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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Customer Expectations Online:
Are They Your Obligations?

Remarks by

Commissioner Laura S. Unger

U.S. Securities and Exchange Commission

At the American Conference Institute's National Conference on
Securities Trading on the Internet, New York, New York

January 25, 1999

The views expressed herein are those of Commissioner Unger and do not necessarily represent those of the Commission, other Commissioners or the Staff.

I hardly need to tell this audience that the Internet is revolutionizing the securities industry. In fact, online accessibility has become commonplace. Recently, I met an individual who had spent the last six months deep in the Congo filming a documentary on elephants. She could not access food (and was forced to eat canned goods), but she could access the rest of the world via her e-mail. Twice a week, she used a car battery, some wires and a satellite dish to log on to her computer to receive and send e-mails. She assured me that individuals who shoot documentaries about elephants in the Congo do not have brokerage accounts, but that if she did – she would have been able to access it.

Internet trading has become so pervasive since 1995, the year of the first online trade, that a number of milestones have passed virtually unnoticed. Before 1995, Internet trading did not exist. Today, investors can choose from among 100 online brokers. Trades placed with online brokers now account for 25 percent of all trades on the New York Stock Exchange and Nasdaq.

Still, 1998 has not been dubbed the year of online brokers. It has been dubbed instead the year of electronic commerce generally, mainly due to the strength of this past Christmas buying season. The popularity of online buying proved that electronic commerce is not some passing fad. The valuations of all stocks ending in "dot com" reflect investors' love affair with the Internet.

Online trading is transforming the securities industry in much the same way that eliminating fixed commissions changed Wall Street in 1975. Full service brokers and discount brokers traditionally have offered very different levels of service to their customers. Now, however, they provide many of the same types of services due to the lower costs of information. The ability to quickly sort, analyze, and use vast amounts of information means that a broker can provide many more services to its clients on a real-time basis. It also means that the broker can gather a lot more information about that client. If you check out a stock quote in the newspaper, no one knows that you are interested in buying that security. If you check out that same stock quote online, your broker – whether discount or full- service – has the technological capability to know that you are interested in that stock.

This raises a number of interesting issues. I cannot claim that any of these issues will be resolved here, but I would like to suggest some ways of looking at them. First, I think that it is useful to consider some of the characteristics of electronic commerce generally, because I believe that where electronic commerce goes, so will electronic brokerage. Second, I want to focus on electronic brokerage and discuss my own, rather unscientific, list of investor expectations. Finally, I'd like to lay out some of the issues raised by these expectations that I intend to explore in the coming year.

Electronic Commerce

First, the defining characteristic of electronic commerce in the future is, in my mind, trust. I started thinking of the Internet in terms of trust when I participated in a Technology Roundtable at the SEC last spring. Bran Ferren, of Walt Disney Imagineering, told the audience that the Internet will fail unless we can make it a trusted medium where people can believe in confidentiality, security, privacy, and accuracy.

Most users want to know that someone they trust is on the other side of the connection, that their transactions are secure, and that others cannot access their personal information. In a 1998 Georgia Tech survey, about 27 percent of respondents said that they did not purchase online because they were concerned that their personal information would not be kept private. Over half said that they provided false information at least occasionally when registering with a website. Obviously, consumers are concerned about online invasions of their privacy.

Second, the successful business model for electronic commerce depends on driving viewers to a website and keeping them there. Marketing experts call this "controlling eyeballs," becoming a "destination of choice," creating "stickiness" or "locking in customers." Predictions abound that today's narrowly tailored websites will be replaced by "virtual communities" composed of users interacting with each other and multiple vendors focused on offering services related to a particular interest, such as gardening or baby care.

A financial virtual community could offer multiple brokers, banks, mortgage shopping, insurance, tax preparation and estate planning advice, and financial planning books hyperlinked from a virtual bookstore. It could have interactive tools, market commentary, chat rooms and bulletin boards where members could post stories, provide a personalized web page and real-time quotes, and offer a range of transactions. That doesn't seem very far-fetched if you look at the sites of Intuit's Quicken, Microsoft Money Central, Yahoo! Finance, Motley Fool, as well as those of some leading online brokers. In fact, you may even be able to one day pull your various accounts into a consolidated portfolio on these sites on a "real time" basis.

Third, the potential for economic value in electronic commerce lies in one-to-one marketing. The fuel that drove the Industrial Revolution was the ability to mass market identical products. Henry Ford said that you could have a Model T in any color you wanted, as long as it was black. The fuel that drives the Internet revolution today is the ability to segment markets down to the level of one person, based on information profiles gathered about the user and thus, mass marketing on an individualized basis.

