Interactive Brokers Group Inc (IBKR) 2009 Q3 法說會逐字稿

Good day, everyone, and welcome to the Interactive Brokers Third Quarter 2009 Earnings Results conference call.

This call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Ms.

Deborah Liston, Director of Investor Relations.

Please go ahead.

Thank you.

Welcome, everyone, and thanks for joining us today.

Just after the close of regular trading, we released our third quarter financial results.

We'll begin the call today with some prepared remarks on our performance that complements the material included in our press release and allocate the remaining time to Q&A.

Our speakers are Thomas Peterffy, our Chairman and CEO, and Paul Brody, Group CFO.

At this time, I would like to remind everyone that today's discussion may include forward-looking statements.

These statements represent the Company's belief regarding future events that by their nature are not certain and outside the Company's control.

The Company's actual results and financial condition may differ, possibly materially, from what's 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 SEC.

I would also direct you to read the forward-looking disclaimers in our quarterly earnings release.

With that, I'll turn the call over to Thomas Peterffy.

Welcome everybody.

Thank you for being here.

As you can see from our results, this was a challenging quarter for our group or market-making activities with many unhelpful dynamics working in unison.

Although I would like to note that due to the vagaries of GAAP accounting concerning foreign subsidiaries, while our GAAP pretax earnings for the quarter were only $133 million, shareholders' equity during the same period increased by $184 million to $4.823 billion or $12.00 a share.

And at the same time, the publicly-held shares now have a book value of $13.63.

Meanwhile our brokerage business continues to expand at an accelerating pace with growing profit margins.

I will review each segment and then Paul Brody, our CFO, will discuss the financials in more detail.

Beginning with Market Making, I will review the various drivers that impact our trading gains and how they behaved this quarter.

First volatility -- actual and implied volatility levels continued their retreat.

The VIX is now in the very low twenties.

As the VIX got below 40, we began to reestablish our customarily long volatility position.

And the ratio of actual versus implied volatility has again become an important factor in our trading results.

Just to refresh, the implied volatility derived from the prices at which options trade in the market so that it determines the price we pay for the options we buy in order to [be long] volatility.

The actual volatility is a measure of price movements of the underlying over time and is a determinant of the trading profits that we derive from this long option position.

As the ratio of actual to implied volatility decreases, our trading results suffer.

As it increases, they improve.

The ratio during the third quarter decreased to 67%, which is an unusually low number, the lowest I can remember.

Volumes -- global option volumes are relatively flat compared to the second quarter and fell 6% from a year-ago quarter.

Our market-making options contract volume fell by 27% from the prior year's quarter, which brought our overall market share to 10.5% globally and 13.4% in the US.

I attribute most of our decreased market share to three factors.

First, as I said before, much of the listed option volume in the past few quarters went to low priced, high volatility financial stocks in which our participation was low.

As these stocks have most recently stabilized, the trading volume is becoming more evenly distributed.

Second, high frequency traders or HFTs as they are often called have been taking an ever larger share of the listed option volume.

I will say a lot more about this shortly.

Thirdly, many of the high volume options are now quoted so tight, often $0.01 wide, that we are no longer on both sides of every market.

Bid/offer spreads -- Bid and offer spreads on option exchanges are another important driver of profits.

As I discussed on the previous quarter's call, we are still witnessing a contraction of spreads, though at a decreasing rate as compared to the first quarter.

I also indicated that we expected to see spreads stabilize in the near term and that actually turned out to be the case.

As published data by US option exchange indicates, spreads contracted further in the third quarter compared to the second quarter by roughly 15%.

However, the trend reversed in September when spreads widened slightly by about 5%.

I believe that for the time being, bid/offer spreads have stabilized and they are unlikely to move much further from these levels either way until the next liquidity event should there be one.

Competition -- competition does not only come from traditional market makers, but also high frequency traders who act like market makers but get certain customer preferences of the exchanges, which gives them a definite advantage.

Effective October 9, the ISC has implemented a mandatory professional trader designation rule, which identifies and classifies HFTs as professional traders, depriving them of customer priority, which they have enjoyed up to now, although they still trade for free while market makers pay exchange fees.

I think it is important for you to understand the exchange model in order to form an opinion of how this issue is going to evolve.

On all of the traditional US option exchanges where more than 90% of listed option trades take place, customers pay no exchange fee and they have priority over market makers at the same price.

So the exchanges generate zero revenues when a customer trades with another customer, including an HFT.

As more and more HFTs came into the market and got priority over market makers, customer-to-market maker interaction diminished and customer-to-customer increased.

Thus the exchanges collected revenues on a smaller portion of the daily trades.

This is the reason the ISC came up with the rule to reclassify HFTs and professionals.

Although they will still not pay exchange fees by being on parity with market makers instead of having priority over them, the market maker trading volume should increase and with that exchange revenues will rise.

The next question is why not have them pay exchange fees just like market makers do?

