Report of NASD Regulation

Public Policy Sessions
Concerning the Advertisement of Online Brokerage

 

September 21, 1999

 

Today millions of investors have power unknown in previous times. Through the Internet, they can quickly find affordable market research, stock information, and economic news. They can gain access to this information from their homes, offices, and virtually any other location. They can communicate more quickly with securities firms, and can take advantage of design tools to better plan and track the progress of their portfolios. Customers often can have their broker/dealers execute trades almost instantaneously, while generally incurring lower commissions.

 

A large number of online brokerage firms now offer these new investing tools. Some of these firms have engaged in extensive and aggressive advertising campaigns to distinguish their style of business from traditional firms and to promote their businesses. These advertisements must, of course, comply with the NASD's advertising rules. In addition, NASD Regulation is troubled by advertisements that may not run afoul of those rules, but which are so aggressive and demeaning to competitors, and in such questionable taste, as to potentially undermine investor trust and confidence in the industry as a whole. Such advertisements do not serve the interests of investors or the industry and we expect our members to take a more constructive and informative approach to their advertising.

 

Most importantly, NASD members have a duty to manage investor expectations about the risks and rewards of online investing. Advertisements that mislead or confuse investors about the risks and rewards of online investing, or that attempt to incite a trading frenzy, harm the investing public and undermine investor confidence in the integrity of the markets. They even will dampen interest in the very online services that these investors are being asked to use, and thus could impede further development of those services. *

 

In short, customer confidence in the integrity of the market as a whole and the industry's professionals is a valued asset that no one has a right to squander. As the self-regulatory organization for the broker/dealer industry, NASD Regulation has established, as one of its primary objectives, the regulation of member advertising to ensure that it is fair, balanced and not misleading. NASD Conduct Rule 2210 and related provisions comprehensively regulate the content and presentation of member sales material. Moreover, NASD Regulation examines its members to ensure that they are complying with these requirements, and investigates reports of possible violation of these rules. When warranted, NASD Regulation disciplines members for violating the advertising rules.

 

The standards imposed by the NASD advertising rules are perhaps the highest imposed upon any industry. Experience has demonstrated that if investors are to be protected, and if the brokerage industry is to prosper, then member advertising must portray the risks and rewards of investing in a manner that is honest, fair and balanced. Members must consider not merely the short-term demands of a sales campaign, but the long-term interests of their customers. Compliance with the highest standards is necessary if the brokerage industry is to retain the public trust that it has earned for so long.

 

At the request of Arthur Levitt, Chairman of the Securities and Exchange Commission, NASD Regulation invited a group of members and their advertising agencies to discuss the public policy implications of member advertisement of online brokerage, particularly advertisement on television. Three meetings were held, on June 24th, June 30th , and July 1st, 1999. These meetings set the stage for an ongoing dialogue about the legal and ethical responsibilities of NASD members when they advertise their online brokerage services.

 

1. Themes of Discussion

 

A. Interest in Online Investing Cuts Across All Demographics

 

According to the broker/dealer and advertising agency participants in the meetings (the "Industry Participants"), interest in online investing has grown dramatically in recent years and, contrary to some reports, this interest is held by both young and old, seasoned and inexperienced investors. Moreover, the Industry Participants have found that many people who invest online also have accounts with other firms that provide investment advice. It is not uncommon for investors to have several accounts, which may include traditional brokerage accounts, mutual funds, and online brokerage accounts. In the future, however, new investors may invest first through online broker/dealers.

 

B. Compliance and Good Service Are Critical

 

The Industry Participants agreed that a high quality of customer service will be the ultimate determinant of a firm's success and will be critical to the future growth of the industry. The Industry Participants agreed that compliance with the federal securities laws and NASD rules would be essential to the achievement of this objective. They also agreed that the investing public will hold them accountable if their marketing materials make misleading claims about the benefits of investing online. Industry Participants strongly support the education of their customers, particularly those who are new to investing.

 

C. Advertising is an Integral Part of a Broader Campaign

 

Industry Participants stated that, while television advertising is an effective means of communication, there are many forms of communicating with investors. Online brokerage firms usually provide a Web site that presents educational material. Further information may be provided in the account-opening process and in routine mailings. These other materials discuss such matters as the risks of market orders and margin accounts, the possibility of interrupted service, and the difference between real-time quotations and execution. Some firms have developed an online tutorial for their customers.

 

There may be many places in the sales process where education and disclosure are provided prior to opening the account. Any marketing campaign thus represents part of an integrated effort in which several advertising agencies, marketing companies, and public relations firms may participate.

 

D. Approaches Vary Among Firms

 

Industry Participants agreed that brokerage firms convey a range of messages. The approach chosen by a firm will largely depend upon its business model, the size of its budget and the degree to which it is established in the marketplace. Industry Participants agreed that the theme of the marketing campaigns will evolve from an effort to attract customers who are new to online brokerage, to the establishment of a brand name and reputation. Advertisements will therefore focus not so much on "Why invest online?" as on "Why open an account at X online firm?"

 

E. Customer Education is Key

 

Industry Participants agreed that educational efforts will help to establish realistic investor expectations. Moreover, the Industry Participants generally agreed that the tone of more recent advertisements had become more moderate, particularly since the SEC and NASD Regulation began expressing their concerns about the climate that earlier advertisements had created. Nevertheless, there was general skepticism about the effectiveness of attempting to educate investors solely through television advertisements. Industry Participants were interested in an educational campaign coordinated by NASD Regulation, perhaps with a Web page created by NASD Regulation to which firms could hyperlink.

