Scott W. Campbell
Vice President and
Associate General Counsel
Charles Schwab & Co., Inc.
The Schwab Building
101 Montgomery
Street
San Francisco, CA 94104
Re: Online
Services
Dear Mr. Campbell:
This letter responds
to your letter dated November 25, 1996, in which you request relief from
the broker-dealer registration requirements under Section 15(a) of the
Securities Exchange Act of 1934 ("Exchange Act") on behalf of America Online,
Compuserve, and Microsoft ("online services") if they agree to connect their
subscribers to Charles Schwab & Co., Inc. ("Schwab") for a nominal, flat, per order
fee. As you noted in your letter, online access to broker-dealers should help
investors gain greater and more convenient access to the securities markets and
their broker-dealers.
We understand that Schwab intends to enter into separate
agreements with the online services under which the online services will allow
Schwab to make its brokerage services
available to the subscribers of the online services. For instance, a Compuserve
subscriber could log on to that service and locate Schwab's icon through [*2] an online menu provided by Compuserve. By
clicking on to Schwab's icon, the subscriber could
access various brokerage services provided by Schwab. If it wished to do so, the
subscriber could open an account with Schwab by accessing, completing, and
returning account opening forms via the computer. After a subscriber has opened
an account with Schwab, he or she will be able to send
orders to purchase or sell securities electronically to Schwab, which will execute those orders
and relate the relevant and required information about those orders to its
customer. Schwab will take responsibility for
orders once they have been received. Schwab has developed a series of
order-entry, verification and acknowledgement screens (which customers can
preview as tutorials) that lead the customer through the order-entry process and
make clear when an order has been received by Schwab. With respect to Microsoft, in
addition to enabling potential investors to access Schwab through the Microsoft Investor
service, an area within Microsoft's Internet site, Microsoft will provide its
subscribers with software that will enable them to download all of their
brokerage information via the Internet and to consolidate [*3] and view that information on their desktop
computers.
We also understand that the agreements Schwab intends to enter into with the
online services will set forth the responsibilities of Schwab and each online service under
the agreement. In particular, under the ageeements, Schwab will be responsible for the
accuracy of all advertising and sales materials relative to Schwab's financial services that are
published by the online services; the online services and their employees will
not be allowed to describe Schwab's brokerage services to
subscribers other than by distributing these materials; and all advertising or
sales material will clearly indicate that the subscriber or user of any of the
online services will be a brokerage customer of Schwab and not of any of the online
services. In addition, we understand that the online services and their
employees will not recommend or endorse specific securities. Neither the online
services nor their employees (except with respect to their own accounts) will
take part (other than by routing messages) in the financial services offered by
Schwab, including the opening,
mainenance, administration, or closing of Schwab accounts, or the solicitation
[*4] of
trades, nor will they provide specialized assistance in resolving problems,
discrepancies or disputes involving brokerage accounts or related securities
transactions. The online services also will not answer questions or engage in
negotiations involving brokerage accounts or related securities transactions;
all such inquiries will be directed by the online service to Schwab's customer support personnel.
The online services will not accept orders, select among broker-dealers or route
orders for customers to markets for execution; all decisions concerning
broker-dealer or market selection will be made by customers or Schwab. The online services will not
handle customer funds or securities related to securities orders transmitted to
Schwab or effect clearance and
settlement of customer trades. The online services will not extend credit to any
customer for the purpose of purchasing securities through, or carrying
securities with, Schwab. Moreover, under the agreements,
Schwab will compensate an online
service by paying it a nominal flat fee for each order transmitted to Schwab. The amount of this fee will not
vary depending on the number of shares or the value of the underlying securities
[*5]
comprising a customer order transmitted to Schwab, nor will the amount of this fee
vary depending upon whether the order results in an executed trade.