If you charge them exchange fees, exchange revenues will increase by those fees collected.

But some HFTs may trade less or stop trading entirely.

To the extent that [slows] volume who trades customers who will now trade with market makers, the exchange is ahead by charging fees to the HFTs.

To the extent that volume grows with HFTs trading with market makers, the exchange would lose revenue.

It seems clear to me and I'm fairly certain that the balance is well in favor of charging the fees and that in order to maximize revenues, the ISC will end up charging exchange fees to HFTs for daily trades, possibly at some lower level.

This brings us to the question will the other exchanges, the CBOE and the PHLX, follow the ISC with this new rule.

And as you know, the CBOE is preparing for an IPO and they appear to be unsure if they are better off maximizing revenues or maximizing volume for the near term.

We think that as HFTs are being pushed from the ISC to the CBOE and the PHLX, their customer-to-market maker trades will diminish further, along with their revenues.

That indicates to me that they will have little choice but to follow the ISC.

Penny pricing -- as you know, in September, the SEC approved the expansion of the NYSE's proposed penny pilot, which already covers 63 US option classes and accounts for roughly 50% of industry volume.

The expansion will extend to 300 additional issues spacing over four quarterly increments and ultimately encompass 85% of market volume.

Options quoted in pennies typically have tighter spreads with greater volume and participation from HFTs.

It is too early to predict how this expansion will affect our business since it will depend on how many - how much trading volume will increase due to tighter spreads and how much of our market makers' share will expand as a result of the new ISC ruling to classify HFTs as professional customers.

As spreads and dealer profits are shrinking in the exchange listed space, OTC dealers are riding high, higher than ever before.

I am referring to large bank trading profits.

This is prompting us to evaluate the pros and cons of expanding our market-making activities to include OTC products.

Regulators are inching closer to requiring central clearing and higher reporting of these - and tighter reporting of these products to promote greater transparency.

The proposal to bring OTC derivatives onto exchanges seems to have taken a backseat for the time being, but may gain momentum further down the road.

However, we believe that introducing a central clearing mechanism is a major first step in gaining transparency.

We have come to the point where the playing field is too small on the exchanges and the opportunity on the OTC markets is too big to pass up given our sizable capital position.

With that capital of - well, with shareholders' equity of nearly $5 billion, we are the largest non-bank broker/dealer and well positioned to enter this market.

The opportunity and the need is presented by our expanding brokerage business.

First, as you know, we are already active in the OTC foreign exchange markets where we conduct hedging transactions for our proprietary brokerage customer needs.

We are now going to expand this to OTC ForEx options.

Second, we brought in a small team of corporate bond traders.

Up until now, corporate bond markets on the IB brokerage platform weren't as liquid as our customers would have liked.

With the addition of this team, we are planning to become a more significant presence in this market.

Thirdly, our prime brokerage customers tell us that the need to be able to trade equity-based individual index and basket swaps in order to [prime] with us.

Given the high barriers to entry due to credit and capital considerations and the lessened competition in wake of the credit crisis, this is a very lucrative market compared to the exchange-traded products.

And this brings up to - brings us to Brokerage.

And the recent development in our Brokerage business, which continues to post impressive growth rates that far outpace the industry.

Year over year total accounts have grown 20% and customer equity has grown by an unparalleled 43%.

This exemplifies the fact that a growing number of sophisticated trader seeks to achieve the best execution using our superior trading technology at the lowest possible trading costs.

Although as a whole our customers are only about 50% invested, year to date through September 30, while the S&P had gained 17%, the average equity per customer account grew by 37%.

Savvy investors will continue to seek out the best priced broker that can make a meaningful impact on their performance.

And with our expanding global presence, this effect will multiply exponentially as we enter new countries and activate our brokerage engine.

While brokerage operating metrics continue to shine, financial results are still up slightly from the year-ago quarter when we saw record customer trading volumes.

People are much more cautious about trading than they were a year ago.

DARTs are 10% year over year.

Pretax income is off 11% year over year, but it is flat with the prior quarter.

Brokerage pretax margin has climbed to 51% from 48% in the year-ago quarter.

We are extremely excited by the accelerating growth of our brokerage business as measured by customer equity.

Customer equity is up 43% year over year and 17% over the prior quarter.

Our target customer base of financial professionals understands the impact of low financing rates and low transaction (inaudible) on greater returns.

Finally, after all of these years, there is a buzz about IB among professional traders and investors.

Finally they are beginning to believe that what we say about our brokerage platform is not just advertising, but the advantage we give them in the cost, execution, quality, and market access are true and very significant.

Looking at the day-to-day increase in our customers' equity is the highlight of my morning routine.

To increase our penetration among financial professionals, we developed our employee track program.

Financial institutions must monitor their employees' personal trading activities.

Working with the compliance staff of several institutions, we have developed online monitoring and periodic customized reporting capabilities.

