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Late in May, some of America’s largest financial services portals sat down with commissioners and high-level staffers at the Securities and Exchange Commission. The corporate names at the table included America Online, Yahoo, The Motley Fool, Reuters America, CBS MarketWatch.com, and Intuit. The question on their minds was: Are we going to be swept up in the strict regulation of broker-dealers? The question for the SEC is: How can we protect unsophisticated investors, who increasingly trade online, from unsuitable advice on the Internet — while still preserving the free flow of market information? Those not attending this roundtable might wonder: What’s the problem? AOL and the others aren’t broker-dealers. A broker-dealer is a person in the business of “effecting securities for the accounts of others.” A financial services portal — or FSP — is a Web site providing market, corporate, and analytical information and tools. How can one be mistaken for the other? The distinctions can, in fact, begin to blur when the FSP offers services that potentially influence investment decisions in the way that a broker-dealer influences investors. Envision, for example, an FSP that provides market information, financial analysis, and investment theory, but also includes a banner ad from a specific broker-dealer promoting a particular investment of the week. Add a hyperlink button, in close proximity to the ad, that takes the user directly to the broker, and imagine that the broker allows investors to immediately open accounts with a minimum investment. Finally, figure that the broker pays the portal a specific sum each time a portal viewer opens an account with the broker or each time a viewer executes a trade (both of which compensation systems are technically practical). At that juncture, a portal’s more general advice begins to sound like the first step in a series of communications that could propel an unsophisticated investor into a world of unsuitable transactions. In other words, the portal might be involved in “effecting securities for the accounts of others.” In fact, the SEC staff in March 2000 explained that a person effects transactions in securities “if he or she participates in such transactions at key points in the chain of distribution.” According to the SEC staff, a broker need not be the entity that actually conducts the purchase or sale of securities. And that’s where AOL, The Motley Fool, and other FSPs could get caught. GOOD vs. GOOD The simple solution is to require FSPs to register as broker-dealers. But that would be overkill. Broker-dealers are subject to comprehensive — indeed, onerous — regulations to deal with risks far greater than those posed by FSPs. More important, the portals would probably respond by cutting their services. The SEC should neither skimp on traditional protections of investors nor discourage the dissemination of valuable investor services and information. To achieve this delicate balance, it will have to resolve several core issues How to define an FSP so as to distinguish it from a typical broker-dealer.Merely saying that an FSP provides information and a broker-dealer effects transactions does not resolve the problem, since the context in which the FSP provides information can well influence the ultimate transactions. Instead, the SEC might come up with a list of functional characteristics to distinguish the two. To avoid being identified as a broker-dealer, an FSP might be advised to refrain from: (1) providing investment advice that places special emphasis on instruments or strategies promoted by its advertisers; (2) providing investment advice specifically tailored for its viewers based upon data gathered about the viewers (or categories of viewers); and (3) using intense advertising on the Internet and elsewhere to induce FSP customers to invest in securities without regard to personal wealth or sophistication. The promulgating release could give examples that would or would not satisfy the criteria. Within this constellation of criteria, transaction-based compensation for the portal might be one, albeit significant, factor. How to evaluate the level of risk posed by FSPs .As a practical matter, investors harmed by unsuitable pressures arising out of FSP activities might not even recognize the possibility that they’ve been misled. The casual relation between subtle investing pressure on a financial services site and the ultimate investment misadventure on a brokerage site is not necessarily self-evident. Thus it might be more appropriate to assess the risks of FSPs by analyzing their operations rather than by tabulating consumer complaints. It is not unreasonable for the SEC to seek regulation to prevent investor harm based purely upon the potential for such harm. This is essentially what the SEC already does each time it requires or advises broker-dealer registration of not-yet-operational Web sites that propose to assist in the offering of securities. How to recognize that the collective risk of financial activities on the Internet can greatly exceed the risk posed by the same activities in print or other electronic media.Spokespersons for FSPs argue that, since we don’t regulate newsprint services that provide investment advice in close proximity to listings of recommended brokerage firms and their persuasive advertising, the same hands-off approach should be taken toward FSPs. But such argument ignores the fluidity of operation possible on the Internet. Once at an FSP, a customer who has been persuaded online to make an inappropriate investment is only a few keystrokes away from making that investment. Missing is the disconnect that occurs between the time an investor reads a newspaper ad or sees a TV commercial and the time the investor communicates with a broker through an entirely separate means. This ease of operation makes the Internet a more compelling target of regulation than are the other media. How to develop a creative regulatory response .When crafting the “broker-dealer lite” regulations for certain derivatives dealers, the SEC chose a reduced regulatory scheme in response to a reduced investor threat. Since the potential risks presented by FSPs are also not as broad as the risks presented by retail brokers, the regulatory response need not be the “full monty.” At a very minimum level of response, the SEC should require notices on FSP sites advising customers that the FSP is not a registered broker-dealer and cannot recommend specific investments. In addition, FSPs should be required to disclose when they are compensated on a transaction basis by a brokerage firm or an issuer of securities. Both of these notices should be displayed prominently on any page displaying specific investment advice. Such a limited regulatory response would essentially place the burden of discerning risk on the consumer. It could be considered short-sighted in that it ignores the certain fact that FSPs are visited by investors who lack the training to balance risks of investment recommendations against assets and investment goals. In a more aggressive posture, the SEC might identify a series of factors, beyond the basic definitional criteria, that the staff would consider significant in determining when an FSP has crossed the line. To avoid broker-dealer status, an FSP would need to refrain from transmitting information and solicitations that would, as a whole, tend to persuade investors to engage in specific courses of investment regardless of assets or goals. If an FSP did not comply with the suggested behavior, then the SEC might well conclude that the portal was involved in a sufficient number of “key points” to be “effecting transactions.” NASD Regulation, a subsidiary of the National Association of Securities Dealers, recently provided analogous advice in a notice to its members regarding suitability of investment advice online. For example, NASD Regulation advised members to analyze and scrutinize communications that might reasonably be viewed as a “call to action” for online viewers or that suggest the purchase, sale, or exchange of a particular security. Similarly, if a message displayed by an FSP could be interpreted as a call to action by investors, then it would be fair for the SEC to argue that the FSP was involved in a securities transaction. In conjunction with other factors — such as ease of effecting the recommended transaction, compensation for the FSP message, and prominence of any cautionary advice — the FSP might then be found to be acting as a broker-dealer. Clearly, AOL, Yahoo, and The Motley Fool are not eager to see regulatory action that threatens them with broker-dealer registration. Indeed, the majority of such portals operate with considerable regard for the financial safety of their users. But the potential for transmitting unsuitable advice is inherent in the nature of an FSP. For the SEC to not initiate some kind of regulatory response could prove quite harmful to unwary investors. David A. Lipton is a professor and the director of the securities program at Catholic University’s Columbus School of Law.

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