Online Brokers 2000: Investors Want Research, but Will Regulators Let Them Have It?

Online investors may be do-it-yourselfers when it comes to picking stocks, but they still want investment research. This is especially true for the more conservative among TheStreet.com's readers.

Fully three-quarters of those who identified themselves as buy-and-hold types in TheStreet.com's Online Broker Survey 2000 said that such research was "vital" or "important." (Daytraders, by contrast, expressed much less of a need for research: Only a third rated online research "vital" or "important.")

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But there's a reason why online investors may not be getting everything they want in this regard. Regulators, including the Securities and Exchange Commission, have been looking into just how online brokers dispense research. Their worry: that research may not be appropriate for all clients and that what is offered as research will be interpreted by some customers as actual recommendations.

What's the difference? A recommendation is only supposed to be directed to "suitable" clients. Under suitability requirements, brokers are supposed to tailor a recommendation to a specific client's individual investment profile.

So far, no one knows exactly where to draw the line between general information and a specific recommendation.

"It is clearly a hot-button issue right now for the industry and the SEC," said Blake Bell, a New York attorney with Simpson Thatcher & Bartlett who specializes in Internet issues. "The real problem that the e-brokers face right now is that there's not a lot of guidance" from regulators.

SEC Commissioner Laura Unger late last year completed a report on online brokerages in which she concluded that her agency should consider clarifying how suitability requirements apply to online trading.

Both the National Association of Securities Dealers, which owns and runs the Nasdaq market, and the New York Stock Exchange have rules to ensure that member companies tailor recommendations to fit the financial, risk and personal characteristics of their clients. The Big Board's requirement is called the "Know Your Customer Rule."

There was a time when traditional brokerages like Merrill Lynch (MER Quote) were the only ones that performed research and then offered investment advice to clients. While online brokers started out as simply a way to get a trade done quickly and cheaply, they soon found that their customers wanted tools to help them select stocks as well. With the number of consumers trading online rising, so have demands for research.

In mid-March, for example, online broker Charles Schwab(SCH Quote), our survey's League A winner in this category, rolled out a new investment advising service that combines individual consultation, online instruction and email alerts about stocks. (Our League A brokers received more than 650 votes each. Our League B brokers received between 72 and 312.) For further explanation of how we crunched the numbers, see our methodology.

Broker Score Datek 11.62 Fidelity 14.88 Schwab 18.44 DLJdirect 16.82 Ameritrade 10.97 E*Trade 16.44 TD Waterhouse 12.91 Scale of 0 to 30. League A brokers received more than 650 votes each. League B brokers received between 72 and 312.

Schwab said it does comply with suitability requirements when it makes these investment recommendations to individuals. But Schwab, which provides analyst research from places like Chase H&Q and Credit Suisse First Boston, doesn't believe suitability requirements are necessary for online broker services that don't involve one-on-one investment counseling to clients.

"The research that people tap into online is done at their own undertaking, and it is general information available to all customers," Schwab spokesman Glen Mathison said. "We don't believe that there's a reason to create new regulations."

The North American Securities Administrators Association, which represents state securities regulators, isn't so sure.

"Since discount brokers don't make recommendations in the traditional sense, it would seem that the suitability rule wouldn't apply to them," Brad Skolnik, the group's president, said in a speech late last year. "But technology is blurring this once-bright line. More and more online brokerages are offering reports, research and recommendations on their Web sites."

The trend is only accelerating with the arrival of full-service firms on the online scene. Take Merrill Lynch, a newcomer to online, which topped League B brokers in research. It's easy to see why: Online investors at Merrill get access to all of the firm's sell-side research.

Broker Score Dreyfus 9.49 Brown 1.57 ScoTTrade 7.73 Merrill 20.80 MSDW 14.97 Vanguard 6.53 NDB 12.43 Suretrade 12.80 Am Ex 10.14 Quick & Reilly 12.30 Scale of 0 to 30. League A brokers received more than 650 votes each. League B brokers received between 72 and 312.

Ron Readmond, co-CEO of online brokerage Wit SoundView at the Web site Wit Capital (WITC Quote) that provides its own research, focusing on tech and Internet issues, insisted that if any aspect of online trading needs additional scrutiny by regulators, it's daytrading, not suitability. Wit, he said, has no concerns about suitability with the research it provides to investors.

"We just don't make recommendations" to individuals, Readmond said. "We make our proprietary research freely available on our Web site. ... I look at it as information that you or I or anyone can view."

Still, despite all of this concern, there have been few disputes about online brokers and suitability. In the past three years, of 650 arbitration cases against the nine largest online brokerages, only 40 included suitability claims, Unger said last month during a American Association of Retired Persons meeting. Even in those 40 cases, it wasn't clear that suitability was the central issue, she said.

But Unger added, "It will be interesting to see what happens if the market turns bearish."

Bell, the cyberspace lawyer, thinks so, too. "The moment you see a substantive downturn ... you would see a rise in the raw numbers of such claims and the percentage of such claims," he said. "I absolutely believe that."