Dow Jones

E-Trade Group Inc.’s latest acquisition would give it stock-trading muscle but could provoke questions about how the firm serves its online investor clients.

The Menlo Park, Calif., firm agreed last week to buy Dempsey & Co., a Chicago trading firm, for $173.5 million in cash and stock. For the first time E-Trade would have a hand in how its customers’ orders to buy and sell stock are actually executed. It would be able to process some of the orders in-house instead of routing them elsewhere.

Such “internalization” has been criticized as compromising brokers’ commitment to providing “best execution” of their clients’ trades. Keeping a big portion of customer orders under its own roof could subject E-Trade’s execution practices to more scrutiny if investors feel that Dempsey is receiving preferential treatment at their expense.

“I worry about internalization becoming a bad word,” said Gregory Smith, a J.P. Morgan H&Q analyst, who liked the Dempsey deal. “Best execution does not exclude internalization,” he said, but “it’s much easier to satisfy best execution by sending the order flow to whoever’s showing the best price.”

Meanwhile, rival firms are turning up the heat on stock trade executions. Last week Ameritrade Holding Corp. of Omaha began to run print advertisements that ask investors if they know “how hard your broker looks for the best price?” And this year privately held Datek Online Holdings Corp. of Jersey City has been posting a “Best Execution Report Card” on the Web site of its online broker unit, Datek Online Financial Services.

Dempsey now handles 20% of E-Trade’s order flow. E-Trade’s brokerage chief, Jarrett Lilien, said his firm wants Dempsey to process more.

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