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Page last updated
February 15, 2003




On-line securities trading


Share, derivative and commodity exchanges, together with the regulators of these exchanges, have increasingly come to face new challenges as e-commerce has burgeoned over the last few years. In many jurisdictions computer systems and electronic communication networks have become the preferred mechanism for conducting business, including the buying and selling of securities. This trend has been most prominent within developed economies (particularly the United States and Europe) and it was inevitable that, with time, this trend would follow through to the more sophisticated developing economies. Indeed, in recent years certain developing African economies have experienced an increase in the on-line securities trading phenomenon. This, of course, has created new challenges for the regulators of securities trading in these markets, but in many instances these regulators have been slow in keeping pace with the progress of the New Economy.

This article focuses largely on on-line securities trading issues as they pertain to South Africa because the writer, being South African, is most familiar with these issues and because South Africa is probably one of the most progressive African states insofar as e-commerce (including internet securities trading) is concerned. Moreover, South Africa possesses a well established trading exchange, the Johannesburg Stock Exchange ("the JSE"), which is home to approximately 20 brokerages which offer on-line trading facilities (the most recent internet based brokerage to become a member of the JSE is the well known international virtual trading company, E*Trade).

The issues identified in this article will, by and large, be relevant to all developing economies. It is, however, not possible to deal with each and every issue that is relevant to on-line securities trading. Instead, this article will focus on three broad issues:

n the issuing of local securities over the internet (i.e. on-line initial public offerings ("IPOs");

n domestic aspects relating to trading shares on-line; and

n international aspects relating to trading shares on-line.

The Issuing Of Securities Over The Internet
Internationally it is becoming increasingly popular to permit companies to list via the internet. In other words, companies are, in many jurisdictions, permitted to publish prospectuses over the internet and investors can subscribe for and pay for shares over the internet. The Securities and Exchange Commission ("SEC") in the US and the UK's Financial Services Authority ("FSA") have issued extensive guidelines in this regard (as have the regulatory authorities in other jurisdictions such as Canada, Singapore and Australia).

However, the on-line issuing of shares has received little attention from the African authorities (perhaps because a relatively large number of Africans still do not have access to the internet). At present the relevant South African legislation (primarily the Companies Act of 1973 ("the Companies Act")) does not envisage the possibility of on-line IPOs. It is submitted that a move towards a paperless listing and trading environment must be encouraged. Not only will this reduce the costs of investing (because it will cut down on what is currently a paper and labour intensive process), it will also make South African (and African) IPOs more accessible to international investors thereby increasing much needed foreign investment.

The scenario of on-line listings would be quite simple to achieve from a legislative point of view. The current framework, as provided for in the Companies Act, whilst not envisaging on-line IPOs does nevertheless by and large cater for such a possibility. The greater challenge lies in ensuring that the regulatory authorities, which in South Africa takes the form of the Financial Services Board ("the FSB"), are properly staffed to monitor, and deal with issues relating to, on-line IPOs. It is also important that enforceable guidelines are put in place which contain adequate investor protections and which provide companies with sufficient guidance for conducting on-line IPOs. Very briefly, these guidelines should deal with the following kinds of issues:

n electronic prospectuses should be checked for accuracy, should be regularly updated and should have a limited shelf life;

n hyperlinks to other sites should be prohibited;

n a safe method of electronic payment and confirmation of an order should be provided for;

n the prospectus should clearly state who the offer is directed at (for example, only local citizens). A failure to do so could make the offer subject regulation in another jurisdiction (see the discussion on this below).

Domestic Aspects Relating To Trading Shares On-line
When it comes to the trading of shares on the domestic market by local investors, there are a number of issues that regulators should focus on (these issues are also relevant to international on-line share trading, discussed below). The two major issues that have on a number of occasions tested, amongst others, the SEC, are the following:

n share price manipulation. The internet provides an easy medium for fraudsters to manipulate a company's share price by, for example, posting misleading and/or false information about a company on a number of prominent financial websites. This type of stock price manipulation has occurred on a number of occasions in the US. As Richard H Walker, the SEC's enforcement director has stated "What used to require a network of professional promoters and brokers, banks of telephones, and months to accomplish can now be done in minutes by a single person using the Internet and a home computer" (Bloomberg News, 7 September 2000).

The scope for this kind of fraud is even greater in developing countries where the regulators do not always possess the necessary sophisticated surveillance technology. The challenge for regulators that are newcomers to the world of on-line trading, such as the FSB, is to ensure that they are appropriately staffed to monitor fluctuations in share prices, to watch the information that is posted on financial websites, and to effectively prosecute those involved in share price manipulation.

