This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
The Securities and Exchange Commission (SEC) is the primary regulator of US securities markets, and the SEC's role in regulating online stocks trading platforms is the same as its role in regulating traditional brokerages. The platform is a broker-dealer subject to the Securities Exchange Act of 1934, the Securities Act of 1933, and the rules of the SEC and the self-regulatory organizations (SROs) that the SEC oversees. The platform is required to register, maintain capital, segregate client funds, and provide best execution on customer orders.
The registration requirement
The first requirement is registration. An online trading platform that operates in the US is required to register with the SEC as a broker-dealer, and the platform is also required to be a member of FINRA (Financial Industry Regulatory Authority) and an SRO such as the NYSE or Nasdaq. The registration is a public process, and the platform's regulatory history is available on the SEC's EDGAR system and on FINRA's BrokerCheck.
The registration process is the platform's first opportunity to demonstrate that it meets the SEC's standards. The platform has to demonstrate that it has the operational, financial, and compliance infrastructure to support the trading activity, and the platform has to pass the SEC's and FINRA's exams. The platform that is not registered is operating illegally, and the trader who uses an unregistered platform is exposed to the risk of fraud and abuse.
The registration is also a continuing obligation. The platform is required to file regular reports with the SEC, to maintain capital, to submit to examinations, and to comply with the SEC's rules. The platform that fails to comply is subject to enforcement action, and the enforcement action can include fines, restrictions, and the loss of the registration.
The disclosure rules
The second requirement is disclosure. The platform is required to disclose its fees, its order routing practices, its payment for order flow arrangements, and its conflicts of interest. The disclosure is made in the platform's fee schedule, its order execution policy, its customer agreement, and its Form CRS (Client Relationship Summary).
The disclosure rules are designed to give the trader the information needed to make an informed decision. The fee schedule tells the trader what the all-in cost is. The order execution policy tells the trader where the platform routes the orders and how the platform gets paid. The Form CRS tells the trader the platform's services, fees, and conflicts in plain English.
The platform that does not disclose is in violation of the rules, and the trader who uses the platform without reading the disclosure is exposed to fees and conflicts that the trader did not anticipate. The disclosure is a regulatory requirement, and the trader should read the disclosure before funding the account.
The order routing rules
The third requirement is order routing. The platform is required to seek best execution on every customer order, and the platform is required to disclose its order routing practices. The platform can route to lit exchanges, to dark pools, to internalisers, or to a combination of venues, and the platform must demonstrate that the routing produces the best execution for the customer.
The best execution requirement is enforced by the SEC and by FINRA, and the requirement applies to all customer orders, regardless of size or type. The platform that systematically routes orders to a venue that produces worse execution for the customer is in violation of the rules, and the platform can be subject to enforcement action.
The order routing rules have become more visible in recent years, especially with the SEC's scrutiny of payment for order flow (PFOF). PFOF is the practice of a market maker paying a platform for the right to execute the platform's customer orders. The platform is required to disclose the PFOF arrangement, and the platform is required to demonstrate that the arrangement does not compromise best execution. The trader who is concerned about PFOF can read the platform's disclosure and decide whether the arrangement is acceptable.
The customer protection rules
The fourth requirement is customer protection. The platform is required to segregate customer funds and securities, to maintain capital, to maintain insurance, and to comply with the SEC's customer protection rules. The segregation is the basis of the trader's protection in the event of the platform's failure, and the insurance is a backstop in the event of a loss that is not covered by segregation.
The customer protection rules are enforced by the SEC and by FINRA, and the rules are designed to give the trader a meaningful recovery path in the event of the platform's failure. The trader who holds a large account with a single platform is exposed to the platform's risk, and the trader should verify the platform's regulatory status and the platform's compliance history before funding the account.
The enforcement record
The SEC publishes its enforcement record on its website, and the record is a useful source of information for the trader. The trader can search for the platform's name and see the enforcement actions, the fines, and the compliance orders. The trader can also see the platform's response to the actions, and the response is a useful indicator of the platform's commitment to compliance.
A platform with a clean enforcement record is not necessarily a safe platform, but a platform with a history of enforcement actions is a red flag. The trader should read the enforcement record carefully, and the trader should consider the pattern of the actions. A single enforcement action for a minor issue is different from a pattern of enforcement actions for serious issues.
How to evaluate a US online trading platform
The honest answer is to check the registration, the disclosure, the order routing, the customer protection, and the enforcement record. The trader who does this evaluation before funding the account is using the platform safely. The trader who funds the account without doing the evaluation is exposed to the platform's risk, and the risk is the trader's responsibility.
The trader should also check the platform's financial statements. The platform is required to file financial statements with the SEC, and the statements are public. The trader can see the platform's revenue, its expenses, its capital, and its leverage. The trader who sees a platform with declining capital, increasing leverage, or unusual expense items is exposed to a real risk of failure, and the trader should consider a different platform.
Related resources
Where to start
If you are choosing a US online trading platform, the most useful exercise is to check the SEC's and FINRA's records, and to read the platform's disclosure. Our broker comparison lists the platform's regulator and the fee schedule, which together tell you what the regulatory standing looks like before you fund the account.