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What is a broker-dealer? The Securities and Exchange Commission is still struggling to come up with an answer, after more than two years of studying Internet financial portals, or Web sites that offer an array of financial services and products, but are not registered “broker-dealers” of securities. The growing number of on-line investors prompted the SEC’s initial interest in portals. According to SEC estimates, 7.8 million U.S. residents maintain on-line brokerage accounts. Millions more use portals such as Motley Fool Inc., Yahoo! Finance and CBS MarketWatch.com that aim primarily to educate and inform investors, offering real-time stock quotes, company news, investment advice and research data. But portals also typically contract with registered broker-dealers to advertise or market the broker-dealers’ services and provide links to their Web sites. These latter activities make the SEC nervous. “Portals are starting to look more and more like broker-dealers,” said SEC Acting Chairwoman Laura Unger at a public roundtable in Washington, D.C., last week. They “make it really easy to execute a transaction,” she explained. CONSTANT INNOVATIONS The situation is complicated by the constant innovations the services portals provide, such as “screen scraping,” which allows an investor to centralize different accounts on one Web site, and steer orders to a broker, mutual fund or bank. Such features, while often quite useful to the individual investor, could potentially blur the functional line between portals and brokers. Industry lawyers downplayed the SEC’s concerns. “I’m not aware of any abuses, customer protection issues or customer complaints that point out the need to treat portals as broker-dealers,” said Steven W. Stone, a partner at the Washington, D.C., office of Morgan, Lewis & Bockius, who spoke at the roundtable. Customers are already protected by virtue of their relationship with the registered broker-dealer who handles their account, regardless of any relationship the broker may have with a portal, he said. RULES NOT IMMINENT Debate about the legitimacy of the SEC’s anxieties aside, most of the lawyers interviewed agreed with the assessment of Brandon Becker, a partner at Washington, D.C.’s Wilmer, Cutler & Pickering: The agency would not act on this issue anytime soon. Although the commission said it was preparing an interpretive release on portals as long ago as last July, the release was apparently derailed and the SEC appears to have put the guidelines on a back burner. SEC spokesman John Heine confirmed that “there is nothing on the table” at the moment by way of interpretive guidelines or rules governing portals. No one expects anything to come from the agency in the near future either. The SEC has no real motivation to promulgate rules, explained one source, because the current regulatory framework affords them maximum flexibility to police financial portals, and guidelines would only operate to restrict them. And although Chairwoman Unger has tried to “inject a dialogue,” her tenure will shortly draw to a close, and the staff may simply choose to wait her out, the source said. The SEC also recognizes that portals are a fantastic tool for investors, said Jay H. Perlman, associate general counsel at the Motley Fool Inc. “Portals provide an invaluable service: education and access to unbiased information to every investor,” he added. If the SEC were to adopt wholesale treatment of portals as broker-dealers, it would be devastating, Stone said. Brokers are subject to a panoply of rules, including pre-approval of Web site content 10 days in advance. “It would effectively shut down their business, which depends on providing current information,” Stone explained. CURRENT APPROACH FAULTED However, the SEC’s expected inaction does not ease lawyers’ concerns on a number of other fronts. On the one hand, the possibility of onerous or inappropriate regulations worries them, but on the other, they also take issue with the SEC’s current approach. The most pressing concern for many industry lawyers is the SEC’s prohibition of so-called “transaction-based compensation,” which ties fees to the amount of business the portal generates for the broker. Such a “success-based” fee is typically how other commercial partners pay portals, but according to the SEC, the securities laws forbid broker-dealers from paying portals in a way that gives them a “salesman’s stake” in the transaction. This narrow focus on transaction-based compensation “ignores the larger environment in which payment arrangements are now developing,” Stone said. By restricting payment terms between portals and broker-dealers, it impedes their ability to stay competitive, he added. Lawyers also derided the SEC’s efforts to define transaction-based compensation. For instance, explained Andre E. Owens, a partner at the Washington, D.C., office of Chicago’s Schiff Hardin & Waite, the SEC takes the position that a fee tied to a customer’s opening an account is transaction-based, because you would not open an account unless you were planning to make a transaction. By the same token, one could argue that sending in an application to open an account is a transaction as well, Owens said. Stone and others suggested that instead of restricting fee arrangements, publicly disclosing those arrangements would alleviate any concerns of bias. In fact, some portals such as the Motley Fool already provide such disclosure for precisely that reason. Another issue for many lawyers is the excruciatingly slow process by which the SEC determines whether a Web site is functioning as a broker-dealer. The official definition of a broker — “any person engaged in the business of effecting transactions in securities for the account of others” — is broad enough to sweep almost any portal activity into its ambit. To avoid problems, a company may seek clarification through a request for a “no-action letter.” But getting one can take years, Becker said. In the interim, portals have to rely on sporadic and somewhat inconsistent agency pronouncements for guidance. Many have operated under the relative strength of a no-action letter sent to Charles Schwab & Co. in 1996. In that letter, the SEC said Schwab investors could pay a small fee to portals that process customer orders. Such a strategy can be dangerous, however. In a recent denial of no-action request to BondGlobe Inc., the SEC made a point of warning financial portals that they rely on such materials at their own risk. “The staff has never extended the Schwab letter beyond [the] narrow context” it addressed: the “broad-based portals” — AOL, Microsoft and Compuserve — “that would not specifically direct their operations toward the securities industry,” the SEC stated. Becker summed up the sentiment of many industry lawyers: “The SEC has been unduly cautious in this area. They need to change the tone.” “This is a good development for investors and one they should be encouraging,” he said, “versus worrying that something untoward is happening.”

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