Based on these facts and representations, the staff of the Division of
Market Regulation will not recommend enforcement action to the Commission under
Section 15(a) of the Exchange Act if Schwab enters into agreements with the
online services as discussed in your letter without the online services
registering as brokers or dealers under Section 15(b) of the Exchange Act. This
letter represents the views of the staff of the Division based on our
understanding of the proposed arrangements between Schwab and the online services as
discussed in your letter. n1 This staff position concerns enforcement action
only and does not represent a legal conclusion regarding the applicability of
the statutory or regulatory provisions of the federal securities laws. Moreover,
this position is based solely on the representations that you have made, and any
different facts or conditions might require a different response.
n1
Although not the subject of this request, a broker-dealer conducting business
over the Internet should consider the extent to which it may be responsible for
content provided by a third party. See. e.g., Securities
Exchange Act Release No. 21383 (October 9, 1984), in which the Commission noted
that a suitability "issue is raised to the extent that a broker-dealer or
related entity provides investors research and analysis amounting to
recommendations of individual securities through the computer brokerage system
or accompanying data bases." See also "Ask the Analysts about
Electronic Communications," NASD Regulatory & Compliance Alert (April 1996),
in which the National Association of Securities Dealers, Inc. noted that a
member must not link to a WEB site that the member knows contains misleading
information about the member's products or services. [*6]
Sincerely,
Richard R. Lindsey,
Director
INQUIRY-1:
Charles Schwab
THE SCHWAB BUILDING . 101 MONTGOMERY STREET . SAN
FRANCISCO, CA 94104 . (415) 627-7000
Securities Exchange Act of
1934,
Section 15
November 25, 1996
VIA FEDERAL
EXPRESS
Catherine McGuire, Esq.
Chief Counsel
Division of Market Regulation
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Dear Ms.
McGuire:
This letter requests that the Staff of the Securities
and Exchange Commission advise Charles Schwab & Co., Inc., a registered
broker-dealer ("Schwab"), that the Staff will not
recommend any enforcement action against Schwab and certain online services if
Schwab enters into compensation
arrangements with such online services, as described more fully below, without
the online services or any of their employees registering as brokers or dealers
under Section 15 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act").
Background
As
the Staff is aware, the online services industry, and the availability of
services through the Internet, n1 is expanding quite rapidly, and the mix of
providers is constantly changing. Schwab has been a leader in making
[*7]
electronic brokerage services available to its customers. Schwab was among the first major
brokerage firms to enter into arrangements with online services (such as
GEnie(R)). Online services have provided two important services to Schwab and indirectly its customers.
First, the online services have provided marketing and advertising space
comparable to a newspaper, magazine, billboard or television network. Second,
and more important, the online services have provided Schwab and its customers with network
access and communications transmissions links. Through these links, Schwab's customers have been able to
transmit their trade orders to Schwab, which has then effected the
transactions as broker-dealer and issued confirmations and statements. n2
n1 In its June 11, 1996 opinion enjoining application of the
Communications Decency Act of 1996, the United States District Court for the
Eastern District of Pennsylvania reported extensive "Findings of Fact"
describing the history and nature of the Internet. ACLU v. Reno, 929 F. Supp 824 (E.D. Pa. 1996) (three
judge panel). Among other things, the District Court found the Internet to be "a
unique and wholly new medium of worldwide human communication." [*8]
n2 Schwab takes responsibility for orders
once they have been received. Schwab has developed a series of
order-entry, verification and acknowledgment screens (which customers can
preview as tutorials) that lead the customer through the order-entry process and
make clear when an order has been received by Schwab.
Schwab now seeks
to enhance the efficiency and convenience of its services to both new and
existing customers by entering into arrangements with a broader mix of online
services. As discussed below, Schwab proposes to pay certain online
services nominal flat fees for each order transmitted to Schwab. These proposed payments are
designed to better reflect the true usefulness to Schwab and its customers of
arrangements with any given online service. We believe that by more closely
aligning payments to online services with the usefulness of the arrangements,
Schwab will be able to offer less
expensive and more efficient brokerage services to customers.
