PREMIUM SEARCH Search by job title, geography and build a list of executive contacts
If you've traded stocks online, you know that online brokers inhabit two different worlds. There's the world you see on TV, where buying and selling from your computer at home or the office is as easy as...well, "as easy as fallin' in love," according to "Stuart," Ameritrade's (AMTD) gonzo pitchman (and my absolute favorite character on CNBC).
Then there's the real world. And according to a recent U.S. General Accounting Office report, reality is often murky, sluggish, frustrating, and sometimes just plain misleading and unfair. If you're tempted to start risking your money online, the report makes worthwhile reading. You can see it on the Web or download it to your desktop by going to www.gao.gov and looking up report number GGD-00-43, "On-Line Trading: Better Investor Protection Information Needed on Brokers' Web Sites."
Or, better yet, keep reading here. I'll fill you in on the lowlights and then offer a few ideas about how to set things right. The GAO, an investigative arm of Congress, looked into the online brokerage business by reviewing industry reports from the likes of Gomez Advisors and the National Association of Securities Dealers Regulation, plus those of the
Securities & Exchange Commission. Next, it contacted a dozen online brokers, including 10 of the largest, which account for 90% of the online trading volume. What did the investigators find?
Brokers don't keep records of the times when their computer systems are delayed or down altogether. That makes pointing fingers difficult, but delays definitely are hurting investors. An analysis of trading records covering 17 weeks last year found what the GAO calls a "statistically significant association between average Web-page processing speed and the rate of success in submitting an order." The upshot? "Investors at firms that took longer to enter a trade had a greater chance that their orders either would not be executed or would be executed at an unexpected price.... One online investor said that he lost up to $6,000 in his 2-day unsuccessful effort to submit a sell order."
Most brokers don't seem to worry if delays hurt customers. Of the dozen firms contacted by the GAO, only two indicated a willingness to compensate customers for losses because of computer system troubles. Four of the 12 firms had given no real warning to clients about which outages or delays are potential risks.
Online brokers often don't adequately disclose the risks of margin trading. Nearly half the firms automatically opened margin accounts for new customers, and three firms notified the customers that they had opened margin accounts only via dense legalese. One investor found he owed his broker $75,000 after unwittingly trading a stock that the firm
did not allow to be bought on margin.
Half of online brokers were more intent on sending customer orders to market makers who paid for the order than on getting the best trade execution for the customers. "Six brokerage firms we contacted," the GAO reports, "were not fulfilling their best execution duty."
Online brokers that tantalize investors with the prospect of getting in on initial public offerings rarely disclose the slim or nil chances the investors have of actually buying shares in IPOs. "The eight online broker-dealers that offered IPOs generally did not provide information on their allocation methods, the probability of any one customer receiving shares, or the number of shares to be allocated to the firms.... Investors, especially those new to trading, could mistakenly assume that the online brokerage firm had sufficient IPO shares available for purchase."
For all the convenience of online trading, the record of these firms should be so much better. The GAO makes some recommendations, such as having the SEC require that online brokers keep consistent records of computer-system outages and delays. That's a start. Regulators or, better yet, the firms themselves should go further. The following five steps would make the world of online trading a better place to invest:
Post computer-system "down" time publicly. With airlines, government rules allow me to learn what percentage of the time a given flight reaches its destination on schedule. If I have some leeway with my travel plans, I'll pick a flight that arrives on time 90% of the time rather than one getting in on schedule 40% of the time. Online brokers should show what percentage of the trading day their systems have crashed or wasted customers' time and money because of delays.
Compensate customers for delays and outages. If an airline loses my bags, there's some monetary compensation. The same should be true if an online broker "loses" my order -- or if I lose the price I had hoped to get in a trade -- because of computer-system troubles.
No margin accounts opened without a client's full understanding and permission. The airlines don't make me sit next to the exit door if that would make me nervous. Why should I have a riskier margin account if I'm not sure I can handle it?
Full disclosure of brokerage firms' records on "best execution." When you give your trading order to a firm, you have entrusted it with the job of getting you the best possible price. As things stand today -- and this goes for all brokers, online and traditional -- the law obliges brokers to get you what's called the "national best bid or offer," or NBBO. That's a fancy way of saying the best price at the moment. But good brokers will "work" an order, trying to get what's called "price improvement" -- a slightly better price inside the bid-offer spread. When brokers sell your order to a dealer for execution, the chances of your
getting price improvement plunge.
My suggestion: Firms should disclose what percentage of their customers' trades wind up enjoying price improvement. Think of it this way: Would you keep going to a travel agent who sold your request for airline tickets to a wholesaler who never worked to get you a lower price?
Straight talk on the entire IPO process. Online brokers often leave the impression that by doing business with them you'll get handed winning tickets to the lottery. At least with the state-run lotteries, you can look up the horrendous odds. The plain truth about IPOs is that most shares in the truly promising ones are snapped up by big-money investors. Brokers blurring that fact should no more be entitled to stay in business than an airline that doesn't take you where it's scheduled to go.
Is there any reason why online brokers should follow my advice? None, really, except to demonstrate that they know that doing business best means doing best by the customer.
Barker covers personal finance in his weekly column, The Barker Portfolio, for Business Week from Melbourne Beach, Fla. And he appears every Friday on Business Week Online
Copyright 2000 , by The McGraw-Hill Companies Inc. All rights reserved.
Printer-Friendly Version
