't go to you.

Pending the outcome of an investigation, say we're not going to settle this trade. We will keep it over here in limbo. It is not going to create us a loss. And then when the investigation is over, if you're cleared, then we will settle it.

That would be wonderful. We trade on exchanges, and on the other side of our trades we have other exchange members. And we are all members in good standing. We have no idea who those members' customers are. And in many cases even those other brokers don't know who their customers are. So it just won't work like that.

Okay, pardon my ignorance.

It is a good idea.

Rich Repetto, Sandler O'Neill.

Just to follow-up here, and I guess this is Paul. I'm just looking -- and I think you mentioned a couple of reasons why the expenses were down in the quarter, which is very good. I'm just trying to see how -- when you look at it compared to the first quarter you dropped $8 million or $9 million in execution and clearing the variable expense. You dropped $4 million in comp. I'm just trying to see is that the explanation for that? I'm trying not to ask a forward-looking question.

I understand. You're right on the $8 million to $9 million, which is the bulk of the reduction in executing and clearing. That is the variable cost of executing trades. As we said, that is directly related to the volume -- not the trade volume, but the contract and share volume. And so that reflects the reduction on the market making side. And as well what we discussed about institutional customers dropping off some of that volume, which is not a bad thing.

On the compensation and benefits line there were some adjustments made as a result of having become a public company, and a new employee stock incentive plan as to what GAAP requires us to record. And so there were some minor adjustments there. But we would expect consistent employee comp expense line going forward.

At the second quarter level rather the first quarter?

Yes.

I guess, Thomas, you have grown this business dramatically, and the other caller talked about potential maybe slow down, or what appears as slow down. I guess I'm just trying to see what your optimism -- like where do you -- how do you feel about the changes in the business and how optimistic you are at having taken the business from nothing to a multibillion dollar company here now?

The fundamental premise of our business is that we focus on building technology, building technology for market making and brokerage. We have been doing that for 30 years. The business doesn't grow in a straight line. In some years it grows faster, in some years it grows slower. Our growth is influenced by outside factors. Our focus on building our technology is completely under our own control, and we grow our technology at a more consistent rate year after year.

On the long run it is always the case that the greater our technological advantages, the better we do relative to our competitors. We believe that the slower growth in our market making is temporary, and that our technological superiority will prevail again.

This quarter that technological advantage was expressed more by the unparalleled growth of our brokerage business, what we have seen from published figures from other brokers showing year-on-year earnings growth mostly in the single digits compared to our 50% growth points to this fact. It is the technology that allows us to, for example, to marginal customers real-time, minute-to-minute online, and to get through a day like this without any credit losses. It is this technological advantage that enables us to execute 1,232,000 trades today without any problem.

That is very helpful. I guess the one fault, and I'm done after this, is that the gap or the lead -- the technology advantage you have over competitors, I guess, do you feel like it is the same today as it was -- if you look in the past, you were the first to automate -- you brought automation to a lot of the option exchanges. It is very easy to look backward, but your advantage because you are the only one, or you were the leader, was so wide. But now we see almost everyone in the market, and you have plenty of algorithmic traders and is that -- are you as excited about that advantage of the gap between you and the competition as you were early on?

You see, there is no visibility in the market making space. We do not know what sort of technology other people have. There is great visibility in the brokerage business, at least as far as the monoline brokers who only do brokerage, many of them are on online. We can see what they have, and we can see what we have. And you can see what we have. And there is an immense amount of -- there is a huge technological gap between us and anybody else that we can see. And we are focusing on that gap, and we are driving it to be bigger and bigger and bigger. And I think that eventually we will have a very unique global brokerage firm that will be completely reliant on technology and nobody is ever going to touch us.

Great. Thanks, Thomas, that's helpful.

Edward Ditmire, Fox-Pitt.

Mr. Peterffy, can you tell us at all about the second quarter was essentially the first full quarter that you guys were advertising portfolio margining as far as what your experience has been with that, both in terms of how it has helped acquisition trends, as well as maybe profit per account for those that have adopted it?

I don't that have the exact figure. I think the figure is --?

It is close to 1,000 accounts.

