One day, we’ll all invest this way! But can we afford it? Online investing has brought huge reductions in the transaction costs of investing. However, there are good reasons for caution, as discussed below.

This ARC-supported research project will analyse the limitations of legal regulation of online investing. Using surveys and interviews it will study the behaviour of online investors and site sponsors. Through an international collaboration it will introduce expertises in the implications of investor psychology for online investing and in the comparative regulation of online investing. This is unique in the field.

It will produce policy recommendations for the future regulation of online investment. It will further regulatory theory. These outputs will be significant to Australia and world-wide.

The project will promote National Research Priority 3: 'Frontier Technologies for Building and Transforming Australian Industries', and priority goals 4 and 5. It will promote smart information use and an innovation culture and economy. It will do this by using good regulation to increase the safety of online investing services. If ordinary investors trust this mostly beneficial technology, it will further Australians’ prosperity through investment e.g. for retirement. Retirement income products can be acquired online.

The Australian Stock Exchange reports that 51% of adult Australians own shares.^[1] There are serious issues of social wellbeing and economic stability at stake. Good regulation will increase Australia’s competitiveness by bringing overseas investors to local markets through the Internet. It will consolidate its role as a major financial centre. This research will show how good regulation could avoid Australians losing more than $1.6 billion per annum!

As mentioned there are reasons for caution about online investing. Research shows that investors who switch from traditional telephone advisory to Internet investing do worse. Recent insights from investor psychology show that, ‘after going online, investors trade more actively, more speculatively, and less profitably than before’ due to over confidence. ^[2] There are several other cognitive biases that cause investors to lose money and seem to be amplified by online investing.^[3] This raises the second reason for caution.

While regulators are rightly keen to facilitate the development of this powerful, cost effective investment mode, online investing is characterised by incentives to trade frequently. For example, aggressive online advertising which ‘conveys a message of convenience, speed, easy wealth, and the risk of “being left behind” in the online era.’^[3] This is intensified by the ease and immediacy of clicking the mouse to trade, rather than talking to a broker on the telephone. Further incentives to trade frequently come from online trading fees that decrease as the number of trades increases. The same is true of the ready availability of margin loans. These are funds borrowed from an online broker to increase the amount but also the risk of invested funds. A third reason for caution is that research also shows that many investors have little understanding of how an online transaction occurs. They do not know whether their trade goes straight through to the market when they click on the mouse. They do not know about time lags affecting the price at which they ultimately buy or sell.^[4]

In 2002-03 chief investigators (CI) 1 and 2 conducted pilot research of one aspect of this project. We compared the information seeking practices of online and traditional investors. We chose this aspect because little is known about when and how traditional investors seek information,^[5] and even less about online investors. Our pilot research revealed two types of online investors.^[6] The first is investors with both time and training. They do a lot of diligent information seeking and follow investments for longish periods before trading. Here there are reasons for optimism about online investors’ ability to make good investment decisions. The other group see online investing as a leisure activity, often likening it to gambling. These investors volunteer that they do insufficient and unsystematic research and often rely on tips from friends etc.

There is other evidence for this easy-going, impulsive attitude to online investing. Around 1 April 1999, 10,000 people visited a sham website launched by the Australian Securities and Investment Commission. It offered interests in a fictitious company, Millenium Bug Insurance, at http://www.smbi.com.au/. Of these 1,200 asked for more information. A further 233 committed themselves to paying between $AUD10,000 and $AUD50,000.^[7] This strategy was emulated by securities regulators in Canada and the US, with similar results.

Finally, there is good reason to question whether legal regulation of investing has kept pace with the particular features of the online mode. For example, because no personal advice is offered, an entire layer of protective regulation does not apply. This requires broker independence and suitability of advice to telephone investors. It does not apply to online investing. While online brokers must be licensed, there are many other sources of online investment information and opinion, which are not. Margin lending (borrowing money to trade) is offered by site sponsors as a financial product that will ‘turbo charge’ returns. Margin loans have been characterised as consumer credit. They fall outside more demanding financial services regulation. The latter requires advice about suitability for the investor, and disclosure about fees and product risk. Often, online investing customer contracts also contain comprehensive liability disclaimers. It is clear however, that many investors have limited information about how that liability might arise, and on whom it will fall.

