Online Buyer Beware
The explosion of aggressive stock trading by individual investors is keeping Arthur Levitt and his team at the Securities and Exchange Commission busy these days.
In recent speeches, the SEC chairman has expressed concern that many investors are so fascinated with researching and trading stocks over the Internet that they’re overlooking the risks involved.
Instead of the instant profits they expect, Levitt frets that unsophisticated investors could incur sizable losses if their supposedly hot stocks turn cold.
The SEC also has stepped up its oversight of electronic brokers to ensure that customers aren’t being misled about the dangers of rapid-fire trading.
And to combat stock fraud--an old problem that appears to be booming anew with the Net--the agency has filed complaints against several Web sites on charges that they illegally promoted stocks to investors.
The Times recently spoke with Levitt about the online-trading phenomenon, and about the steps investors can take to protect themselves:
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Question: What should investors keep in mind when researching and trading stocks over the Internet?
Answer: The Internet is a superb and important new tool. But there is no magic button to separate good from bad information . . . . Individual investors need to ask questions, to educate themselves, to look to the long term and avoid hasty speculation. There is no way that our agency, or any group of government agencies, can do a job that totally protects investors. The best way to protect the public, in my judgment, is to help the public protect themselves.
Q: What do you think of so-called day traders who engage in rapid-fire trading from their homes or from specialized brokerage firms?
A: Day trading is not a new phenomenon, but recent advances in technology [have] made online trading possible. They brought trading strategies--the mechanisms of professionals--within the reach of individual investors.
The difficulty is that our culture has built up a kind of machismo image of the trader, with books, novels, movies, television shows about traders. They are in some cases deified and vilified in the same way as professional athletes.
The difficulty is that the new technology makes it very, very easy for individuals, with the touch of several keys, to think of themselves as--and to take on the posture of--a professional trader. [But] individuals lack the temperament, the experience and the resources of professional traders. That’s where you fall into problems.
Q: Day traders still make up just a fraction of all individual investors. Do you sense that the phenomenon is expanding?
A: I think it is growing and it will grow exponentially as markets continue to heat up. Markets such as we’ve had make people emotional, rather than intellectual, about investing. And that is an absolutely sure way for failure. A good market such as this covers up lots of bad judgments. But a down market can be punishing and will exact a fearsome price from investors who are using their hearts rather than their heads to invest.
Q: What specific steps should online investors take to protect themselves?
A: Investors have to be skeptical of offers that they see on the Internet and assume that they’re scams until they are proven to be legitimate. Investors have got to do their own homework and buy securities only when they’ve done enough research to know precisely what they’re buying. And to be sure that they know all the risks involved in potential investments.
They should go so far as to get financial statements from companies--and look at them. And if they don’t have the ability to do that, they should have someone they trust do that: their accountant, their lawyer. They should be certain that the people running the companies are reliable, whether they’ve made money for investors before.
They should intellectually and practically avoid getting-rich schemes. I often say, “If it’s too good to be true, it probably is.” They’ve got to resist strenuously high-pressure sales tactics, salesmen who say that you must send the money in right away. That’s a sign that he doesn’t want to give you enough time to think.
Q: Is increased regulation needed to protect investors?
A: The Internet is a superb tool, and I’d be reluctant to try to stand in the way of investors’ access to that tool. Even if I wanted to, I don’t think there are any regulations that could or should do that. I think we have to be prepared to address fraud [and] misleading advertising when those things develop. But I think to say that investors can’t deal in online trading would be a mistake.
Q: The National Assn. of Securities Dealers, which runs the Nasdaq Stock Market, has generated a lot of controversy lately with a proposal to require that firms screen new customers extensively to ensure that they’re “suitable” for day trading. Do you support such an idea?
A: I expect that [the NASD is] going to present rule changes to the commission with respect to the suitability of people who trade online. I’m not for the moment saying that we need a suitability requirement. I want to see what the NASD has to say about that. I think if advice isn’t given electronically, probably suitability is not a likely issue.