We are now in the great position where compliance personnel is helping us market our brokerage platform to our target audience, the financial professional.

With a similar purpose in mind, we developed the Interactive Brokers order management system for broker/dealer trading desks.

This system is now installed at five sites, at Bernstein, FBR Capital Markets, GFI, Cantor, and a large hedge fund.

And we are in conversations with other potential users.

In addition to numerous additions and upgrades to our global brokerage platform, I would like to point out two significant steps that we have taken in the past quarter.

I'm sure you have heard there has been a great deal of attention by securities regulators focused on the securities lending market with a demand for greater transparency and centralized trading model.

Quadriserv's AQS platform addresses these concerns and we believe it will be a critical component of our total offering that will help fuel our prime brokerage business.

We are just in the process of completing full integration of this electronic securities lending platform into our trading and brokerage systems.

Our trader workstation now displays the best borrowing and lending rates that are available in the market for each stock and our customers can now borrow or indicate their own rates at which they like to borrow a stock.

If you want to look at this, please remember that the stock loan market closes before 11 a.m.

The lending side we are still working on and expect to bring it online soon.

The transaction are cleared by OCC so that they become the counterparty to each trade the same way as in listed auctions or in listed single-stock futures.

Several other large member firms have also joined, which will add liquidity to the platform, which is key to its success.

Also pending acceptance by [AFFA], we are introducing our complementary free market data service for noncustomers on the iPhone.

Our customers can already access most of our services on the iPhone and now noncustomers may also receive market data from over 80 global exchanges, charts, screening, and price alert services for free.

The noncustomer data is delayed from those exchanges that charge for real-time market data, but it is up to the moment for other things like foreign exchange codes and all price alerts.

We are currently working on offering the same service for BlackBerry users.

Finally, I'd like to provide an update on our international activities and reiterate that Asia presents our biggest opportunity for growth in brokerage where we face little or no competition in terms of servicing professional traders that seek a global platform and can benefit from that trade execution.

In Japan, although our acquisition of Moriai Securities gave us a jumpstart in securing exchange membership and licenses and we have just received or membership in the Osaka Exchange, we are still facing some hurdles to becoming a direct member of the Tokyo Stock Exchange.

We opened our representative office in Shanghai last month, although we are not allowed to solicit from here, but we may talk to potential customers who come there and ask us various questions.

In India, we are still working on our membership in the Bombay Stock Exchange and our license is to provide brokerage services to nonresidents in India and for any institutions.

We are active at the National Stock Exchange and we are servicing Indian citizens residing in India.

I will now turn it over to our CFO, Paul Brody, to discuss the financials.

Thank you, Thomas.

Welcome, everyone, and thanks for joining the call.

As usual, I'm going to review our summary results and then we'll discuss the segments before we take questions.

Our overall operating results for the quarter, as you can see, were down from the third quarter of 2008 as a comparison period, the year-ago quarter was a time of great market turmoil that drove record trading volumes in all product categories.

In addition, interest rates were nearly 2% higher than in the current quarter, which produced higher net interest income in that quarter.

Electronic brokerage remains a bright spot as we repeated the strong results of the second quarter.

Market-making revenues were down sharply, but were partially offset by a decline in noninterest expenses.

The variable costs of execution and clearing were lower than in the year-ago quarter, reflecting both a drop in derivatives volumes and a shift in trade volumes to products with lower costs or liquidity rebates.

Overall operating metrics were mixed this quarter, but were solid in brokerage.

Average overall daily trade volume was 909,000 trades per day, down 7% from the year-ago quarter.

Market-making trade volume was down 9% from the prior-year quarter, reflecting primarily a decrease in listed options volume for reasons that Thomas discussed earlier.

Electronic brokerage metrics were strong this quarter.

The customer base continues to grow as total customer equity increased 43% to $13.4 billion.

While volume was off from near all-time high of the year-ago quarter, total customer DARTs were down 10% and cleared customer DARTs were down 9%.

Volume from cleared customers who clear and carry their positions in cash with us and contribute more revenue continues to account for about 90% of total DARTs.

Net revenues were $272 million, down 45% on the year-ago quarter.

Trading gains were $155 million, down 57% from the same period in '08.

Commissions and execution fees were $89 million, down 9%.

Net interest income was $15 million, down 51% from the third quarter of '08.

And other income was $13 million, up 83%.

And that's primarily on a non-recurrence of a write-down in our Hambrecht investment that we took in '08.

Noninterest expenses were $138 million, a decrease of 8% on the year-ago quarter, driven by lower variable costs.

Our aggressive expense management has kept our fixed costs fairly stable.

Within the noninterest expense category, execution and clearing expenses were $70 million, a decrease of 16% from the year-ago quarter.

This reduction in variable costs came from both Market Making and Brokerage as volumes shifted towards stocks where exchange and clearing fees are generally lower and liquidity rebates can be higher.