 

F. Responsibilities of the Media

 

Industry Participants expressed concern about the tendency by some members of the media to exaggerate the benefits of online investing. Some media reports focus on the success of young investors who trade frequently online. In essence, some Industry Participants felt that the press may confuse investors about the differences between news and "financial entertainment." According to Industry Participants, these media reports do a disservice by confusing readers about the risks and rewards of online investing. They felt that the press should take a more responsible role in reporting about online brokerage.

 

2. Focus Groups

 

In order to assist the discussion, NASD Regulation retained an independent consultant to conduct two investor focus groups, each with 8 people¹.  The focus groups viewed 10 television advertisements for online brokerage services and the consultant asked the focus groups a series of questions. The focus groups were not scientifically conducted (and thus not statistically valid), nor were they conclusive about investor perceptions. Nevertheless, the results were discussed at our meetings with Industry Participants and the SEC, and following is a brief summary of those results.

 

The respondents believe that the investing environment is highly charged, and some of them fear that they are "missing out" on potential returns. Respondents often confuse "online investing" with investing in Internet stocks through online brokerage. The respondents indicated that they had a reasonable understanding of the risks of online investing, with the exception of the risk of trading delays and system failure, in which case their understanding was more limited. The respondents believe that firms should enhance their disclosure of this risk. The respondents believe that online investing has certain advantages, such as better access to information and a reduction in costs.

 

Respondents indicated that online investing contributes to different trading habits, such as more frequent trading and trading in higher-risk securities. Respondents felt, however, that an increased interest in and control of their portfolios were positive outcomes of online investing.

 

Respondents felt that advertisements designed to attack the ethics of full-service brokers were ineffective and offensive. However, they did not object to criticism of high fees or poor service, which some felt that they had experienced.

 

3. Future Actions

 

During the past year, the SEC and NASD Regulation have taken several measures to ensure that the advertisement of online brokerage services is fair, balanced and not misleading. We have issued both Notices to Members and Regulatory and Compliance Alerts to our members, reminding them of the need to accurately portray the manner in which trades are executed online; to disclose the risks associated with online investing; and to fairly present the fees that will be charged. Moreover, we have publicly expressed our intention to hold these advertisements to the same high standards that the industry has imposed upon other types of sales material.

 

NASD Regulation believes that these efforts have paid off. In recent months, the tone of many advertisements for online brokerage has become more moderate and several members have expanded their educational efforts.

 

Nevertheless, NASD Regulation recognizes that our efforts must continue if we are to ensure that advertisements for online brokerage are accurate, balanced and not misleading. Consequently, NASD Regulation intends to adopt the following measures:

 

A. More Aggressive Oversight and Investigation of Possible Violations

 

NASD Regulation recognizes that oversight and enforcement of the advertising rules is an effective means to ensure compliance. We vigorously investigate the use of any sales material that seems to violate our advertising rules and, when a problem appears, we notify the member firm and request appropriate action.

 

In recent months, we have focused on the advertisement of online brokerage services that seems to unfairly portray the benefits of the trading online, without disclosing the risks associated with online investing. We have requested that members alter their television advertisements to balance claims about possible investment results, the speed of trade execution and low costs of investing online. We have also insisted that members correct any misimpression that trades can be executed directly, without use of a broker/dealer.

 

In certain cases, NASD Regulation has insisted that a member terminate use of particular television advertisements, at significant expense to the member. We will continue to insist that members comply with their high ethical and legal responsibilities. When necessary, we will request corrective action, including termination or modification of expensive marketing campaigns. We will take disciplinary action when appropriate. Members that repeatedly have issues regarding their compliance with the advertising rules will be subject to greater sanctions.

 

NASD Regulation is concerned about the attempt by some members to accuse an entire group of broker/dealers of dishonest or unethical behavior, without any basis for this accusation. Unfounded claims of this nature can harm the reputation of the entire industry, including those who are making such claims. NASD Regulation will continue to discourage members from making these types of assertions in their advertisements. In addition, we will continue to monitor the portrayal of broker/dealer and customer relationships in specific advertisements, to determine whether further measures may be appropriate.

 

NASD Regulation will continue these efforts to oversee television advertisements. We encourage members of the public and NASD members to notify us of any concerns they may have about specific advertisements for online brokerage services.

 

B. Education of Investors

 

NASD Regulation agrees with the Industry Participants that if investor expectations are to be realistic, then investors must be educated concerning the risks and rewards of online investing. Consequently, NASD Regulation intends to launch an educational campaign to inform investors about the risks and rewards of investing online. The centerpiece of this campaign will be a new Web site, which will discuss the characteristics and the risks of investing online. Members will be encouraged to hyperlink to this Web page from their own Web site. This educational campaign will supplement the NASD's many other efforts to educate the investing public.

 

C. Continued Dialogue With Members

 

NASD Regulation intends to continue the discussion with its members concerning the public policy implications of advertisements for online investing. We will provide clarification to the advertising rules as needed, and will notify our membership about any specific concerns that these advertisements may raise in the future. We also expect our members, online as well as more "traditional" brokerage firms, to communicate with us concerning any issues that particular advertisements may raise and any questions that they may have concerning our regulation of this type of advertisement.

 

4. Conclusion

 

The Internet has provided investors with a powerful tool to find information quickly and to gain access to the securities markets through their broker/dealer. At the same time, the availability of online brokerage services imposes a new set of responsibilities upon member firms to educate investors and ensure that investor expectations are realistic. NASD Regulation will continue to monitor online brokerage advertisements, to educate the investing public, and to work with other regulators, investor groups and our members to ensure that investors are fully protected.

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* One recent study examines the trading patterns of online investors, and the potential harm from speculative and more active trading by those investors. Barber and Odean, Online Investors: Do the Slow Die First? (September 1999 draft)

 

¹ The respondents were men and women, aged 35 to 39 years, with at least $75,000 in annual household income and $50,000 in investable assets. They had recently begun to invest online or were considering whether to do so.