Seth Merrin launched Liquidnet Inc. in April 2001, to bring institutional buyers and sellers together and enable them to negotiate trades anonymously. The firm is ranked as one of the top 14 largest NYSE institutional brokers and the 15th largest Nasdaq broker; Liquidnet's members represent more than $6.8 trillion in equity assets under management. Last year, the firm's average daily volume reached 20.2 million shares, more than double its 2003 level. After nearly ending up in the restaurant industry, Mr. Merrin found himself on Wall Street, where he eventually became a risk arbitrage trader, working closely with computer consultants to create programs to make his job easier. Still, he was spending more time on manual tasks and less time actually trading and thinking about the art of trading. To rectify this situation, Mr. Merrin came up with the idea of an order management system, which led to his founding Merrin Financial Inc. in 1985. Mr. Merrin spoke recently with Pensions & Investments reporter Gregory Crawford about his Wall Street roots, the success of Liquidnet and what it means for institutional investors.
Q Where did the idea of Merrin Financial come from?
A I started out in the training program at Oppenheimer Co. They put me through rotations … ultimately in the risk arbitrage group.
The owners sold Oppenheimer and formed a hedge fund and I went with them, and I became head trader of the risk arb group. It was there that I got the understanding of trading. … Ultimately I pitched the idea of an order management system (to my boss).
He bought it and got me another couple of clients, and in 1985 I formed Merrin Financial. In 1987, Merrin Financial created the first order management system.
Q 1987 was a rough year.
A At that point nobody knew whether they were going to stay in business, and they certainly didn't want to hear from a 26-year-old kid that you could save them a few bucks. ... Going into 1990, we had all of nine clients ... not a raving success. But in 1990, the whole outlook changed, and people started investing money. In 1990, we signed 18 clients alone. … I sold Merrin Financial to ADP (Automatic Data Processing Inc.) in 1996 and worked there for a couple of years. In 1998, I just quit, and I was moping around trying to figure out what my next life was going to look like.
Q Is that how you came up with the idea for Liquidnet?
A I had tried to figure out the solution to institutions' liquidity problems, but I wasn't the first to figure out that they had a problem.
The one missing piece that I couldn't figure out — nor could anybody else … was how to create a critical mass of liquidity on day one. Traders will try something, but they're not going to stick around if they can't get execution.
I was lying in bed one night, not particularly thinking of anything, but it was that Eureka! moment that the final piece of the puzzle came together. … I drew everything out on a diagram, I called Eric LeGoff, who's our COO, and just handed it to him without saying a word. He looked at it, all the lines connected, and he said, "This is it." That was October 1999.
Q What was "it?"
A Eric and I had been brainstorming about our next venture together. "It" was the idea we had been looking for. So what we did for the next couple of months was go and hit some industry bigwigs like the chairman of CIBC Oppenheimer … the chairman of Neuberger & Berman … all people we knew.
We said, "Look, this is what our idea is … we'd like you to blow holes in it." And they couldn't blow any holes in it. So then we asked them to be on our board of directors, and they all agreed. And we asked them to put up some money, and they all agreed. That was January 2000 — that's when we knew we had a company.
So we got office space. We started putting together a prototype, and we started going out and trying to validate it with some trading friends. … The good news was that they gave me a meeting; the bad news was that they didn't want to be there. But they pretty much instantaneously understood that we had something. They blew holes in it. But one thing led to another.
In March that year (2000), we raised our first round of venture capital. From the time we raised the money, we had to hire the people, spec out the product, build the product, (test) the product, sell the product and install the product; we were up and running in 14 months.
Q So it's been smooth sailing?
A There were three years of famine. Our business plan never contemplated a 9/11 or an Internet implosion or a telecom implosion or a research scandal or an accounting scandal or a prolonged bear market. It was nasty. I was in a bad mood for two years.
Then when all of that seemed to have been over — all the other stuff seemed to come down, like (New York Attorney General) Eliot Spitzer shining a spotlight on not only (mutual fund) trading and payment for distributing funds, but the whole research scandal. Those were a lot of reasons people gave us for not being able to do business on Liquidnet, because they had to pay for research … they had to pay these brokers who sold their funds. Some of this stuff is outlawed now.
Q Are you in a good mood now?
A All of that stuff is a huge wind at our backs, and any type of regulatory restructuring they make — all the trends are clearly in Liquidnet's favor.
Take the trend toward electronics to begin with. If the regulators mandate more electronics, it's good for us. If they mandate trading in the (bid/ask) spread, that means there's not a broker on earth that's going to commit capital anymore, and the only place you're going to be able to go for a block trade is Liquidnet.
It's all good.
Q How can Liquidnet help pension funds?
A Every dollar saved in trading costs is worth as much as a dollar in performance. If there's anybody … where it's most directly applicable, it's pension plan sponsors.
These people have been trying to figure out a way to cross stock between themselves forever. Liquidnet is that solution. And it's not just between themselves, it's between 250 participants globally, and growing. This is something they've thought of on their own that they've never been able to do. They save on commissions, but where they really save is on market impact cost, and that goes directly to the people they serve.
Q With Liquidnet on firm footing, what are your plans for the company and yourself?
A This is an unbelievable company — from the people to the culture. It's just fun to work at. Merrin Financial was a 10-year venture — that was the only other company I was CEO of. This company is five years old, we've got enormous potential left and just a tremendous amount left to do.
I'm not what people would consider a serial entrepreneur — I don't just start businesses to sell them. I think that's stupid. I enjoy running the business.