Compensation expenses were $43 million, a 9% increase on the year-ago quarter, reflecting growth in staff count.

At September 30, our total headcount was 794, an increase of 9% from September 30 of '08 and 6% from the year-end 2008 count.

We continue to expand staff at measured pace, looking to hire talented people, especially in the areas of software development, trading and risk management, and customer service.

As a percentage of net revenues, total noninterest expenses were 51%.

And out of this number, execution and clearing expense accounted for 26% and compensation expense accounted for 16%.

Our fixed expenses were at 25% of net revenues, which is above our target range and obviously a direct result of lower revenues in the quarter.

Pretax income was $133 million, down 62% from the same quarter last year.

For the quarter, Market Making represented 55% of pretax income and Brokerage represented 45%.

These proportions shifted from 82% for Market Making and 18% for Brokerage in the year-ago quarter.

And while this is a reflection of the poorer results in Market Making, it also reveals a robust quarter in the Brokerage business.

For the third quarter, our overall pretax profit margin was 49% as compared to 70% in the third quarter of 2008 and 58% in the trailing quarter.

Market Making pretax profit margin was 50%, down from 79% in the year-ago quarter.

Brokerage pretax profit margin was 51%, up from 48% a year ago and nearly even with the historical high of the second quarter of '09.

We continue to view this diversification of the revenue streams as positive development in the long-term growth of our business.

Diluted earnings per share were $0.20 this quarter as compared to $0.65 for the third quarter of '08 and $0.31 for the trailing quarter.

Turning to the balance sheet, the balance sheet remains highly liquid with relatively low leverage.

And we actively manage our excess liquidity and we maintain significant borrowing facilities through the securities lending markets and with banks.

In response to the credit market environment, we continue to hold a higher level of cash on hand, which can be seen on our balance sheet.

This provides us with a buffer should we need immediately available funds for any reason.

We also continue to maintain well over $1 billion excess regulatory capital in our broker/dealer companies around the world.

Long-term debt-to-capitalization at September 30 was 3.7%, which was down substantially from 9.1% at year-end '08 and up slightly from the prior quarter.

Our consolidated equity capital at September 30, '09 was $4.82 billion.

Now I'll turn to the segments beginning with Market Making.

Trading gains from Market Making for the third quarter of '09 were $148 million, down 58% on the year-ago quarter.

Net interest income from Market Making was $1 million, a decrease of 86% on the year-ago quarter, but an improvement from the $5 million net interest expense of the trailing quarter.

Net revenues from Market Making were $150 million, down 58% from the third quarter of '08.

Mixed trading volumes -- down in options and futures, but up in stocks -- led to a 10% decrease in the variable costs of execution and clearing, our largest expense category, which amounts to 57% of noninterest expenses in Market Making, from the third quarter of '08 to $43 million.

Pretax income from Market Making was $75 million, down 74% on the year-ago quarter.

Turning to Electronic Brokerage, customer trade volumes were healthy.

Though down 5% from the outstanding levels of the year-ago quarter, customer accounts grew by 20% over the total at September 30, '08 and by about 5% in the latest quarter.

Total customer DARTs were 340,000, down 10% from the third quarter of '08 and 1% sequentially.

Our cleared customer DARTs, which generate direct revenues for the Brokerage business, were 307,000, down 9% on the year-ago quarter and 3% sequentially.

Customer equity grew to $13.4 billion, up 43% from the year-ago quarter and 17% sequentially.

The source of this growth continues to be a steady inflow of new accounts and customer deposits and so far in 2009 profits by customers as well.

We believe this reflects the continuing trend of customers transferring their accounts to Interactive Brokers for safety and security as well as for our advanced execution services.

In order to foster this growth, we have developed new software and staff who specialize in the customer onboarding process, and we are achieving higher new customer funding rates as a result.

Trade volumes resulted in revenue from commissions and execution fees of $89 million, a decrease of 9% from the year-ago quarter and 1% sequentially.

Net interest income fell to $15 million, down 27% from the third quarter of '08.

Lower benchmark interest rates have continued to compress the spreads earned by our Brokerage unit on customer credit balances.

Average US interest rates measured by the overnight Federal Funds rate, were about 0.2% during the third quarter of '09 as compared to about 2% during the third quarter of '08.

Our net interest income, which historically we have relied upon less than other brokers do, fell to 12% of net revenue from 15% in the year-ago quarter.

However, this represents a slight improvement on the trailing quarter, and our growing customer cash balances position us well for any increase in interest rates.

Net revenues from Brokerage were $122 million for the quarter, down 10% from the third quarter of '08, but up 1% sequentially.

As with our Market Making segment, execution and clearing fees account for a large part, 45% in the case of Brokerage, of our noninterest expenses in Brokerage.

Based on the mix of trade volumes across product and customer types, these variable costs decreased to $27 million for the quarter, down 27% on the year-ago quarter and 1% sequentially.