Overview of Online Services
The online
services with which Schwab has or may in the future
establish arrangements include providers of services and content on computer
networks, including the Internet, and may [*9] be grouped into three categories. The
first, and more established in the marketplace, are commercial networks
(e.g., America Online, CompuServe, GNN, MSN, NetCom and Prodigy) and
Internet access providers (e.g., AT&T, Bell South, MCI, Pactel,
Sprint and TCI). A second type of online service includes sponsors of World Wide
Web electronic communities or search directories (e.g., InfoSeek and
Yahoo). Finally, a third category consists of software companies (e.g,
Microsoft, Intuit, Netscape and Meca).
One of the more
established models for providing online services is the commercial online
service, like America Online or CompuServe. These leading online services have
traditionally operated as closed computer networks that allowed subscribers with
personal computers and modems to dial into the services through local access
telephone numbers. Subscribers typically have paid modest monthly or hourly
subscription fees to such online services for network access. Once logged on,
subscribers are able to access readily extensive subject matter areas maintained
by a community of independent information content providers ("ICPs"). ICPs
maintain information and content in the "native" [*10] environment of the commercial online
service normally in segmented areas of the service accessible through
user-friendly navigational menus. For example, in a financial services area of
an online service, ICPs likely would include market data vendors, financial
publications and financial service providers such as banks or broker-dealers. In
addition to access to content, subscribers are able to transact business with
ICPs and communicate with each other and ICPs via e-mail. Today, most commercial
online services also enable their subscribers to obtain broader access outside
of the proprietary network to the Internet and other online services.
In contrast, an online service that offers its subscribers only access to
the Internet likely will differ in several respects from a traditional
commercial online service. First, such Internet access providers are not likely
to have content of ICPs available in a closed "native" environment like
traditional commercial online services. Instead, subscribers expect to access
content by using the Internet access provider to view any number of sites on the
World Wide Web operated by ICPs. Subscribers could also expect less navigational
assistance [*11] in
locating content of interest on the Internet. For example, an access provider
may provide its own software "browser" together with a directory of Web sites
listed by subject matter or subscribers may opt to use another browser entirely.
In this type of environment, subscribers may require more knowledge and
technical skills than in the more structured environments of traditional
commercial online services.
As technology and customer demands
change, distinctions between traditional commercial online services and simple
Internet access providers, however, may become less pronounced. As noted above,
commercial online services are providing enhanced access to, and integration
with, the Internet. In addition, online services that have focused primarily on
access to the Internet may enhance the "native" content on their networks and
develop improved navigational tools.
World Wide Web-based
communities or pages provide yet another online service model which is located
and operated primarily at one or more Web sites. These Web sites may organize
around subject matters or themes to attract user traffic to their sites. For
example, Yahoo and Infoseek have heavily promoted their names [*12] and search capabilities for Internet
access. n3 Business models vary greatly across such services, and sites are
supported by various combinations of revenues such as advertising, "pay per
view"-type transaction services and subscriptions.
n3 The
respective URLs (Universal Resource Locators) for Yahoo and
Infoseek are http://www.yahoo.com/ and http://www.infoseek.com/.
Finally, although traditionally considered manufacturers of
desktop applications such as spreadsheets, software companies like Microsoft and
Intuit are exploring ways to integrate seamlessly desktop software "clients"
with commercial online activity "servers" through uniform standards, systems
interfaces and links. For investors and other consumers of financial services,
these developments promise to simplify the task of organizing data from multiple
financial institutions and locations into one location. Similar to online
banking systems, such desktop and online integration is expected to enable users
to view their brokerage account positions, submit and receive transaction
instructions and download data from their financial institutions. The
communications transmitted between users and their financial [*13] institutions may travel through any
number of dedicated networks or the Internet but would appear seamless to the
user as a result of integrated standards, interfaces and links.
Proposed Compensation Arrangements
As part
of Schwab's plans to better respond to
changes in the online services industry, Schwab proposes to enter into or modify
arrangements with the leading online services, America Online, CompuServe, and
Microsoft ("Online Services" or, an "Online Service" as the context requires),
pursuant to which Schwab would pay the Online Services a
nominal flat fee for each order transmitted to Schwab, subject to the conditions
listed below. Schwab's current and proposed
arrangements with each of the Online Services, and the additional conditions
that Schwab proposes now to incorporate into
those arrangements to permit the payment of variable compensation along the
lines described in this letter, are discussed in turn below.
