May 17, 1999  

Mr. Peter Clark Secretary General International Organization of Securities Commissions PO Box 171, Stock Exchange Tower 800 Square Victoria 42nd Floor, Suite 4210 Montreal, Quebec Canada  
Re: IOSCO Technical Report, “Securities Activity on the Internet”
Dear Mr. Clark:  
The International Councils of Securities Associations1 (ICSA) welcomes the opportunity to comment on the IOSCO Technical Committee Report entitled “Securities Activity on the Internet” (the Paper). ICSA finds much to support in this Paper and believes that the Key Principles and Key Recommendations in the IOSCO Internet Paper are sound and generally endorses them.   
IOSCO Paper: “Securities Activity on the Internet”  
The IOSCO Paper states that regulators must determine whether their current regulatory framework adequately addresses use of the Internet by their respective markets, issuers, and financial service providers. The Paper discusses the general approaches that regulatory agencies should take in relation to the Internet. For purposes of the Paper, IOSCO states that the three fundamental objectives of securities regulation are: the protection of investors; ensuring that securities markets are fair, efficient, and transparent; and the reduction of systemic risk.   
With these objectives in mind, the Paper first discusses five Key Principles that regulators should consider when formulating policies regarding securities activities on the Internet:  
The fundamental principles of securities regulation do not change based on the medium;   
Consistent with the fundamental principles of securities regulation, regulators should not unnecessarily impede the legitimate use of the Internet by market participants and markets;  
Regulators should strive for transparency and consistency regarding how their regulations apply in an Internet environment;  
Regulators should cooperate and share information to monitor and police securities activity on the Internet; and 
Regulators should recognize that electronic media and the use of such media is likely to evolve.  
These principles in turn guide 24 Key Recommendations. We have summarized these principles and the subject areas of the recommendations below:   
Recommendations 1-13 address the application of domestic regulatory requirements to securities activities on the Internet, in particular rules relating to: offers and advertisements, delivery of disclosure documents and other information, voting in meetings, communications and customer orders, and recordkeeping.  Recommendations 14-16 address the exercise of regulatory authority over cross-border securities activities on the Internet.  
Recommendations 17-20 address the use of the Internet to foster investor education and transparency.  
Recommendations 21-24 address the use of the Internet to enhance cooperation in enforcement matters.  
COMMENTS ON IOSCO INTERNET PAPER2 The fundamental principles of securities regulation do not change based on the medium.  
This statement supports Key Principle #1 in the IOSCO Internet Paper. However, we think it is a point worth emphasizing because it relates to a number of the Key Recommendations in the paper. For example, Key Recommendation #1 states that regulators and self-regulatory organizations (SROs) should provide guidance alerting market participants and markets as to how their existing regulatory requirements apply to offers of securities or financial services and advertisements conducted on the Internet (emphasis added). We suggest that this Recommendation be reworded to state first that all relevant regulatory requirements apply regardless of whether offers and advertisements are conducted on the Internet or through other communications media. The guidance should then state how the requirements apply. This should be emphasized, because some market participants seem to believe that activities on the Internet are somehow exempt from regulation or that different rules apply to securities activities conducted on the Internet.   
Also, Key Recommendation #2 states that regulators or legislative bodies should amend specific requirements to ensure appropriate regulatory coverage of the Internet. Generally speaking, new legislation should not prove necessary where existing statutes are drafted broadly to address all securities activities, whether they occur on the Internet or otherwise. At most, we believe regulators and SROs need to adapt, interpret, or expand existing rules to allow market participants and markets to use the Internet. The National Association of Securities Dealers (NASD) already has done so in several instances. For example, with respect to using the Internet to satisfy delivery obligations, which is discussed in Key Recommendation # 6, the NASD issued Notice to Members (NTM) 98-3 addressing this very issue. The Securities and Exchange Commission (SEC) previously issued a release in 1996 addressing the issue. We recommend that other regulators and SROs follow these examples and provide similar interpretive guidance.3   
Regulators should not unnecessarily impede the legitimate use of the Internet by market participants and markets.  
This statement supports Key Principle #2, and relates to our first point. We would emphasize that regulators and SROs should not inhibit the legitimate use of the Internet by suggesting that new rules must be developed and statutes must be amended before markets and market participants can use the Internet. As we stated above, we believe that existing securities statutes are broad enough to encompass securities activities on the Internet. At most, regulators and SROs may need to make minor amendments to existing rules to enable market participants to take advantage of the numerous benefits offered by the Internet.   
General antifraud provisions apply to all offers and advertisements involving securities or financial services, regardless of the medium.   
Key Recommendation # 3 states that “[g]eneral antifraud provisions should apply to all offers and advertisements involving securities or financial services, regardless of the medium . . . (emphasis added)” It is our belief that most general antifraud provisions do apply to these activities. To the extent that they do not, we recommend that they be reworded to state that they apply in these circumstances.   
Financial service providers must continue to satisfy suitability requirements when transacting business over the Internet.  