Total cost of execution and clearing arises from several factors, including declining options volume from non-cleared customers, which is a lower profit margin business, the proportion of customer orders that provide liquidity, which results in fee rebates from the exchanges and ECNs, and the mix of options, futures, and stocks.

In particular, we saw a sharp 86% increase over the year-ago quarter in shares of stock traded by our cleared customers.

Our real-time risk management systems operated well during the quarter and there were no unusual errors or reserves for bad debt.

Pretax income from Electronic Brokerage was $62 million for the third quarter, down 3% on the year-ago quarter and level with the second quarter of '09.

We believe the fundamental factors for continuing to grow our low cost automated brand of brokerage are in place and we are encouraged by the steady expansion of the customer base.

Now I'd like to turn the call back over to the moderator and we will take questions.

Thank you.

The question and answer session will be conducted electronically.

(Operator Instructions).

And we'll go first to Rich Repetto with Sandler O'Neill.

Yes, good evening, Thomas, good evening, Paul.

Good evening, Rich.

I guess the first question is it seems from on the Market Maker, there was a couple things that if you put it in broad terms, the competition and narrow spreads being one and then the other thing being the - something that's in the - the actual being much, much lower as a ratio than the implied volatility, and I was just trying to get - I know you can't break this out, Thomas, but if you had to attribute the lower gaining trades to one or the other, which do you think played a bigger factor?

Just the competition in the spreads or this --

Well, if you want to look at the deterioration for quarter to quarter, then it's the volatility ratio was a greater [problem] really.

If you want to look at the deterioration from the year-ago quarter, then it's the smaller spreads.

Okay.

So all in all, if that ratio would've been better, you would've seen results probably as good as last quarter then on a very - the sequential - the prior quarter comparison.

Right, probably close to it, yes.

Okay.

And then I'm just trying to see the -- like you pointed out, spreads did in September start to expand slightly, like you predicted.

And I was just wondering, any big variation in the inter -- the monthly results as far as the market making profitability?

Well, we -- if -- as you know, we publish quarterly results and we don't narrow them down.

Okay.

Fair enough.

And I guess my last question is you mentioned this and I know it's a complex subject, but the impact, you said that equity went up by $184 million, even though I believe pretax was $133 million, and I know, Paul, this is not easy to review on -- but could you just go through, I'm assuming it was foreign currency translation being the issue and the difference.

That's right, Rich.

We're essentially saying that we hold as you know, we target to hold our equity in a basket of currencies.

And when those currencies appreciate against the dollar, then our equity goes up.

And it - to the extent that it is our - the equity of our foreign subsidiaries growing in value, then it shows up in the balance sheet according to GAAP, not in the income statement.

So in this particular quarter, it obviously hurt you in the reported - on your reported income and pretax income and net income.

Is that - if we went back to the prior quarter, I know we could just look and find the translation, but if we looked at the change in equity versus -- and the change in your pretax income, I got a feeling it's going -- they move in different directions and I guess trying to see whether this is a big - bigger differential than usual.

It did not have a large impact on the income in this quarter.

And we'll -- as you know, we'll report that in the 10-Q.

Understood.

We wanted to give you a little bit more color in advance.

Okay, that's all I have.

Thank you very much.

Thank you.

We'll go next to Chris Allen with Pali Capital.

Good evening, guys.

Can you hear me?

Yes, yes, sorry.

Yes.

Thomas, you talked about the new rule being put in place by the ISC, but on the last conference call, you mentioned that there was going to be problems in terms of measuring - the brokers measuring high frequency trading customers' activity.

Can you just expand?

Has your thinking changed around the ability to measure their activity levels?

Well, I actually do not know what procedure the ISC is using to identify which trades belong to HFTs.

We understand that there is some cheating that goes on and -- but we also hear that people tell on each other.

So it's a -- I don't have any hard data for you on this.

Okay.

And I guess putting it another way, it sounds like you have increased confidence, though, that they'll be able to enforce the rule.

Is that a fair statement?

I think they eventually will enforce the rule, because it goes to their bottom line.

So they will have to.

They have this funny loyalty to -- the exchanges compete with each other on share of the US option volume.

So it's very hard for an exchange to swallow the idea that they will go from second place to third place or whatever because those are bragging rights.

On the other hand, the net income, nobody knows.

Nobody ever hears about because these exchanges are subsidiaries of larger companies.

And up until the CBOE, if it goes public without becoming a subsidiary of the Merc, then we will hear about it.

But if the Merc idea goes through, we will never know.

Got it.

And then just one other question, just on the expansion into adding the corporate bond team into FX options, I would imagine that these expansions are not very material right now.

Is that a fair statement?

They are not very material right now, but, you know, if we carry through with going into the OTC swap dealing, then we expect them to be a substantial business.

Got it.

Thanks a lot, guys.

Thank you.

We'll go next to Edward Ditmire with FPK.

