In a new report released Thursday, the U.S. Securities and Exchange Commission (SEC) warned Internet brokerage firms to improve their overall business practices, including online trading technology and advertising, to ensure that consumers are adequately protected and informed.
The report, “Examinations of Broker-Dealers Offering Online Trading,” said that in the past two years the most common investor complaints have been failures or delays in processing their orders online, difficulty in accessing their online accounts, and errors in processing their orders.
“As more investors trade online, it becomes ever more important for broker-dealers to ensure that their online systems are meeting the needs and expectations of investors,” said Lori Richards, director of the Office of Compliance Inspections and Examinations at the SEC.
Online trading has grown dramatically since the first Internet-based trading systems were introduced in 1995. Currently, according to the SEC, there are 7.8 million online investors making a total of 807,000 trades per day through the over 200 broker-dealers that allow investors to trade online.
One of the most common problems in the world of online investing is a lack of full disclosure.
“Regulators have expressed concern that certain aggressive advertising by broker-dealers could lead investors to have unrealistic expectations about the risks and rewards of investing,” the report said.
In addition to recommending that online brokerages tone down their advertising campaigns, the SEC said online brokerages need to provide more information about the basics of investing — including a glossary of terms, an explanation of how orders are executed, and a detailed explanation of the risks associated with investing on margin.
Online brokerages were also warned that “firms should also provide conspicuous, plain English disclosure about the risks of securities trading, including the risk of systems outages or failures.”
The agency also said it has received numerous complaints about inadvertently placed duplicate orders that occurred because the online brokerage did not process a cancellation for an earlier order of the same security in a timely manner.
Although brokerage firms have taken steps to prevent the unintended execution of duplicate orders, the SEC concluded that these methods do not eliminate all unintended duplicate orders. The steps taken include eliminating the ability of investors to cancel market orders, placing a lock on securities subject to a buy or sell request, and automatic notification if investors enter a buy or sell order when there is already an order pending for the same security.
The SEC also warned online brokerages of their legal obligation to obtain the best execution of their customers’ investments. According to the report, “many broker-dealers were not meeting their best execution obligations because they sent all of their order flow to their clearing firm and conducted no independent review of execution quality.”
During its review of online brokerages, the SEC observed “many instances” of confidential information — including account numbers, passwords, and social security numbers — being sent via unencrypted e-mail.
The review also found only one-fifth of the firms reviewed had written policies on employees sending confidential information over e-mails and a fifth of the firms warned customers about sending confidential information through e-mails.
In addition to warning online brokerage firms to implement measures to protect consumers’ personal information sent via e-mail, the SEC recommended that the firms implement procedures to prevent unauthorized access to their internal computer systems and to prevent access to a customer’s account through unauthorized use of the customer’s password.