RCA - March 1999 - Electronic Trading Advertisements Raise Investor Protection Concerns

NASD Regulation recently reminded members that advertising and promotional materials must not set unrealistic expectations about investors' ability to "instantaneously" access markets during volatile times or about the opportunity to profit through electronic trading, including day trading. NASD Regulation issued these cautions as part of a larger discussion of volatility in the markets and electronic trading issues in Notice to Members 99-11 and in a letter addressed to CEOs of member firms from Frank Zarb, Chairman and CEO of NASD, Inc., the parent company of NASD Regulation. NASD Regulation has recently become concerned about reports of investor dissatisfaction with service and execution of on-line brokerage firms.


NASD Regulation has identified the following areas in which members need to exercise greater care with respect to their communications with the public regarding electronic or day trading.


Accuracy

Members must accurately describe their services and avoid language that misleads customers about their trading capabilities. NASD Conduct Rule 2210 requires that firms be able to substantiate claims they make in communications with the public regarding the speed or accuracy of executions. For example, language such as "best" or "fastest" cannot be included unless the member firm can substantiate such claims. Similarly, language that guarantees trade executions within a set time frame may pose a risk to both the customer and the member firm if circumstances prevent the firm from providing the trade within the guaranteed time frame. The Rule specifically prohibits exaggerated statements or claims in members' communications and requires that members limit their communications to accurate information.


Similarly, if communications describe a member firm's electronic trading systems, they should not exaggerate customers' access to the markets by stating or implying that a customer can execute trades without reliance on a broker/dealer. Accuracy is also critical in describing how a member's internal trading systems will interact with market proprietary systems such as SOESSM (Small Order Execution SystemSM), SelectNetSM, or the ECNs (Electronic Communication Networks). Members must not imply that such third-party provided services are the firm's own proprietary product.


NASD Regulation has observed certain communications regarding day trading that state or imply a member firm is recruiting employees when, in fact, the firm is soliciting customers who will pay commissions to the firm for using its trading services. Such communications are misleading and fail to reflect the just and equitable principles of trade mandated by the NASD Conduct Rules.


Disclosure Regarding Delays

Members must balance discussions of the speed, accessibility, or reliability of electronic trading services with disclosure that market volatility and volume may delay system access and trade execution. Because this information is material to an investor's understanding of the service and may impact an investment decision, members must ensure that it is communicated clearly and prominently. For example, television advertisements should present the information in the audio portion of the communication and not merely in an on-screen footnote.


Disclosure Regarding Risk of Loss

If a communication promotes the opportunities associated with using an electronic trading service or day trading strategy, at minimum, it must prominently disclose that there are risks including the possible loss of capital. Specific claims regarding the future profitability of a service or strategy run a high risk of misleading the reader and cannot be cured by the addition of disclosure or hedge clauses. Conduct Rule 2210 prohibits promises of specific future results and/or projections of investment returns to customers.


General claims regarding the past success of a service or strategy are permitted provided the member firm has a documented basis for such claims. This documentation must be maintained in the member's files and must be produced for examination upon the request of NASD Regulation staff. Failure to maintain such files may be deemed a violation of the rules regarding maintenance of books and records. Further, the communication itself must disclose that past performance is no guarantee of future results.


If members include specific claims regarding the past success of an electronic trading service or day trading strategy in a communication, they must provide accurate and complete information. Members must not select or manipulate performance data to show only positive results or to overemphasize short-term positive performance. Also, performance data should reflect all costs normally associated with the service or strategy. Specific performance claims must be accompanied by the basis for such performance. As with general claims regarding historical performance, the firm must maintain documentation of the performance data and the communication must explain that past performance is no guarantee of future results.


If a communication focuses on an investment approach that involves a high volume of trades, it must disclose the risks and costs associated with such a strategy. Such disclosures must be set forth prominently to ensure the reader understands them.


Investor Education

With a broader range of individual investors in the marketplace, increased use of technological tools for trading, and the expansion of trading activity such as day trading, educating the investor is more important than ever. The issue of investor education was addressed in both NASD Notice to Members 99-11 and Mr. Zarb's letter to CEOs of member firms. As discussed in the Notice, many firms devote portions of their Internet Web sites to investor education on issues related to market volatility.


If you have questions regarding electronic or day trading communications or wish to file such communications for review by NASD Regulation, please contact the Advertising/ Investment Companies Regulation Department at (202) 728-8330.