Is the spread dynamics in the market making business relatively uniform globally?

And can you detail the performance of the US market making business versus the international business?

It is fairly uniform.

And I would prefer not to get into breaking out the different geographies, because we are already an open book to our competitors.

Gotcha.

And then I'm sorry if I missed this earlier.

Did you discuss the tax rate?

It seemed like an unusually high tax rate this quarter.

We didn't discuss, Ed, sorry, but as we've discussed in the past, there is an element of the tax expense that comes from the benefit, the tax benefit that is built into our - the structure that we created at our - at the time of our IPO.

And as a result of that -- and I'll try to explain this without being too longwinded.

The result of that is that a fixed tax expense is reported in the income tax expense line every quarter.

It actually represents a benefit that's being taken in real tax terms.

When the income is lower, as it is this quarter, that fixed number appears to be disproportionately high.

And that's what you'd see in a quarter like this.

Okay.

And is there any real reason you think that in the coming quarters that your tax experience will be any different than say it was up until this quarter over the last couple of years?

We have no reason to foresee it changing much.

As we've explained also in the past that it -- there -- it's somewhat dependent on where our earnings are realized, in what tax jurisdictions, as to how they are taxed in the United States.

And that does affect what shows up on our income statement.

But we have no way to predict that, because the way the market-making operation is run, a kind of integrated market making around the world, there is a somewhat random element as to whether profits are earned here or there.

And then one question for Mr.

Peterffy -- it seems like what - in the past you've talked about the dynamics and the spreads as being highly cyclical and due to the nature of that low returns thin the competitive landscape and high returns attract it.

It sounds like what you're saying right now is that perhaps there's a bigger structural element to the low returns and that's why you're prioritizing new markets and new products more so than in the past?

Well, that is partly, only partly the reason.

The -- we are more attracted by the huge profits we see the big brokers harvesting here.

And don't forget that as our capital approaches $5 billion, we have to look at other opportunities.

So it is not that -- well, as I have said before, there are a number of structural changes that have taken place in the listed market, such as the penny quoting and the competition by the HFTs.

I do not -- I can't quite see where that HFT or professional trader designation will take us all, but even though I believe that their advantage will be diminished, it will not completely disappear.

So it sounds like what you're saying is that there's probably a good deal of upside in the legacy business from a reversion of some of the cyclical omens that are currently working against you, but perhaps the spreads don't get as wide as they have at other points of the cycle in the past.

We will not see years as good as '08.

Thanks guys.

We'll go next to Mac Sykes with Gabelli & Company.

Good evening, guys.

Hi.

If we could just circle back to the over-the-counter opportunity, can you just describe when -- the timing of that in terms of revenue?

Is that something you're thinking about for the latter part of next year?

And then what would be some of the requirements?

Would it be additional personnel, knowledge, or technology that you would need to sort of facilitate that or the sort of the catalyst for that business?

Well, if you look at the swap markets, there is basically not a heck of a lot we would have to do to our trading system in order to be able to quote them and keep track of positions.

What is more unpredictable is where these rules will actually end up.

Now our early information is that there will be legislation sometime by very early next year based on which swap dealers will have to register, and that they will have to register with the SEC if they are dealing swaps that are securities-based and with the CFTC dealing in swaps that are commodities-based.

There will also be legislation that will require the SEC and the CFTC to promulgate capital requirements and haircut rules for swap positions on the books of swap dealers within 180 days after the enactment of the legislation.

So that -- also most swaps will be required to be cleared by clearinghouses.

So all of this adds to a point where what we see is that there will be more transparency in the market that is dealing with stocks and baskets and indexes, which we are very, very good at and we are currently dealing with.

On the other hand, there will also be important capital requirements, which very few dealers next to the current swap dealers will be able to meet other than ourselves.

So that's why we feel that this is a logical expansion of our business at this time.

Great, thanks.

And we'll go next to John Rowan with Sidoti & Company.

Good evening.

Paul, I know you gave - you talked about the - how the variable costs shifted on a quarter - a year-over-year basis.

But can you explain why there really wasn't a decline in operating costs on a sequential basis when the revenues were down 20%?

Well, the primary factor in the decrease is from the variable cost of execution and clearing.

So that's exchange fees and clearing fees primarily, a little bit things like SEC transaction fees.

But it's highly dependent on the actual mix of products, because as we described in the past, for example, executing a futures contract has an entirely different expense associated with it, a high expense, than executing 100 shares of stock.

In fact, executing 100 shares of stock may even generate a rebate rather than a fee.

So there are a number of moving parts in the product set between options, futures, and stocks that have to come together to determine what that blended expense is.

And so it was fairly stable, down a little bit sequentially, right, but down more significantly year over year, because as you can see, a lot of -- one of the reasons is a lot of the volume was pushed into stocks.

You said the volumes were pushed into stocks, but that's year over year.

