Web stock firms bound by `suitability' rules

NASD requires knowing the customer when recommending a buy

March 21, 2001|By BLOOMBERG NEWS

WASHINGTON - Securities industry regulators told Internet stock-trading firms yesterday that they are bound by traditional know-your-customer rules when advocating stock purchases, though not when simply executing orders or providing research.

The National Association of Securities Dealers Inc. issued the legal guidelines in a seven-page policy statement. NASD regulators said the guidelines were needed to clarify duties of stock-trading firms amid the rise in Internet communications.

The long-standing "suitability" rules require a broker or dealer to make sure investments fit each customer's financial goals and experience. The new rules apply to brokerages that operate on the Internet, including such firms as Charles Schwab Corp., E*Trade Group Inc. and Ameritrade Holding Corp.

"There has been much debate within the industry about whether, or to what extent, the suitability rule applies at all to online brokerage activities," said Mary L. Schapiro, president of the NASD's regulatory arm. "It should be clear that the suitability rule applies to all recommendations made by members to customers, including those made by electronic means."

"They've taken a good initial stab at a difficult issue," said Barbara Roper, director of investor protection for the Consumer Federation of America, about the NASD guidelines.

"These guidelines are an effort to strike the right balance between investor protection and marketplace and technological innovation," said Ashley Baker, director of communications for the North American Securities Administrators Association.

"They do not attempt to address every possible scenario; there remains a lot of gray area. But these guidelines begin to bring needed clarity to this important area."

Dan Michaelis, assistant vice president of corporate communications for the Securities Industry Association, said the group's lawyers are still reviewing the new NASD guidelines. He said, however, "We have had concerns in the past about too rigid interpretation of suitability requirements with regard to online operations."

The new guidance provides examples of electronic communications that the NASD's regulatory arm considers to be within or outside the definition of "recommendation."

An Internet brokerage acting merely as an order-taker in a transaction is not making a recommendation, the notice said.

Also not covered is a case in which a brokerage creates a Web site with research pages, or "electronic libraries," that contain research, news, quotes and charts that customers can request, the NASD said. The research reports may include an author's buy and sell recommendations, the NASD said.

A situation covered by the definition of "recommendation" would be a brokerage sending a customer-specific electronic communication, like an e-mail or pop-up screen, to a targeted group of customers encouraging them to buy a security, the NASD's regulatory arm said.

Another covered situation would be if a brokerage uses "data-mining technology" to analyze a customer's financial or online activity - whether known by the customer or not, the NASD said. Then, based on this data, the brokerage "pushes" specific investment suggestions that the customer purchase or sell a security, the NASD said.

The NASD offered three broad principles governing when to define an online communication as a "recommendation."

First, the broker or dealer must analyze the "content, context and presentation of the communication," the NASD said.

Second, the firm should consider whether a person reasonably would view the communication as a "call to action," the NASD said.

Finally, the more individually tailored a communication is the more likely it would be judged a "recommendation."

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