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SEC Evaluates Online Brokerage Firms
he Securities and Exchange Commission (SEC) recently published its findings with respect to the online brokerage firms. Most of the firms examined were traditional firms that had added online capabilities, though some of the firms specifically have been formed to provide online services. The SEC focused particular attention upon those areas in which one sees frequent customer complaints. The study can be found at www.sec.gov/news/studies/online.htm.
The study discusses the following aspects of online trading: 1) information provided to customers about trading and making investment decisions; 2) advertising; 3) execution of customer transactions; 4) capacity for handling customer trading volumes; 5) security measures; and 6) supervision of employees' use of the Internet.
This article will focus upon the first aspect of the report, relating to the SEC's evaluation of the online firms' disclosure and investor education. The SEC states that it has "received a significant number of investor complaints that appear to indicate a lack of knowledge about trading and investing". The SEC especially is concerned that many investors opening online accounts have no prior experience trading or investing. The difficulty presented, the SEC finds, is that there is no human (that is, a broker or investment advisor) available to whom questions may be posed. Hence, the online firms' websites must fill in that gap. Unfortunately, the SEC concludes that most online firms do not do an adequate job posting relevant information in a conspicuous and accessible location.
As a result, the first recommendation that the SEC makes is that online firms should consider enhancing their websites to provide basic information about securities trading, as well as plain English disclosure about the risks of trading, and a glossary or help screen to explain investment terms. The basics about securities trading should include:
The differences between various types of orders (market order, limit order, stop limit order, for example);
Notice that a market order may be executed at a price higher or lower than the quote displayed on the website at the time the order was entered;
An explanation as to how orders are executed;
A description of situations in which a customer may not receive an execution;
Restrictions on the types of orders that customers can place;
The possibility of delays or outages in the system, the effect of such delays, and any alternative methods to place an order; and
How market volatility can affect customers' orders.
The second SEC recommendation relates to trade cancellations. The SEC notes that it has received "numerous investor complaints about inadvertently-placed duplicate orders". This happens when reports of trade cancellations are delayed (for hours, even days), leading customers to believe that their orders already have been cancelled. Often, customers then place another trade, resulting in either a duplicate purchase or an unintended short sale (because they sold a security thinking that they just had bought it, but in fact had not bought it). Some firms have adopted measures to attempt to avoid this problem of placing duplicate orders, but few are effective. The SEC recommends that online firms design and implement procedures to prevent executions of these duplicate orders.
The final SEC recommendation is that online firms should better inform investors about the risks of trading on margin. The SEC notes that complaints about margin "have increased significantly recently".
In its review, the SEC found that one-third of the firms examined did not even provide or make available information about margin (apart from the margin agreement, a non-informative legal document). Another quarter of the firms examined had "less than complete" definitions of margin terms (for example, one firm defined margin balance but not margin call). Critically, the SEC found that only a few firms explained how margin works in a rising market as well as in a falling market, which the SEC believes is "an important concept for investors to understand".
Accordingly, the SEC recommends that online firms disclose the risks of trading on margin, including the risks that:
A customer can lose more funds than he or she deposits in the account if the securities purchased on margin decline in value;
A firm has the right to force the sale of securities in the account to cover a margin deficiency if the equity in the account falls below a certain level, and the customer is responsible to pay any shortfall;
A firm can sell a customer's securities in a margin account without advance notice (arguably, though, only some of the time) and a customer is not entitled to choose which securities are to be liquidated;
The firm can increase its internal margin requirements without advance notice; and
A customer is not entitled to an extension of time to meet a margin call (arguably, though, circumstances may create that right).
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