Close to 1,000 accounts that have elected portfolio margining. And the money under (multiple speakers). It is some hundreds of millions of dollars. I am sure that those accounts are able to have larger positions now. And that means that they are -- they must be trading more. And we clearly see that the trades that we are processing are larger now than they were before. This may be partly the impact of portfolio margining. It is probably also the impact that we have from the fact that our customers now tend to be larger than what we used to have.

I have another question. Can you expand a little bit on why you think that penny priced options will allow you to shake off these customer competitors that are free writing on your quotes? Because what I don't understand is that presumably they will still get the preferencing, the free exchange freeze, and then also the payment for order flow advantages. Can you kind of expand on why you think this creates a real dividing line in the experience?

I'm happy to. You understand that when you can only move in $0.05 increments, you -- what you basically do, you figure out a very precise bigger offer. And then you have to round it to the nearest price that is acceptable. So your underlying price keeps moving around, but it keeps getting rounded to the same price, because it is either up or down and it has to be to the nearest nickel. Once you are at the nearest penny you'll move more. You understand that?

Yes.

You'll move more, and accordingly it is more difficult for somebody to come in and copy you in the belief that they will do the trade before we will do the trade, so we will not move up until we had our fill. So he can come in. He will do the trade first. And then he can move back and forth and buy and sell in the belief that we're going to sit there for a while anyway. Right?

Whereas if we can move a penny at a time, we will move a lot more so it is going to be a lot easier for him to -- a lot more difficult for him just to copy us. And if the trade goes against him to turnaround and undo it with us. Don't forget that in this situation we're offering -- he is offering -- he can sell some. If he doesn't like what happens, he can turnaround and buy from us, and he still makes money because he gets payment for order flow.

One more question. This is more for the CFO. Can you tell us on a fully diluted basis what the latest quarter, how it went? What you think the best tax rate to assume going forward would be?

I estimated our tax rate is about 34%. But remember and we have been through the analysis before, and I understand it is a little bit complex. That the tax benefit built into our corporate structure, which arises to the extent that an amount over book value is paid for the public shares, gives rise to a fixed amount of tax benefit over 15 years. And on a quarterly basis that fixed amount is $4.1 million.

As a result, if you look at our pro forma statement, what you will see is an adjustment to the tax to arrive at the pro forma public earnings per share. This quarter it was $5.4 million. And so that represents two components. One is a fixed $4.1 million, which is really an accounting entry. And the remainder $1.3 million this quarter represents the real cash tax that will be payable.

Steve Zamachello, Third Millennium.

Tom, you mentioned that you were sort of reducing your exposure in the market making business. And I guess that means in the nickel quote, not the penny quote. And you were doing so I guess by widening your spread and reducing your size, is that correct?

No, we didn't widen our spread. We just reduced the size.

Just reduced the size. And part of that is response to the market structure issue that you have with hedge funds who get priority?

That's correct.

Was the other part of it also these insider trading things, these corporate news front running things, is that the motivator as well?

Right.

The penny -- moving to pennies is going to help you fend off hedge funds, but it is not going to help much on the front running of corporate news, is it?

That's correct.

I keep beating this thing like a dead horse, but it is hard for me to believe that there is nothing you can do about it.

About the front running of insider --?

Yes, about like early warning (multiple speakers).

Inside information.

Yes, that technology-wise you can't do an early warning thing and reduce your size and start running away like the house does in Vegas?

I must tell you I have never been to Vegas. I'm not a gambler, I am a computer programmer.

You're more like -- you are like the book in Vegas. You take the other side of the bet.

Yes, but I have come to this from a very different direction. Our issue is to build technology for the long term, to make this a solid growing Company. We cannot expand our energies on trying to deal with people who are engaging in illegal activities. I think the regulators sooner or later will take care of them. We are into the long-term prospects for this business and that is what we have to work on.

[Eric Bell], T. Rowe Price.

I have a very simple question. If I were to frame the ideal environment for your business, would be fair to say it is one with high volatility and low, or below, average number of corporate events, i.e. LBOs, etc.?

You're right.

So my words, not yours, it would seem that the current environment very much fits that bill. Am I missing something there?

No, that is what it looks like today. Yes.

That is all the time we have for questions. I would now like to turn the conference back over to our speakers for any closing remarks.

This is Alexander Isle again. We would like to thank you for participating today. This call will be available to replay on our website in a couple of hours. Thank you again for your time. Good night.

Thank you everyone. That does conclude today's conference. You may now disconnect.