Amazon.com is a good example of the attraction of personalized information. Amazon automatically analyzes past purchases to make recommendations for future purchases that are personalized to each buyer. You can also personalize your own purchases on the Internet. For example, you can shop for the Saturn automobile of your dreams on the Internet. Wouldn't Henry Ford have been surprised that you can point-and-click your way to a car and choose from seven models and four colors?

Virtual communities thrive on information. By definition, a virtual community must both bring a critical mass of members together and provide useful resources to those members. In order to accomplish this, virtual communities must gather information about their members, either through profiles their members voluntarily provide or through tracking with cookies where their members go online. This information allows virtual communities to better target their members and therefore to develop more precisely relevant products.

A fourth characteristic of electronic commerce is information access. The Internet can put customers and vendors on a level playing field. You could think of this as customer empowerment.

Electronic Brokerage Issues

Putting aside cheap execution, I believe that investors expect three things from online brokers: convenience, access, and trust. By convenience, I mean that investors expect to get information quickly, usually within three clicks and around the clock. Investors also expect to find all of the information that they need within one site, as you can see from the popularity of financial "portals."

By access, I mean that investors expect to access a significantly greater amount of information than ever before. For example, basic research is becoming such a commodity that it does not seem to differentiate one online firm from another. One major firm even decided to give away its research for a brief period as a way of generating client interest.

I have heard the predictions that the future value for online firms lies in providing personalized advice to investors, not in providing commodities such as basic research, information, and executions. It was over 30 years ago that a smug businessman told Dustin Hoffman, "I just want to say one word to you – just one word – `plastics.'" Well, I suspect, if that businessman today owned a brokerage firm, he would say, "I just want to say two words to you – `relationship management.'"

Relationship management is the only sure way to bring the promise of one-to-one marketing from e-commerce to e-brokerage. That's where trust comes in again. Today, by and large, investors online want to do it themselves. The market is strong, and information and opportunities abound. When tomorrow comes and brings with it more challenging market conditions, I suspect online brokers will provide added value to customers in sorting through the deluge of available information.

The increase in access to information by investors has raised some interesting issues. I believe that brokers should be able to use the technology from electronic commerce to improve the efficiency and quality of the information that they provide to their customers. But brokers should provide that information responsibly, and investors should use it to trade responsibly. Information may be a boon to the disciplined investor and a cautionary tale for the unwary. Imagine the normally conservative investor who switches to daytrading to save for his retirement.

A number of firms have told me that they have a pressing need to address the issue of what actions online trigger a suitability obligation. A broker generally triggers a suitability obligation if it makes a recommendation to a customer. Everyone here has probably heard about another "graduate" who sued his broker recently for making unsuitable recommendations after daytrading his way through $40,000. The difficult question is when is a broker making a recommendation online:

  • Is it a recommendation if a broker makes research and other information available to a customer based on information gathered through profiling that customer from his movements online? Amazon.com certainly does this.

  • What if the broker gathers information about the investor for another purpose, such as to meet its obligations under some money laundering rules?

  • Once the broker has the information for one purpose, such as marketing, does he have a duty to use it for another purpose?

  • What is the online customer's expectation regarding the information that she gathers? Does the investor know that she is receiving information that is personalized to her interests?

  • Does she assume that this information is in fact a recommendation by the broker?

  • Can a broker make a recommendation through anonymous reps dealing with online investors?

Let me pose some hypotheticals along what I believe to be a spectrum of possible situations. Do you believe that a recommendation has been made in any of these situations?

  • First, at the low end of the spectrum, I am an investor and I use an online broker that provides pure execution with no other bells and whistles. I am not a daytrader. Maybe I even executed a trade based on information gathered elsewhere.

  • At the second point in the spectrum, I execute trades, plus I gather information from the broker's "virtual library" (research reports, market commentary, news). This "virtual library" looks the same to every investor.

  • At the third point in the spectrum, I personalize the broker's website that I see every day. I have a personalized webpage called "mybroker" with a quote tracker tracking Internet stocks, alerts about new technology stock research reports, and a daily investment newsletter highlighting IPOs in Internet highfliers. Just to make things interesting, I identified myself to my broker as a very conservative investor.

  • At the fourth point on the spectrum, my broker personalizes my website based on the information that the broker has gathered about my interests when I was online. I initially set my quote tracker to track Internet stocks that I am interested in following. My website brings market commentary and research reports about tech stocks to my attention. I don't even know that the library of information that I see is personalized for me.