We support this statement in Key Recommendation #8 insofar as it states that use of the Internet does not eliminate the need for financial service providers to comply with suitability rules. However, because suitability issues become more complicated when the Internet is involved, regulators and SROs should try to provide guidance to markets and market participants clarifying how (and whether) existing suitability rules apply to securities activities occurring online. For example, in the U.S., suitability obligations are triggered by a recommendation. Regulators and SROs should consider whether guidance can be provided on whether certain activities that occur online constitute a recommendation, triggering suitability obligations.   
Another set of issues being raised in the U.S. is the increased popularity of day trading, which has raised issues relating to suitability (i.e., do suitability obligations apply when a firm recommends the strategy of day trading to a customer) and the use of margin for day trading. We suggest that IOSCO focus on these issues and consider revising the Paper to add a recommendation addressing day trading.4   
Financial service providers must have sufficient operational integrity (security, reliability, capacity, backup systems, and alternative means of communication) and must have adequate personnel to handle Internet communications, including trading instructions.  
We also support this statement made in Key Recommendation #9. Again, we would like to highlight the importance of adequate capacity and personnel in light of the recent volatility in online trading and we recommend that other regulators and SROs take action in this regard.5  
Regulators should have the authority to gather and share information regarding activities that occur over the Internet.  
We support this statement in Key Recommendation # 21. We believe that this authority is particularly important in light of the burgeoning markets whose creation has been facilitated by the Internet. These markets have resulted in the transfer of information that is not part of traditional audit trails and is not encompassed by the current enforcement process. For example, information that is currently posted on Internet chat rooms is difficult to monitor and capture for enforcement purposes. In light of these issues, we believe that regulators and SROs should redouble their efforts to develop cross-market and inter-SRO memoranda of understanding.  
The application of new technologies has resulted in an entire new range of benefits which individual and institutional customers and corporate clients receive – such as, investor choice, lower costs and speedier dissemination of information. ICSA also recognizes that new technologies, combined with the global nature of today’s capital markets, poses new challenges to regulators. Given the internationalization of the capital markets, ICSA members urge IOSCO and domestic regulators to work with the private sector and develop a harmonized approach to supervisory issues raised by new technologies which will enhance transparency between markets, rather than to develop a patch-work of domestic regulations which will only serve to complicate and raise costs to investors. We note that the use of new technologies in the financial markets are in their relative infancy and caution regulatory bodies that these systems need time to evolve. A too burdensome regulatory approach may impair these markets by raising costs to investors and issuers while stifling innovation. Any structure must be flexible, allowing technology to facilitate innovation and meet customer needs.   
ICSA members would be pleased to discuss this issue with you.  
Sincerely,
David G. Strongin ICSA Secretariat Tel# 212/618-0513 Fax# 212/608-1604  
FOOTNOTES:
1 The objectives of the International Councils of Securities Associations are to aid and encourage the sound growth of the international securities markets by promoting and encouraging harmonization in the procedures and regulation of those markets thereby facilitating international securities transactions, and by promoting mutual understanding and the sharing and exchange of information among the members of the Councils. ICSA is comprised of securities industry self-regulatory organizations and trade associations from nine countries (Australia, Canada, France, Japan, Korea, Switzerland, Taiwan, U.K., U.S.). ICSA members represent the overwhelming majority of the world equity, bond, and derivatives markets. A list of ICSA’s members is attached.  
2 Please note that our comments are directed to the version of the paper dated October 20, 1998.  
3 The NASD also amended its rules to require firms to develop written procedures for the review of incoming and outgoing electronic correspondence between employees and the public, as discussed in Key Recommendation #10. In both of these examples, the NASD interpreted or amended existing rules to allow firms to use the Internet while at the same time ensuring that Internet activities are subject to appropriate regulation.   
4 The NASD Board of Governors recently approved the solicitation of comment on proposed rules that would require firms that recommend a day trading strategy to a retail customer to determine that the strategy is appropriate for the customer prior to opening the customer’s account and to deliver a disclosure statement to the customer discussing the risks posed by day trading.   
5 In January, the NASD issued Notices to Members 99-11 and 99-12, where it reminded firms that the SEC staff has stated (in Staff Legal Bulletin #8) that firms must have adequate systems capacity to handle high trading volume and high volatility trading days. It also stated in NTM 99-12 that failure to maintain adequate staff to handle orders manually during extreme market conditions may be a violation of NASD rules. It further emphasized that firms should have the systems capacity to support any claims they make about their trading services in their advertisements and sales literature.   
The SEC also has taken steps to address this issue. It has recently proposed a rule that would require broker-dealers to have sufficient operational capacity to conduct a securities business. Under the proposal, broker-dealers would be required to have and maintain operational capability, taking into consideration the nature of their business, to assure the prompt and accurate entry of customer orders; execution, comparison, allocation, clearance, and settlement of securities transactions; the maintenance of customer accounts; and the delivery of funds and securities. If the rule is adopted, and a broker-dealer fails to comply with the rule’s requirements, the SEC will be able to bring enforcement actions for violating the antifraud provisions of the federal securities laws and the SEC books and records rules, if customers are harmed by the failure to comply.