Since the year 2000 tech-stocks crash, there has been a recovery of interest in investing online. The time is ripe for a full consideration of online investing services and the adequacy of their regulation. In doing so our aims are:

This project is highly significant because it is the first comprehensive study of the position of Australian online investors. There are a number of works dealing with e-commerce generally. However, the collection edited by CI1 in 2001 in Australia’s leading corporations and securities journal,^[8] stands out as the only substantial legal contribution on online investing.^[9]

The following are significant questions to be addressed by the project:

The project is also highly significant because substantial sums are now in the hands of ordinary investors and available for online investment. As mentioned the ASX reports that 51% of adult Australians own shares. Given the findings of our pilot study, this may mean that some people will experience serious losses. These may be due to overconfidence, disinclination to study investments closely and ignorance of the operating conditions of online investing. There are several reasons for the increased amounts available to everyday investors. One is that the modern state often regulates the provision of essential services by non-state entities, rather than supplying them directly.^[10]

The privatisations that have contributed to this change have increased the numbers of retail investors in investment markets and heightened interest in investment generally. Also, state restructuring has led to individual provision for retirement through private sector superannuation. In Australia superannuation choice during the contribution phase is growing, increasing the scope for individual investment decisions that may be implemented online. Further, on retirement the retiree usually receives a ‘lump sum’ that has to be invested. Thus bad investment decisions may reduce individual wellbeing in retirement. They may also diminish the overall orderliness and allocative efficiency of financial markets because the aggregate amounts are so large.

The project is innovative because it introduces a powerful new direction in regulatory thinking to the analysis of online investment problems, and the design of future regulation. Traditional investment regulation uses state created criminal and civil law. It contemplates investing transactions using brokers (or ‘gatekeepers’), which are paper based and mostly within a single jurisdiction. By contrast the Internet is characterised by speed and innovation, by inter-jurisdictionality,^[11] pseudonymous transactions and directness (i.e. few ‘gatekeepers’).^[12] Because of this contrast, it is now generally acknowledged that a pluralist or decentred dimension to regulation should be added in the online world.^[13] CI1 has been at the forefront of this development in regulatory theory, particularly as it applies to online investment.^[14]

By ‘plural’ or ‘decentred’ is meant that, as well as relying on legislation and case law, regulation enrols other non-state actors or technologies into the regulatory task.^[15] Self-regulatory rules and compliance practices, computer programs (such as filters which detect insider trading), publicity and investor education, even competition, can be enlisted in combination with (not instead of) laws of state origin. The idea of regulatory design in this field, is to create state law which promotes and steers decentred elements towards the public interest. For example, state law could provide that where there has been aggressive online advertising, online investors could rescind trades through exercising ‘cooling off’ rights. It could also provide that if site sponsors implement compliance plans to limit advertising, the ‘cooling off’ rights are not available. The state law would thereby steer site sponsors towards regulating themselves, consonant with the interests of investors.

This project is also innovative in combining legal research with a mixture of empirical approaches to investigate the detailed circumstances of online investing. With conspicuous exceptions there are almost no empirical surveys of note dealing with online investing. Even these surveys^[16] concentrate mostly on identifying rather than analysing the main features of online investing. They research the views of site sponsors and brokers. These are important and our study updates this work. However, we think it is also crucial to study the attitudes and behaviour of investors to gain the ‘solid sense of how decisions occur or what social dynamics are at work’.^[17] We have already mentioned the investor psychology studies on biases in online investor behaviour. ^[18] These will be used to guide our research especially in relation to investors.

In its empirical phase, the project will use a ‘mixed method’ approach. It will use a quantitative survey to obtain the over-all contextual picture of the key issues. In-depth individual and focus group interviews will follow. These are to capture the multiple perspectives, needs, individual and social contexts of online investors, online site sponsors and government (ASIC) and market (ASX) regulators. The latter approach is particularly fruitful in new fields like online investing. Here there has been little research, and issues are unexplored – or even uncovered.^[19] The combination of legal and empirical research is significant and innovative in online investing regulation, particularly extending it to study the behaviour of investors.

Highly innovative will be the comparative study of online investing practice and regulation. As far as we are aware, it is the only one of its kind. The project will compare online investing regulation in the world’s leading markets – the US, the UK, Canada and Australia. The US is home to the most developed market in online investing, and the most developed regulation and literature about this. In particular the US has developed a body of literature on the effect of investor psychology on securities regulation. This has been particularly fruitful in the area of online investing.