  • At the fifth and high end of the spectrum, my broker helps me manage my portfolio online, either by providing benchmarks which my portfolio should meet or asset allocation advice for my portfolio.

Let's look at the facts and circumstances of each case. In the first instance, the broker is providing pure execution. In the second and third example, I am targeting the information that I receive by actively gathering information, either by myself or with my broker's help. In the fourth example, my broker is targeting the information that he sends to me by profiling me. In the last example, my broker is advising me about my portfolio allocation and performance.

If online investors control the information that comes to their attention, then one could argue that most online firms today are merely acting as order takers. If, however, brokers can make the information that investors see highly personalized based on the investor profile (whether given voluntarily or not), someone could well argue, under those facts and circumstances, that such targeting is a recommendation. These issues clearly concern online firms whose disclaimers all say that they are not making recommendations or suitability determinations.

A related issue is what liability, if any, should attach when a broker hyperlinks to another document. A hyperlink may make it appear that the linking party has adopted and approved the information. A hyperlink may make the linking website seem legitimate. Hyperlinks may also go "deep" into a linked document and circumvent warnings or explanations. Again, the facts and circumstances involved will control the outcome.


The quest of online firms for the "holy grail" of relationship management may clash with privacy concerns. You may think that investors do not have particular privacy concerns, until you learn that "spamming" is our number one investor complaint in the Office of Internet Enforcement. Privacy should concern "good" firms. One major firm told me that a third of their prospective customers registered using false information. Clearly, these customers are going to unusual extremes to protect their privacy.

Similarly, the FDIC received over 3,000 e-mails in one week from people worried that the proposed "know your customer rules" would be too much of an intrusion into their financial affairs.

I believe that working to make your customers comfortable with your privacy policy is simply good business. In laying out its strategy on electronic commerce, the Clinton Administration observed that electronic commerce will thrive only if privacy rights of individuals are balanced with the benefits that arise from the free flow of information. While the Administration expressed support for commercial privacy initiatives, it cautioned that if privacy concerns were not addressed by businesses, the Administration would face increasing pressure to step in to ensure consumer choice regarding privacy online. Online firms should take this issue seriously before the heavier hand of legislation becomes inevitable.

On a related issue, firms should try to give investors meaningful notice and information about their privacy practices, not just create a liability document. The "legal stuff" online seems to be buried and often overlawyered. One agreement that I found ran longer than my mortgage document. Would a plain English agreement that investors can find make for smoother investor relations down the line? Are firms concerned about investors being able to control how information gathered about them is used?

Best Execution

Online brokerage customers are usually portrayed as expecting merely a quick execution. However, the duty of best execution requires that a broker seek to obtain for its customer orders the most favorable terms reasonably available under the circumstances. Do online customers expect to get the NBBO and no better? Are they really aware that price improvement opportunities differ significantly depending on where their order is routed? Should firms somehow have to disclose this?

Competition between online brokers appears to be moving from commissions to services. An online broker could compete by offering order routing to markets with better price improvement opportunities than competitors. Another way would be to offer online customers a menu of order routing options. Would offering such a wide choice of execution venues impact online brokers' best execution obligations to their customers since the duty runs from the broker to the customer?

Real Time Quotes

Online customers also increasingly expect access to real-time quotes. In a traditional telephone trade, the customer did not make much use of quotes and would rely on a broker to pull it up when she was considering a transaction. With online trading, customers want access to real-time quotes.

Currently, online brokers provide real-time quotes for some purposes (prior to transactions, list of stocks a customer tracks), but not others (account statements). This is driven in large part by the cost structure for quotes, which as you well know, has become quite a contentious issue between the CTA and online firms.

Customer demand for real-time quotes will no doubt continue to increase, and the markets will have to accommodate this demand to remain competitive. The Commission should not be in the position of rate maker however. I am confident that we will work for a fair and equitable resolution that takes into account the business model of online brokers.

Systems Capacity

Online customers want immediate and uninterrupted access to their accounts. Customer complaints about problems with access have been widely reported and firms have been scrambling to add capacity. The Division of Market Regulation recently issued a staff legal bulletin on capacity. The Commission recommended that brokers follow the Automation Review Policy guidelines it has required for markets. Do firms need any further guidance or assistance from the Commission?


Finally, I'm interested in the larger question of what this increased direct investor access means for the markets. For example, I am sure that you have all been following the debate over investing part of the social security trust fund in the stock market. Are there problems arising today from increased investor participation that require immediate attention by the Commission or is it too early to tell? I plan on discussing these issues going forward in a series of roundtables and would welcome the opportunity to discuss these issues with any of you.