Schwab's Current Arrangements
with "Online Services"
Under the CompuServe
arrangements, CompuServe is obligated to develop an interface, links and
connectivity between its networks and Schwab which will allow CompuServe's
subscribers to access Schwab's [*14] services through specified areas and
navigational menus. In particular, CompuServe is responsible for the development
and implementation of all network infrastructure and capacity CompuServe also is
responsible for maintaining and operating its online services in accordance with
certain performance and service level standards.
Although
CompuServe has final authority over the physical placement of Schwab's service, Schwab's service will be placed in
prominent positions relative to other broker-dealers as agreed upon by the
parties. CompuServe also agreed to provide network access or sign-on software to
Schwab for distribution to Schwab's customers and others as agreed
upon by the parties. The parties also agreed to provide each other general
marketing support.
In the proposed America Online arrangement,
America Online is obligated to provide connectivity to enable Schwab and America Online subscribers
to communicate with each other and initiate transactions through Schwab's brokerage area. America Online
also would agree to develop, manage and operate its network in accordance with
certain performance standards and to provide all computer, telephone and other
equipment required [*15] at
America Online facilities to enable America Online members to access Schwab and its related sites. With
respect to points of access to Schwab services, Schwab will be listed and available
through certain designated subject matter areas and navigational menus. In
addition to America Online providing diskettes of sign-on software, the parties
generally will coordinate marketing activities related to the arrangement.
The online arrangement with Microsoft will enable investors to
access Schwab through the Microsoft Investor
service, currently an area within Microsoft's Internet site, msn.com. Microsoft
Investor is a Web-based online service designed to provide investors with
portfolio tracking, business news, stock quotes, historical market data and
access to online trading services provided by participating broker-dealers like
Schwab.
Future versions
of Microsoft Investor may be incorporated into "client" software that would be
loaded onto an investor's desktop computer from a CD-ROM or diskettes. These
later versions of Microsoft Investor are still expected to rely on connectivity
with the Internet for current news and information and investor access to
participating broker-dealers.
[*16]
Specifically, Microsoft Investor will be designed to enable investors to
download via the Internet, consolidate and view all of their brokerage
information in a single portfolio software application stored on the investor's
desktop. In addition, investors will be able to place trades with Schwab initially through links to
customized trading pages at Schwab's Web site, schwab.com. Later, such activity will
be effected using Open Financial Connectivity ("OFC"), a data format designed to
facilitate the transmission across the Internet of financial information
instructions between a broker-dealer and an investor using client software like
Microsoft Investor. In connection with such development, Microsoft and Schwab have agreed upon certain
license's and uses of OFC, OFC software modules and other software development
tools.
During the initial phase of Web-linked connectivity
between Microsoft Investor and Schwab, Microsoft is required to
develop Microsoft Investor to enable users to hyperlink from the Microsoft
Investor Web area to customized trading pages on Schwab's Web site. Microsoft also has
agreed to operate Microsoft Investor in accordance with mutually agreed upon
standards. [*17] In
Microsoft Investor's later implementation of OFC, Schwab will develop an OFC converter
system connected to the Internet that will translate OFC-formatted data streams
into a format recognized by Schwab's back-end computer systems.
Microsoft will further develop Microsoft Investor to enable investors to send
and receive OFC-formatted data transmissions to and from Schwab. Among other things, the parties
intend to enable Microsoft Investor users to look up their brokerage account
positions and place trade orders with Schwab through Microsoft Investor.
Proposed Additional Conditions
Schwab proposes to enter into or modify
arrangements with the Online Services pursuant to which Schwab would pay an Online Service a
nominal flat fee for each order transmitted to Schwab, subject to the conditions
listed below. Accordingly, the amount of the fee paid to an Online Service under
the proposed arrangements would not vary depending on the number of shares or
the value of the underlying securities comprising a customer order transmitted
to Schwab or whether the order results in
an executed trade. The precise fees paid under Schwab's arrangements with a particular
Online Service would be [*18]
negotiable and might vary according to relevant business, technological and
service level considerations.