There are differences in the practice of online investing between markets, and in the way it is regulated in different countries. Comparing practices and regulation and incorporating insights such as investor psychology, helps to broaden our horizons and to expand our sense of the possible or appropriate. By learning how problems are dealt with in other countries we get a sense of perspective on our own difficulties and regulation. The comparative element of this project will be of interest to regulators, rule-makers, securities and financial services scholars and lawyers in the countries included, and world-wide.

The aims of this analysis are to:

Empirical Analysis

As indicated, a ‘mixed methods’ approach will be used for this project. The aims of the empirical analysis are to:

The US, Canada and the UK, have been chosen for comparison with Australia. All four countries have financial markets characterised by the use of sophisticated information technologies. In each there are large numbers of online investors. In each it is expected that financial markets will be part of the provision of services once provided by the state. There are however, different regulatory approaches and styles adopted in these countries. Regulation in the US has been characterised as ‘adversarial legalism’^[20] or ‘regulation by prosecution’.^[21] By contrast regulators in Australia are thought to be ‘of manners gentle’^[22] and UK regulators to seek negotiated compliance before using litigation as a deterrence.^[23] There are also different regulatory structures and levels of regulatory resources. There is a sufficient general and regulatory diversity between the countries that divergent strategies have been adopted to solve substantially similar problems. Valuable insights for Australian regulation will be gained from the comparisons proposed here.

This comparative study will be primarily descriptive and explanatory, rather than normative or prescriptive. It will describe and compare the institutional structures and practices of online investing in the chosen markets. It will identify and explain the regulatory responses adopted in addressing to problems of online investing in the different countries. The study will include critical analysis, but due to cross-cultural differences in regulatory approach and enforcement style, will not attempt to prescribe a universally applicable regulatory response to online investing. Professors Langevoort, Bradley, Condon and Dr Black have been chosen for their expertise in the field, their familiarity with comparative outlooks and their policy experience.

The aims of this phase are to:

This project will provide policy recommendations to promote national research priority 3: Frontier Technologies for Building and Transforming Australian Industries, particularly priority goals 4 & 5, smart information use and promoting an innovation culture and economy. It will do this by using good regulation to increase the safety of online investing services. If ordinary investors trust this mostly beneficial technology, it will further Australians’ prosperity through investment e.g. for retirement. Good regulation will increase Australia’s competitiveness, bringing overseas investors to local markets through the Internet.

The project will bring to Australia international expertise not available in this country, and crucial to good regulation of online investing. This is particularly so of the inter-disciplinary expertise of Professor Langevoort. He is the world’s leader in researching investor psychology and its effects on securities regulation, especially in online investing. All international collaborators will enrich Australian regulatory and scholarly experience through their comparative and policy expertises.

As the ASX does not collect this data, it is difficult to estimate the percentage of trades done online by comparison with advisory telephone orders. Nevertheless other research indicates the percentage is very significant. An OECD report^[24] suggested that by 2005 this could be between 25-50%, depending on the country, on customer attitudes and safety and security of infrastructure. In the US about 50% of trades are online, and it is likely that in Australia this could be 30%. The ASX reports that in 2002-03 the equities market alone, had a traded value of $535 billion.^[25]

Assuming that 30% of trades are online and that only 1% of online trades cause losses, this is a potential loss of 1.6 billion dollars, per annum! This does not include the 90,000 individual options accounts traded on the ASX or retirement income products such as managed funds and superannuation. This application requests an ARC investment of $365,243 over 3 years, to address a problem that could cost Australia more then $1.6 billion per annum.

The initial outcomes from the project will be a series of conference papers delivered at seminars for industry participants, regulators, practising lawyers and investors. These will be jointly sponsored by the Cyberlaw and Policy Centre at the University of New South Wales Law Faculty, and the Centre for Commercial Law at the Australian National University. The papers will also be posted on the websites of the two Centres. The idea is to make the outcomes of the project available as widely as possible. The research will also be published by traditional academic means: national and international academic conferences, refereed articles in Australian and international journals. The research will also be published as a culminating collection of scholarly essays entitled One Day, We’ll All Invest This Way! Regulating Online Investment.