On-Line Trading:

Better Investor Protection Information Needed on Brokers' Web Sites

GGD-00-43: Published: May 9, 2000. Publicly Released: Jun 8, 2000.

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Pursuant to a congressional request, GAO provided information on on-line trading, focusing on: (1) the growth in on-line trading; (2) the extent to which on-line broker-dealers had experienced trading system delays and outages, including the causes of these problems and their reported effect on investors; and (3) how on-line broker-dealers address investor protection issues related to margin, privacy of information, risk disclosures, best execution, suitability, and advertising.

GAO noted that: (1) from the last quarter of 1997 to mid-1999, the number of broker-dealers offering on-line trading more than doubled to about 160 firms; (2) also, the number of on-line trading accounts established nearly tripled to 10.5 million within this time period, and the volume of on-line trades increased to about 37 percent of all retail trading volume in equities and options; (3) this growth in on-line trading has been accompanied by a series of delays and outages in broker-dealers' automated trading systems that have caused some investors to suffer losses or miss investment opportunities; (4) each of the 12 on-line broker-dealers GAO contacted had experienced trading system delays or outages; (5) officials from these firms maintained that several factors caused delays and outages, such as inefficient message routing by Internet service providers, glitches in vendor-supplied systems, and computer hardware and software failures often associated with service upgrades; (6) the officials said that they expect delays and outages to continue because they must constantly upgrade their systems' services and capacity to remain competitive and to keep up with the growth in on-line trading; (7) on-line investors have access to extensive financial information through the Internet and other sources, but they are responsible for their own trading decisions in the absence of solicitations and recommendations by a broker-dealer; (8) to help investors make informed decisions, the Securities and Exchange Commission (SEC) and the securities self-regulatory organizations (SRO) require that broker-dealers furnish investors information relating to margin trading, have proposed rules concerning privacy of information, and recommend that broker-dealers also furnish information about trading risks and best execution of trades; (9) however, the broker-dealers that GAO contacted did not always provide their customers all such information, especially on the firms' Web sites where it would be most useful since this is where investors go to trade on-line; (10) SEC and the securities SROs are responsible for overseeing the securities industry and markets for the ultimate benefit and protection of the investor and each has taken initial steps to monitor the activities of on-line brokerage firms; and (11) ensuring that investors receive appropriate information on margin requirements, privacy considerations, risk disclosures, and trade executions is especially important considering that an estimated 8 million new on-line trading accounts could be opened by the year 2001.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: As of November 2010, SEC's Office of Compliance Inspections and Examinations had completed its examinations of 20 or more broker-dealer firms conducted to assess their compliance with tracking and reporting outages and website capacities. These reviews indicated that firms were generally monitoring outages and delays and were expanding capacities sufficiently to handle even recent peak traffic days. They also found that brokers were making disclosures on their websites about the potential for outages. As a result, although the SEC staff saw a possibility in the future for creating a rule in this area, such a rule did not seem warranted now given the level of appropriate practices currently in use at firms. In addition, with the assistance of a recently-hired information technology specialist, they anticipated continuing to take steps in future examinations to ensure that firms were maintaining good practices regarding outages and website capacity.

    Recommendation: The Chairman, SEC, should require broker-dealers with on-line trading systems to maintain consistent records on systems delays and outages and their related causes and to disclose the potential for service disruptions on their Web sites. The Chairman should monitor these records to ensure that firms have adequate capacity to serve their customers.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: As of July 2002, various SEC and Financial Industry Regulatory Authority (FINRA) rules that apply to all broker-dealers requires that firms must provide disclosures to their customers and post conspicuously on their websites regarding the risks and other information that apply to online trading. First under NASD Rules 2341, firms must disclose to customer and post on their websites information about the risk of margin trading. The risks that must be disclosed include that customers can lose more funds than are deposited in the margin account, that the firm can force the sale of securities or other assets in the accounts, securities or other assets may be sold without contacting the customer, customers are not entitled to choose which securities or other assets are liquidated or sold to meet a margin call, the firm can increase its maintenance margin requirements at any time and is not required to provide advance written notice of such, and customers are not entitled to an extension of time on a margin call. In addition, NASD Rule 2361 requires firms that are promoting a day-trading strategy must furnished to each customer and post in a clear and conspicuous manner to the firm's Web site a disclosure statement that highlights various risks of such trading. These risks include being cautious of claims of large profits from day trading and that such trading can be extremely risky, requires knowledge of securities markets, requires knowledge of a firm's operations, will generate substantial commissions even if the per trade cost is low, and that trading on margin or short selling may result in losses beyond the initial investment. SEC Regulation S-P that became effective July 1, 2001 requires firms to disclose their privacy policies to their customers, including allowing such disclosures to be made on their websites. SEC Regulation NMS that became effective in August 2005 also includes disclosure requirements for broker-dealers regarding best execution practices. SEC's Office of Compliance Inspections and Examinations recently completed during the summer of 2008 a review of more about 20 firms that offer online trading to their customers and found that these firms were generally disclosing the required information covered by these rules on their websites.

    Recommendation: The Chairman, SEC, should ensure that broker-dealers with on-line trading systems include accurate and complete information on their Web sites in the key investor protection areas of risk disclosure, margin requirements, privacy considerations, and trade executions.

    Agency Affected: United States Securities and Exchange Commission

 

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