It is also essential that the regulators publish guidelines or regulations to prohibit improper conduct relating to the trading of securities. These must be practical in nature and flexible so that they can be adapted to the ever changing world of e-commerce.

In South Africa the FSB has very recently published a draft piece of legislation called the Investment Services Bill which, amongst other things, outlaws various forms of manipulative practice. When finalised, the Bill will be legislated in the form of an Act of Parliament. Of concern is whether this Bill, when it becomes an Act, will be adaptable to new situations and new concerns that may from time to time arise.

n It is imperative that the regulators require those firms that offer on-line trading services to utilise secure and sophisticated systems in order to avoid losses to investors as a result of outages and faulty processes. While it is important that the investing public understands that the trading of shares is a risky business, this risk must not be exaggerated by the failure to promptly execute trades and a failure to deliver on the services which have been promised. In this regard the regulators should put the following kinds of controls in place:

n set technical standards with which internet brokerage systems must comply;

n financial penalties where certain performance claims are made but are not met;

n set time limits within which an on-line trade should be executed;

n a requirement that on fast moving shares only "limit" orders be placed as opposed to "market" or "best" orders.

International Aspects Relating To Trading Shares On-line
In addition to the usual e-commerce and conflict of laws questions that may arise in the event of a dispute (for example, in which jurisdiction was a contract concluded and what law applies to the dispute), a number issues arise which a particularly relevant to on line share trading. These issues are conveniently dealt with under two primary sub-headings, namely, the trading of domestic shares by foreign investors, and the trading of foreign shares by local investors.

The trading of domestic shares by foreign investors is obviously not a new concept. Foreigners have for many years been able to invest in domestic shares abroad, and have indeed done so on a regular basis. The internet, however, creates a new ease of access to foreign markets. Again it is important that the domestic regulations relating to share trading are sufficient to give foreign investors security and comfort regarding their investments. In addition, brokers should be obliged to inform foreign traders that, when trading in the domestic market, they will be subject to local laws. Brokers must be required to make international investors aware of the relevant laws relating to, for example, domestic tax laws and exchange control restrictions.

Regarding the trading of foreign shares by local investors, the two examples referred to above (tax and exchange control) are equally relevant. South African investors, for example, must comply with:

n exchange control regulations. Individuals are currently only permitted to invest Rand 750 000 off-shore, provided they have obtained the necessary tax clearance certificate (and South Africa is not the only developing country with exchange controls in place);

n tax provisions. South Africa is currently moving from a source based tax system to a residence based system. Persons resident in South Africa will, from next year, be taxed on their worldwide earnings.

The ability of local residents to easily trade in foreign stocks over the internet poses new problems for local regulators. It is essential that local regulators take cognisance of the fact that foreign share offers and the ability to trade foreign shares over the internet can be directed at local residents.

In South Africa foreign share trading by South Africans will be subject to the Companies Act and to the Stock Exchanges Control Act of 1985 ("the Stock Exchanges Act") (the provisions of which are carried forward in the new Investment Services Bill). This current regulatory regime is inadequate for dealing with the ability of South Africans to trade shares internationally. Under the Stock Exchanges Act, for example, no foreign person, other than a member of a foreign exchange recognised by the Registrar of Stock Exchanges, is permitted to advertise or canvass for business relating to the trading of foreign listed securities.

It is important that this legal framework be amended to permit legal and effective on-line share trading. Furthermore, local regulators must devise guidelines for determining whether, under what circumstances, and as of which moment, trades or offers of shares via the internet would be deemed to be made in or from their local jurisdiction, and therefore whether or not such trade or offers are subject to the relevant local laws. In doing so regard should be had to the 1998 SEC guidelines on this topic which, very briefly summarised, state that an off-shore internet offer of securities will not be subject to US regulation where the website in question includes a prominent notice making it clear that the offer (or trade) is intended only for persons in countries other than the US and the on-line offeror implements procedures that guard against US citizens participating in the offer (or trade) (for example a registration process).

From the above it is clear that regulators in the developing world need to move quickly to put the proper controls and systems in place in order to allow developing countries to take advantage of the opportunities heralded by the New Economy and to create a safe but friendly environment within which on-line securities transactions can take place and are indeed encouraged.

Brian Pringle
Webber Wentzel Bowens


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