Online stock market hit by crashes of technological era

Crash is perhaps the least loved word in the stock market world, but it has appeared continuously over the past month in relation to online trading services, the websites which allow customers to deal in shares over the Internet.

In February alone, E*Trade , one of the biggest sites, went down four times over three days; the main US site for the largest online brokerage, Charles Schwab, crashed; and Ameritrade Holding's site and phone access service went offline as well.

One E*Trade customer has filed a class action lawsuit in the California courts on behalf of all E*Trade clients, claiming they suffered "potentially millions of dollars" in losses due to the "virtual lockout".

In addition, the New York attorney general is investigating the industry after receiving numerous complaints in January and February that websites crashed and that orders were delayed when executed through online brokers.

"The public knows there are always risks involved in investing in the stock market. But part of that risk should not include questions about whether trades will be executed promptly or whether online brokerage firms can deliver the services that they've promised," said New York's attorney general Mr Eliot Spitzer in a statement in early February.

Several US Congressional representatives have filed a written complaint with the US Securities and Exchange Commission regarding the same issues, and the US government is considering some form of regulation.

The problems are attributable to the brokerages' sudden success and the sometimes finicky nature of computer systems when companies add additional capabilities and capacity, or the ability to handle a greater number of trades.

As more investors switch to the Internet as their primary method of trading shares, the computer systems which online brokerages have installed come under enormous pressure.

Daily, at least 400,000 trades, or one in seven transactions in the US is now done over the Internet, according to Credit Suisse First Boston. Other estimates place the figure as high as one in four. Charles Schwab says it alone executed an average of 93,000 trades daily in the fourth quarter.

Overall, online trading volume has risen by two-thirds since September, which means brokerages have had to expand their systems rapidly. Most seem to have encountered difficulty in

handling the surging volumes of trades. Although most brokerages put in place an alternative phone system as a back-up, these have also failed simultaneously or been swamped with calls as panicky investors try to complete their trades. In the February run of system crashes, the brokerages pointed fingers at both software and hardware problems. According to E*Trade, a software upgrade that would not work smoothly with the previous version of the application caused the system to go down repeatedly over three days.

Schwab attributed its crash to a mainframe computer it was attempting to upgrade.

Another set of massive capacity-related crashes at brokerages occurred in October 1997, when websites were flooded with trade requests following the major stock market tumble that month. Following this, a number of investors filed suits against E*Trade, then one of the only online brokers.

Online trading has had a far slower take-up in Europe, say industry analysts, but they expect a swift increase in Web-based transactions. Four brokerages handle Internet-based trades in Britain, and none in the Republic.

There are no particular guidelines for online trading at the moment. The British financial industry regulatory body the FSA says it is "technology-neutral" in its approach to brokerages.

"Regulations are binding equally whether you do things over the Internet, or over the phone or fax or whatever," said FSA spokesman Mr Peter Parker. In general, he says, British law requires a business to have adequate software for carrying out the services it offers to customers.

Barrister Mr Denis Kelleher, a specialist in information technology law, said an EU directive on the distance selling of financial services was pending. It is likely to incorporate regulations for online brokerages.

In the meantime, online brokerages might follow the cautious example of Edinburgh broker Stocktrade (www.stocktrade.co.uk). The company website notes: "Orders can be dealt instantly, given that the system is up and running and working smoothly."