But on a -- looking at the quarter over quarter, the -- your brokerage clearing expense fees aren't down that much when obviously your trading volume and your trades were down quite a bit.

Was there a shift into a more expensive product versus the June quarter?

I don't believe our trading volumes were down quite a bit from the previous quarter.

Well, market-making trades were down.

Yes, but remember -- the trades are one measure, but the volume that is contracts and in terms of options futures and shares in terms of stock is a better measure because that's what the fees are based on.

Okay.

And just two housekeeping questions -- can you give me the full average diluted share count and also just make sure that the ownership is still 10.4%?

Approximately 10.5% and the share count is - if you look in the release, you'll see it on the page with the (inaudible) --

41 million, 920 thousand something I remember.

41,000,000, but you mean but --

(Inaudible -- multiple speakers)

-- you didn't give the --

41,920,000 --

41,923,518 is the diluted share count.

But it's stated right in the release.

Yeah, but what about the full share count?

I mean, it's obviously - I mean, before that, the fully diluted share count was closer to 400 million.

And it still is.

It's - it - okay.

All right, thank you.

We'll take our next question from Milan Gupta with Southpoint Capital.

Hi guys.

So I just wanted to follow up on that previous question on your guys's foray into the OTC markets.

It sounds like a big chunk of that is contingent on some of these rules and legislation coming through.

In other words, if they don't come through like you guys are anticipating, you might not enter those markets.

I wouldn't say that.

I think that we are going to enter - well, we are considering entering these markets.

And whether the legislation comes about or not, that is not going to be one of the considerations.

If -- in other words, if there is no new legislation whatsoever, we will enter into these markets.

If the legislation is favorable, we will enter.

If there is some legislation that makes it prohibitive, then we won't.

I understand.

I guess in the past you've been reluctant to enter the OTC markets.

And I understand the legislation would help you get comfortable with the risk parameters around some of these markets, but I guess if the legislation doesn't happen, you're still considering entering.

How do you get comfortable given your previous hesitation to enter some of these markets?

Well, given that everybody's more under the magnifying glass now, at least as far as the larger brokers are concerned.

I don't think that the counterparty credit risk is as bad as it used to be.

Secondly, any deal we would enter, it would be the kind where there is an agreement to pay and receive variation margin and marking to market every day.

And also even if there is no legislative change on these swap deals right now that the curve between US counterparties there is an initial margin of roughly 10% posted by both sides.

So the counterparty credit risk is greatly diminished as things stand today, provided that you are dealing with US entities only.

Got it.

That's very helpful.

And then secondly the other question I had was just sequentially the cleared DARTs are down, your accounts are up nicely.

What do you attribute the sequential fall to?

Sequential, sorry?

The sequential drop in the volume?

In DARTs, yeah, and on the brokerage side.

Well, people were very hectic a year ago and the market was extremely volatile at this time last year, and there was a lot of trading.

So people roughly were trading twice as much as they do today.

No, I know, but sequentially I guess.

Eventually it - what is that?

Since the last quarter.

Oh, oh.

Oh, oh, I tell you, we have many of our new accounts are financial advisors.

And they trade substantially less than - per account than individual traders or money managers do.

I mean, like proprietary traders and --

Yes, got it, got it.

Thank you.

Thank you.

We'll go next to [Mauricio Vladkins], private investor.

Good evening.

I would like to ask you to expand a little bit on the issue of shares outstanding, basic, diluted, and the number of shares owned by what is called in the balance sheet as non-controlling interest in subsidiaries.

And I would also like to understand why the public shares have a different value of equity per share than the others.

Yes, so to the first question on the non-controlling interest, I would point you back to our original SEC filings where there is a diagram on our corporate structure.

But I can tell you that our operating company has two owners.

One is the public company, which owns about 10.5%, and the other is called IBG Holdings, LLC, which is owned by the private former owners of the whole operating company.

That is what is represented by what is called the non-controlling interest.

GAAP rules actually changed a little bit.

They used to be called minority interest.

It is now known as non-controlling interest.

But it is the same thing.

With regard to your question on the book value, the answer is that the public company's book value per share is somewhat higher because, again, as I mentioned before, there is a tax benefit that was built into the IPO structure, a tax benefit that accrues to the public company.

It is essentially similar to goodwill.

It's captured over time in the lower taxes paid by the public company.

There is an agreement between the public company and IBG Holdings, the 90% owner, to pay 85% of any tax benefit realized in cash over to the private company as it's received, which means that the public company retains 15% of the tax benefits over time that it otherwise would not have an opportunity to keep.

That is the primary reason - that benefit, which will accrue over time, is the primary reason why the public book value per share is higher than what you would compute as the total.

Well they also - they - in addition, there is - we pay dividends quarterly to the owners of the private company so that they can pay their taxes.

And the public company receives dividends pari passu and the dividends exceed - so far have exceeded the public company's tax obligation.

So as a result, the public company is sitting on some - a chunk of cash.