But technological advances can allow for online trading firms to provide more personalized guidance, which does raise some suitability issues. We’re going to look at this very closely. This is an emerging area, and I don’t know what will come out. But I’m reluctant to use regulation as an instant fix to a new technology such as this.
Q: Do you think a suitability guideline is needed for the most aggressive day traders, those who go to on-site trading firms?
A: For the time being, that represents a small part of our population. And I guess the people that go to Las Vegas with money they can’t afford to lose; I feel that that’s unfortunate, but I think that society being what it is, people will find ways to do that. As long as those day-trading operations are not fraudulent in terms of taking money for services not rendered or representing profits that don’t exist, and people are foolish enough to day-trade--and I do think that day trading for the typical retail investor is a foolish pursuit--I think the market’s response to that is far stronger than any regulatory response.
Q: Are you concerned about the spate of system crashes that have struck online firms and stranded customers who were unable to trade?
A: We’ve been concerned as an agency with the ability of the industry to meet the surge in volume that has taken place. It’s not just online trading. We’ve had concerns about the NASD, the NYSE, and we manifest those concerns in our inspections. And I’m satisfied that both the NYSE and the other major exchanges around the country are geared up to handle more volume than we are presently seeing.
With respect to online trading, that’s a new area and we’re not certain what their capacity is. And we’re asking questions and we’re conducting inspections. But it is a concern, obviously.
Q: Are you making progress in combating online fraud?
A: I think we’re making progress, but think it’s unrealistic to expect that we can eliminate fraud on the Internet. There will always be fraud on the Internet that escapes our attention.
But by bringing cases, by helping people understand what their complaint mechanism can be and should be, by adding staff within the limits of our resources, and with refocusing our enforcement effort to target electronic fraud, I think we can come to grips with the problem. Do we need more? Yes. Can we use technology more effectively than we have been? Absolutely.
Q: It seems that individual investors have greatly evened the playing field against larger, institutional investors. Would you agree?
A: That’s absolutely true. I think that with respect to other players in the market--dealers, institutional investors--I don’t think the individual investor has [ever] had a more powerful position in our markets than he and she have today, for a variety of reasons: The breadth of the market, the duration of this market rise, the enormous growth of mutual funds and the role of individual investors in that market, the growth of investment in debt issues through municipal bonds, and steps that the commission has taken.
Q: Are you concerned that individual investors will panic in an extended market downturn?
A: One of the reasons that I so emphasize investor education is to dampen the possible impact of individual investor sentiment turning precipitously in the event of a market decline. Investors who understand the nature of markets are much better able to sustain the impact of a decline.
Q: Do you think the trading mentality among individuals is here to stay, or will it dissipate during any lengthy downturn?
A: I think it is exacerbated in an up market, but I think that technology has produced as much of the impetus for it as emotions have. In other words, you simply couldn’t use your computer to do this seven or eight years ago, and you can today. People become much more cautious in down markets, so you wouldn’t see it grow the way it’s grown in a down market. But I think you would still see evidence of it.
Q: A couple of private firms are working on plans that would make it possible for individuals to trade stocks in the evenings after the regular markets have closed for the day. Are you in favor of such plans?
A: I think it’s fine. I think that we have to be certain that investors know that markets tend to be less reliable after hours. [But] as long as there is that level of knowledge, I’m in favor of options which give individuals the maximum number of opportunities.
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At the Conference
SEC Chairman Arthur Levitt will be a featured speaker on the second day of The Times’ Investment Strategies Conference, to be held May 22 - 23 at the Los Angeles Convention Center. His speech is free and open to the public. Levitt invites reader questions in advance, though he will be able to address only a sampling. To submit a question for consideration, e-mail business@latimes.com and put “ISC Questions” in the subject field, or write to ISC Questions, c/o Kathleen Brady, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Note: To gather information for his speech, Levitt is also surveying Times readers on their general investment habits. To participate, see survey on Page 38. *
Walter Hamilton covers stock market investing and writes the Street Strategies column for The Times. He can be reached by e-mail at walter.hamilton@latimes.com, or by mail at Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
