How This Broker Can Succeed Now

When E*TRADE Financial (Nasdaq: ETFC  ) announced earlier this year that it was putting itself up for sale in response to pressure from investors, it looked like it might end a long-standing battle among the country's leading discount brokers. But now that E*TRADE is apparently off the chopping block, there's one move the broker with a spokesbaby needs to make right now to assert its status as an independent force in the industry: Establish a partnership to bring its customers commission-free exchange-traded funds from the biggest remaining ETF provider that hasn't paired off with a rival brokerage company.

Reigniting the broker wars
Back in July, it didn't look like E*TRADE would still be an independent entity by now. With hedge fund Citadel as a near-10% shareholder demanding that the company find a potential merger partner, it looked as though the broker would fulfill the long-held expectations of many shareholders and marry itself off to rival TD AMERITRADE (Nasdaq: AMTD  ) .

But yesterday, E*TRADE said that after its strategic review, it would best serve investors by remaining independent. Shareholders weren't happy about the move -- shares traded down nearly 5% after-hours following the announcement.

In order to thrive going forward, E*TRADE needs to get itself back in the game. And right now, there's no better way to jump on the bandwagon than for it to finally enter the broker wars and offer its customers a wide selection of ETFs at no commission.

Come on -- everyone's doing it!
The thing is that E*TRADE is one of the only brokers left that isn't giving its customers free access to ETFs. Schwab (NYSE: SCHW  ) started the trend two years ago by creating its own line of proprietary ETFs to make available to customers. Vanguard followed suit by opening its already-thriving ETF line to brokerage customers, and Fidelity paired up with iShares manager BlackRock (NYSE: BLK  ) to offer a sampling of 25 iShares ETFs to its customers, later expanding its menu to 30.

Slowly but surely, other players fell into line, emphasizing their own particular strengths. Scottrade launched FocusShares ETFs based on indexes from Morningstar (Nasdaq: MORN  ) . Firstrade chose a select group of 10 ETFs that customers could use to build a simple asset-allocation-based portfolio. Interactive Brokers (Nasdaq: IBKR  ) offered ETFs that were suited to the broker's frequent-trading clientele. And TD AMERITRADE, after waiting almost intolerably long to enter the fray, ended up offering a smorgasbord of more than 100 ETFs from several different providers.

For E*TRADE, the answer going forward is simple: Make a deal with State Street (NYSE: STT  ) to offer its SPDR line of ETFs at no charge.

A win-win-win
Consider the impact that such an E*TRADE/State Street partnership would have on the financial industry. For E*TRADE, it would put an exclamation point on its decision to remain independent, making it clear that the company wants to do whatever it takes to compete. For State Street, it would reinvigorate the No. 2 ETF manager, lifting it back up against charging No. 3 player Vanguard and asserting its position against BlackRock as a top ETF industry player. And for customers, having SPDRs available at no commission would make it cheaper and easier to establish an ETF-based diversified portfolio -- and potentially draw new customers away from rivals.

Of course, ETFs alone won't save E*TRADE. With Schwab having recently completed its acquisition of optionsXpress, growth at all costs seems to be the rule of the day. And in a highly competitive industry, having a good selection of popular exchange-traded funds is increasingly a necessity to be considered a serious contender -- and to attract assets from high-frequency traders who are most likely to generate commissions in other areas of the business.

E*TRADE says it has a perfectly good plan going forward. Until that plan includes commission-free ETFs, however, I don't think it will succeed over the long haul.

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Fool contributor Dan Caplinger always wants to see lower costs for investors. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Interactive Brokers Group. Motley Fool newsletter services have recommended buying shares of BlackRock, Charles Schwab, Morningstar, and Interactive Brokers Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy brings you success.


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