Schwab proposes to incorporate the
following conditions into its arrangements with the Online Services entitled to
receive such variable compensation:
1. Marketing Materials. Schwab will review and be responsible for the accuracy of all advertising and sales materials relative to Schwab's financial services that are published by the Online Service. The Online Service and its employees will be prohibited from describing Schwab's brokerage services to subscribers other than by distributing these materials. All advertising or sales material will clearly indicate that the subscriber or user of an Online Service will be a brokerage customer of Schwab and not the Online Service.
2. Limitations on Activities. Online Services will agree to the following limitations on activities:
(i) The Online Service will not recommend or endorse specific securities. n4 Schwab, however, may continue to communicate with its customers and recommend specific securities.
(ii) Neither the Online Service nor its employees (except with respect to their own accounts) shall take part (other [*19] than by routing messages) in the financial services offered by Schwab, including the opening, maintenance, administration, or closing of Schwab accounts, the solicitation of trades, or provide specialized assistance in resolving problems, discrepancies or disputes involving brokerage accounts or related securities transactions.
(iii) The Online Service will not answer questions or engage in negotiations involving brokerage accounts or related securities transactions. All such inquiries will be directed by the Online Service to the customer support personnel of the broker-dealer involved.
(iv) The Online Service will not accept orders, select among broker-dealers or route orders for customers to markets for execution. All decisions concerning broker-dealer or market selection will be made by customers or Schwab.
(v) The Online Service will not handle customer funds or securities related to securities orders transmitted to Schwab or effect clearance or settlement of customer trades. n5
(vi) The Online Service will not extend credit to any customer for the purpose of purchasing securities through, or carrying securities with, Schwab.
3. Written Agreements. The arrangements [*20] between Schwab and an Online Service will be governed by a written agreement that will set forth the responsibilities of the parties and the compensation to be received by the Online Service. Schwab will provide a copy of the no-action letter Schwab receives from the Staff in response to this request to each Online Service. In addition to entering into agreements with Online Services, Schwab will have separate brokerage account agreements with subscribers or users of the Online Services who wish to access Schwab brokerage services through electronic media.
n4 The Online Services may make available
to their subscribers and users market data and investment research prepared by
others, including Schwab or its affiliates, that are
responsible for such content.
n5 An Online Service that is a bank
within the meaning of Section 3(a)(6) of the Exchange Act may effect electronic
funds transfers to or from Schwab in connection with trade
settlement or other transactions.
Discussion
Given today's environment of rapid and unpredictable
technological change, the online service compensation arrangements proposed by
Schwab are designed to enable
broker-dealers to service [*21]
investors more efficiently and at lower cost. With fewer fixed or arbitrary
costs, broker-dealers would be able to service investors from a broader mix of
online services. Investors would gain greater and more convenient access to the
securities markets and their broker-dealers through a variety of online
services. Schwab also believes that more
flexibility in compensation arrangements will further the Commission's goal of
assuring economically efficient transactions in securities and the efficiency of
the order entry and execution process. n6 Finally, Schwab's proposal to move towards more
variable compensation arrangements mirrors the clear technological trend away
from closed, proprietary computer systems (with high fixed costs) towards open,
distributed networks (with lower variable costs). As this trend progresses,
investors should be expected to gain greater access to information, financial
services and securities markets, all at lower costs.
n6 See
generally Section 11 A of the Exchange ACT. See also footnotes 1
and 2 of SEC Release No. 34-21383 (October 9, 1984) (Computerized Brokerage
Systems)(the "1984 Release").