I see.

The second question is if whether you intend to release information on the market making part of the business monthly as you have started to release on the brokerage part --

We will never do that.

Okay.

Thank you.

Thank you.

Thank you.

We'll go next to Rob Rutschow with CLSA.

Good evening.

Hi.

I just wanted to ask another question on the spread information that you gave.

It looks like your market share in the US was pretty flat from second quarter to third quarter and --

It went down a bit.

I'm sorry?

Went down a little bit.

Yes.

Right.

So I guess I'm wondering if - historically you've kind of shied away from the activity in the very low priced stocks, which I feel like made up a bigger percentage of third quarter volume than they did in the second.

And you can correct me if I'm wrong there.

But I guess I'm wondering if that was the dynamic that was the increase in spreads we saw a result -- the increase in spreads that we saw in September, was that a result of less activity in those lower priced stocks?

That's partly the result.

I mentioned three reasons and that was one of them.

You have to understand that with very low priced stocks, the options are very inexpensive, so the spreads are very tight, and the tighter the spread, the easier it is for a HFT to compete, because as the volume of the contract itself, the spread by itself is a larger amount and on a very low contract, we have to pay something like a $0.20 exchange fee where the penny - where the spread - bid/offer spread is only a penny wide, so even if we had there both sides of the market all the time, it's - half of the profit would be paid out to the exchanges.

So it's not a good deal for us to compete in those things.

Okay.

Well, I guess the reason I asked was that I was kind of surprised that your market share was as high as it was given that dynamic.

Right.

Okay.

I guess most of the other questions have been asked.

It seems like the pace of hiring has slowed a little bit.

Is that something we should look for going forward?

That's not intentional.

We are anxious to hire qualified people.

Okay.

And last question, do you guys generate a significant amount of your market making options volume from other online brokers?

No, we only - the only - so far, we only market make on exchanges.

Okay.

But they don't route any of their volume to you or --

I can't hear you.

I --

They don't use you to access the options markets?

Well, we do execute for certain other brokers, yes, but that - we are not more likely to trade with them than people who execute through other means.

Okay.

All right, thank you.

We'll go next to Patrick O'Shaughnessy with Raymond James.

Hey guys, a couple of quick questions for you and then I'll let you go.

I don't think you mentioned this -- have you gotten an early read and I think the 10 or 11 trading days since the ISC mandatory professional designation went into place?

Has your market share in ISC increased since that's gone into place?

Or is it just too early to tell?

It's too early to tell.

I was worrying that you'd answer that with that response.

Perhaps something that you can address --

Because I also don't know to what extent the rules are being followed and how they are enforced.

I know that nobody has been penalized up until now for not following the rules.

And I understand from the ISC that they will not levy any penalties in the first quarter of this experiment.

All right.

And presumably you haven't seen a very substantial jump in your market share at this early point?

Not that really jumps at us, right.

Fair enough.

And then on the second and last question I had was with the SEC talking about banning flash trades, not just in equities markets, but also in options markets, potentially that could impact the traditional pro rata exchanges like CBOE and ISC where if I recall correctly, you tend to do a little bit better.

So is that a market structure issue that also concerns you looking forward?

You know, we do worry a little.

Our participation in receiving flashes is very small.

And we do not - it wouldn't impact us if they banned it because you see, the idea was flash trading is that some people see the flashes and then they front run it in another market, which we believe to be illegal.

And so we've never done it.

And so I don't expect that to have an impact on us.

Fair enough, thank you very much.

Thank you.

Thank you.

We'll go next to Justin Hughes with the Philadelphia Financial.

Good afternoon.

Thank you for taking my question.

It's been a long call, so I'll try to make it quick.

On the OTC clearing, I'm just wondering where are you going to source business from?

Because in your market-making business now, you get business when you have the best bid and the best offer on an exchange, but OTC business is usually more of a direct customer-facing relationship, so...

It is a customer-facing relationship.

We have some existing relationships with larger hedge funds that would like to see come competition in the marketplace.

And so that is where we would be starting.

Okay.

I mean, is that just a handful of accounts at that - at this point so we don't overdo it --

Yes, but they are large.

Okay.

And then the second question on OTC trading, investors have always had kind of peace of mind that all of your trading was done on exchange and centrally cleared.

And if we look at companies that are kind of similar that have done OTC trading, whether it be MF or FCStone, inevitably these products are less liquid and blowups happen.

How can you avoid that where others have kind of fallen into pitfalls.

Yes, FCStone got into the trouble they got into because they were clearing for an option market maker and they didn't understand options.

Okay.

Thank you.

And we are talking about swap markets here that are very simple.

They are just plain delta trades.

Okay, thank you.

Thank you very much.

Okay, we are done.

One more?

We --

Thanks everyone.

We'd like to thank you for participating today.

This call will be available for replay on our web site and thanks again for your time.

That does conclude today's call.

Thank you for your participation.