Someday we'll all stop talking about "traditional" and "online" stockbrokers. The biggest of the full-service brokers are betting their future on the Internet. Major online firms, meanwhile, know they can't grow without offering research and advice. But as brick-based and click-based brokerages converge, shouldn't both be held to the same rules?
Securities & Exchange Commissioner Laura S. Unger plans to shine a light on that question. On Nov. 22, she called for a major SEC push to see that rapid changes in online technology don't gut traditional rules governing "suitability," a broker's duty to recommend only investments that a customer has the knowledge and financial resources to handle. Online brokers "now are offering research and advice that they can fine-tune to customers' interests and account activity," she says. "At what point does advice become recommendations?"
NO LIMIT. Online brokers contend they're nowhere near that line. But the SEC and other securities regulators need to take a tougher stance. Online brokers, whose ads imply that Wall Street's lion's den is little more than a petting zoo, must ensure that their customers are educated, informed, and equipped for the risks of investing. No investor should be led in over his or her head by a broker's advice, whether it's delivered at the country club or via e-mail.
Online brokers do enforce some suitability rules. Charles Schwab & Co., which has urged the SEC not to add new rules, screens clients when they open accounts and blocks unsophisticated investors from such tricky securities as options. But companies like Schwab are accustomed to dealing with self-directed investors who don't want brokers reviewing their trades. Schwab e-mails research only to clients who have registered interest, a spokesman says. Since "we don't give specific stock advice," the spokesman adds, "we don't turn away orders."
But those policies aren't well suited to the new investors rushing into markets today--drawn in part by the online firms' low commissions. Take Cathy Dellinger, a 57-year-old Honolulu social-service worker who, after a disabling injury in July 1998, decided to start day trading with her $94,000 life savings. "There were Schwab ads with a housewife who was day trading," Dellinger says. "The brochures made it sound easy."
It wasn't. Dellinger couldn't figure out how to place limit orders to buy and sell stock at specified prices in her Schwab account. Instead, she placed market orders and monitored her stocks every 30 seconds--activity, Schwab later told her, that convinced the broker she was a sophisticated investor. Her inexperience cost her in November 1998, when she tried to get a piece of theglobe.com Inc.'s hot Internet initial public offering. She placed orders at $9 and $30, then tried to cancel. But she wound up buying 3,000 shares at $90--and lost $60,000 before she could unload them. Dellinger brought a complaint charging that Schwab should have blocked the trade because it exceeded her buying limit and was unsuitable for her. Schwab won't comment because the case is in arbitration.
Investors can't always be protected from their own choices: With the freedom to invest comes the responsibility for risks. But free and fair markets require that investors get the information they need--even if brokers need to force it on them. Account sign-ups should uncover information that brokers need to assess a clients' knowledge and sophistication.
Online brokers have a great opportunity to post educational materials on their Web sites. Many do--but those pages should be made required reading for new clients. And if brokers can use data mining to target research that matches clients' investment interests--an option many brokers told Unger they're considering --they can use the same techniques to require informed consent on trades that don't fit. Too often, Wall Street sees only new technology's moneymaking opportunities. When it comes to protecting individual investors, the Street needs to remember it has obligations, too.