May 23, 2001
It is a pleasure to participate in today's roundtable regarding relationships between broker-dealers and financial portals. As use of the Internet by investors continues to grow, we have seen an expansion of online services directed toward these investors, including online education, research, securities quotations, stock screening, portfolio aggregation and other services offered by portals. Given the growing use of portals by investors, the alliances that have developed between many unregistered portals and broker-dealers are a natural occurrence. Chairwoman Unger should be commended for her efforts not only in organizing this roundtable, but also for her earlier report on Online Brokerage, which set the stage for much of what undoubtedly will be discussed today.
My perspective in this area stems primarily from the representation of broker-dealers engaging in advertising, co-branding, referral and other arrangements with portals. As in any venture, broker-dealers seek to minimize their potential exposure in connection with portal arrangements. The primary concern voiced by my clients relates to their potential liability in the event that a portal partner is later deemed to have acted as an unregistered broker-dealer. In addressing this issue, we focus on all of the traditional indicia of broker-dealer status – with a heavy emphasis on assessing permissible compensation structures, and determining how to avoid confusion among investors with respect to responsibility for content on the portal web site.
A couple of points are worth noting with respect to portal compensation arrangements. First, the range of potential compensation arrangements between portals and broker-dealers depends only on the creativity of the business persons involved in the deal. Viewed as a continuum, compensation arrangements may vary from a fixed fee paid to a portal for an advertisement or referral arrangement (depending on other factors, perhaps the least risky compensation arrangement from a broker-dealer registration perspective) to compensation based on the number and/or size of transactions generated by referred accounts (most problematic under current Staff views). Along the way are a number of other alternatives – payments based on portal site "hits", the number of account opening applications referred from a portal or the number of accounts opened as a result of an advertisement or referral arrangement – any of which may be more or less acceptable from a regulatory or business perspective. In the absence of specific guidance on permissible referral compensation arrangements in the online context (with the exception of the 1996 Schwab Letter and some recent letters not involving portals), broker-dealers and portals have looked to Staff no-action letters involving so-called "finders" in the bricks-and-mortar world. However, as you know, there is a marked difference in the relief from broker-dealer registration that the Staff traditionally has afforded to not-for-profit entities and for-profit finders of customers for broker-dealers in terms of permissible compensation arrangements. (The rationale for this distinction is not always readily apparent to clients or outside counsel) Moreover, the Staff has cautioned financial portals against relying on these prior finder letters.
Second, the limitations on the types of compensation permitted by Staff interpretations can create competitive disparity. The regulatory prohibition against paying transaction-based compensation to portals – as well as uncertainty as to just what constitutes "transaction-based," as opposed to "variable," compensation – can have a disproportionate impact on smaller and newly established broker-dealers. Such firms may have less ability to pay fixed fees for advertisements or referrals. Payment of a fixed fee also may be particularly risky when dealing with portals that do not have an established track record in terms of their ability to draw viewers or subscribers.
The underlying concern with respect to transaction-based compensation is that it gives a portal a "salesman's stake" in generating a securities transaction. Viewed through a regulatory prism, one could envision disreputable portals modifying their content in an inappropriate or confusing manner to promote securities transactions in order to receive higher referral or advertising revenue. This concern is heightened, perhaps, by the fact that most broker-dealers exercise little, if any, control over the content on portals and, as a result, such content is not subject to NASD advertising rules.
Without minimizing concerns over the content of portal web sites, there are a few measures already in place that may help address regulators' concerns in this area. First, both the NASD and the SEC have provided interpretive guidance about when a broker-dealer/issuer will be liable for content on a third-party web site. The NASD in particular has indicated that a broker-dealer may not establish hyperlinks to sites that the broker-dealer knows or should know contain false or misleading information. Moreover, many portals disclose the extent to which they or their broker-dealers partners are responsible for portal web site content. Some broker-dealers also use "landing pages" for persons clicking through to their sites disclaiming responsibility for information on the third-party web portal. Others have suggested disclosures along the lines of those required of investment advisor solicitors for portals referring customers to broker-dealers. Finally, the Commission, as well as private parties, may bring antifraud actions against persons publishing misleading information with respect to securities.
These are just a few of the issues surrounding broker-dealer portal arrangements. I look forward to participating in today's discussion.