The Commission and its Staff have
questioned [*22] in the
past whether transaction-related fees payable to an online service may give rise
to broker-dealer registration requirements but have not had occasion to offer
definitive guidance to the industry. In the 1984 Release, Computerized
Brokerage Systems, the Commission said that it was "not addressing . . .
whether a company that provides communication and information services and
transmits orders between investors and broker-dealers for a transaction related
fee would be required to register as a broker-dealer under Section 15(a) of the
[Exchange] Act" n7 Given the relative youth of the personal computer industry at
that time, it was not critical for the Commission to offer more guidance.
n7 See footnote 4 of the 1984 Release.
More than a decade later, however, the use of electronic media is more
universally accessible and accepted. The securities industry, the Commission and
its Staff have become increasingly sophisticated on the uses of electronic media
and how it can help investors without compromising investor protection.
Accordingly, Schwab believes that the time is ripe
for the Staff to give broker-dealers latitude to enter into more efficient
compensation [*23]
arrangements with online services. The Staff's fairly recent no-action letter in
Quick America Corporation (available June 18, 1993) appears to signal
its willingness to offer more guidance in this area in recognition of the
growing importance of computer usage in the delivery of securities brokerage,
market data and related financial services. In addition, the Commission recently
issued two significant interpretive releases to market participants to
facilitate the use of electronic media under the federal securities laws and to
encourage continued research, development and use of such media. n8
n8 See SEC Release No. 33-7233; 34-36345; IC-21399 (October 6,
1995) (use of Electronic Media for Delivery Purposes) and SEC Release No.
33-7288; 34-37182; IC-21945; IA-1562 (May 9, 1996) (use of Electronic Media by
Broker-Dealers, Transfer Agents, and Investment Advisers for Delivery of
Information; Additional Examples under the Securities Act of 1933, Securities
Exchange Act of 1934, and Investment Company Act of 1940).
In
Quick America, Quick America Corporation ("Quick") had developed an
online service which offered both a market data system and an order management
[*24]
system. n9 Quick's customers and broker-dealers would pay periodic monthly fees
for their use of the system. In particular, Quick customers would be charged a
flat fee for its server and for each workstation. The monthly server and
workstation fees would vary according to the level of services provided.
Participating broker-dealers would be charged for their lines into Quick's host
computer.
n9 Quick's Market Data System provided users with
access to securities and futures market information, such as current prices,
last trade, montages of quotes in different market centers, news wire stories,
and the ability to display, analyze and format the information in various ways.
The Order Management System enabled users to route orders to participating
brokers, monitor the status of orders, receive electronic order reports from
brokers and perform transaction analysis.
In granting no-action
relief to Quick for not registering as a broker-dealer under Section 15 of the
Exchange Act, the Staff noted that:
Quick will not charge any fees that are related, directly or indirectly, to the value of the completed customer transactions facilitated by the use of the Quick Order Management [*25] System.
Consistent
with Quick America, the compensation arrangements with Online Services
proposed by Schwab are not related to the value of
the customers' completed transactions. Rather, as stated above, Schwab will pay a nominal flat fee to
an Online Service for each transmission of an order to Schwab without regard to the number of
shares or the value of the underlying securities comprising each order or
whether the order results in an executed trade.
In addition,
Schwab has incorporated into its
proposed arrangements, described above, conditions identified by the Staff in
Quick America, which were intended to clarify the respective roles of
the Online Services (Quick) on the one hand, and the broker-dealers on the
other. These conditions appear to have been designed to assure that Quick would
not, in fact, be engaged in the business of "effecting transactions in
securities for the account of others" or "buying and selling securities for its
own account" within the definitions of broker and dealer found in Exchange Act
Sections 3(a)(4) and 3(a)(5), respectively
On the basis of the
foregoing, particularly in view of the fact that Schwab will be serving as broker-dealer
[*26] and is
a registered broker-dealer, we respectfully request that you advise us that the
Staff will not recommend that the Commission take any enforcement action if
Schwab and Online Services enter into
arrangements described above without the Online Services or any of their
employees registering with the Commission under Section 15 of the Exchange Act.
If you wish to discuss this matter further, please contact the
undersigned at (415) 636-6120.
Very truly yours,
Scott W. Campbell
Vice President and
Associate General Counsel
Charles Schwab & Co., Inc.