Online investing raises questions about suitability


More firms may be required to make a determination

November 28, 1999|By Bill Atkinson and Amanda J. Crawford

THE EXPLOSION of Internet investing is fueling a debate as to whether online trading firms are legally responsible for making sure that investments are suitable for their clients. The online firms argue that they simply process orders. But others say there are times when the firms might be making recommendations.

What is the definition of suitability?

Should online brokerages be held liable -- as traditional brokerages are -- for selling investments that are appropriate for their customers' circumstances?

Bradley Skolnik

Indiana securities commissioner and president of the North American Securities Administrators Association, Washington

This is an urgent issue because of the phenomenal growth of online brokerage. When I became Indiana securities commissioner in December 1994, there were virtually no online brokerage firms. Today, there are 150, and the number is probably growing daily.

The question that you are going to confront is: When do you have a cyber recommendation? The suitability requirement is generally triggered once there is deemed a recommendation made by a broker. In many instances in the online world, oftentimes you are not going to have a recommendation; therefore, we need to expand the suitability rule to prevent investors from blowing themselves up. If the rule becomes too expansive, I think we run the risk of choking off information and research [that] the online firms are willing to provide to investors.

If the suitability rule is expanded and applied every time somebody invests online, it could have a potential chilling effect on investors.

Stuart Kaswell

General counsel, Securities Industry Association, Washington

On the issue of suitability, most people think the NASD [National Association of Securities Dealers] suitability rule means that a broker-dealer would recommend to an individual a specific stock. What has never been considered is: `Equities look good this year. We favor tech stocks. We have a research report on our Web page that looks at the semiconductor industry.' Those kinds of things have never been considered recommendations because they didn't involve a specific recommendation to an individual of a specific stock based on that investor's set of circumstances.

If a firm makes a specific recommendation -- I don't care whether the recommendation is made over the telephone or made face-to-face, or over the Internet -- suitability should apply.

If you go to a full-service broker, you go through the suitability exercise; therefore, the broker has done research. If you choose to trade through the Internet, that is fine, that is great, but that means you are going to have to do some of your own homework. Did I read the research report? Or did I do it because someone passed me a rumor in a chat room?

Steven Caruso

Partner, Maddox, Koeller, Hargett & Caruso, New York

The online firms obviously claim they do not have that responsibility because they don't want the liability for making a mistake as far as determining whether the investor was suitable for buying any security.

If you go to Merrill Lynch and they make a recommendation to you, they have an obligation to make sure the recommendations they make are suitable. Online firms claim that, since they are not normally making the recommendation and you are choosing on your own, that they do not have a responsibility. We think that they do.

We've been successful in bringing claims against online firms and getting settlements.

I think, ultimately, more online firms are going to be required to make a suitability determination on every single trade.

Ultimately, it's going to be up the SEC to step forward and require them to do that, which as of now they have not done.

Patrick Di Chiro

Vice president of corporate communications, E*Trade, Menlo Park, Calif.

As a broker-dealer, we don't provide advice or recommendations on stocks, so we are not required to check on the suitability for investors. It's an issue that was raised in the SEC [Securities and Exchange Commission] report last week.

But it really isn't an issue for us. We're not required to do the suitability checks like a full-service broker that provides stock recommendations would have to do. For what would be viewed as higher risk investing, such as online IPOs, and options trading, we do require an online questionnaire that checks the suitability for customers for those more high-risk investments.

The real issue is investor education, which is why we provide investor information and tools on our Web site so that our customers are able to make informed decisions for themselves. We think that's what you need to do today.

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