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. Last Updated: 07/27/2016

Regulators Urge Safeguards for Online Investors




NEW YORK -- Online brokerage firms are the hot rods of Wall Street, providing fast and cheap access to stock market investors every trading day. Now, securities regulators want these firms to install seat belts.


After months of inquiries into the practices of the nation's online brokerage firms, securities regulators in Washington and New York issued weighty reports on the industry Monday, identifying lapses in investor protection at many online operations and offering suggestions about how to correct them.


The reports, issued by the Securities and Exchange Commission and the office of Eliot Spitzer, the New York state attorney general, are an attempt by securities regulators to bring some order to the fractious online brokerage business, which has transformed the way investors buy and sell stocks. Until now, much of this change, driven by technological advancements, has been watched by regulators from the sidelines.


Although neither of the reports recommended new rules for the online industry, they telegraph to the brokerage community a regulatory commitment to online investor protection.


Laura Unger, the SEC commissioner who wrote the report, said in a statement: "I think it may still be premature for extensive rulemaking in this area, but the report will allow the commission to focus upon and consider the most vital issues concerning online brokerage."


By the second quarter of this year, investors had opened about 9.7 million online brokerage accounts, almost three times the number in force in 1997. Online trading volume has grown, the SEC said, from fewer than 100,000 trades a day in mid-1996 to more than half a million three years later.


This explosive growth, according to the regulators, has made the nation's stock market much more accessible to investors. But the popularity of online investing, Spitzer's report said, "also poses unique risks to the public and presents tough challenges to regulators charged with ensuring the integrity of the trading environment."


Spitzer's report, the result of nine months of inquiries into the practices of seven firms in five states, concluded that online brokerage firms hyped their technology and services, contending that they provide direct and immediate trade execution while downplaying the risks of computer system breakdowns.


For example, the report found that many firms do not update customer account information regularly enough to provide accurate readings on investors' margin accounts. That has allowed investors to buy stocks using money they thought was in the account when in fact they had none.


In addition, Spitzer's investigators reported that online investors were able to buy stocks in their individual retirement accounts that exceeded the value of those accounts. Both of those findings gave substance to the fears of some market observers that online brokerage firms will do anything to keep investors trading.


One of the SEC's biggest concerns is that some online firms may try to escape their obligation to ensure that investments that their customers make are suitable for their circumstances. Suitability is one of the main avenues of protection for investors under federal securities laws; almost one-third of the arbitration cases filed by investors with the National Association of Securities Dealers since 1995 involved investments alleged to be unsuitable for the investors who bought them.


In the past, some online firms have argued that because their customers make their own investment decisions, even if it is based on research taken from the web site, the firm need not consider whether an investment is suitable to the investor.


Glen Mathison, a spokesman for the Charles Schwab Corp., said Monday that existing regulation adequately covers suitability. "There's no need to separate out online investing for some sort of differentiated or specialized regulation," Mathison said.