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99-32 NASD Regulation Requests Comment On Proposed Rules Regarding Approval Procedures For Day - Trading Accounts, Including Appropriateness Determinations, And Disclosure Of Risks Of Day - Trading Activities
Comment Period Expires May 31, 1999
Legal & Compliance
NASD Regulation, Inc. (NASD Regulation®) is requesting comment from members and other interested parties on proposed rules that would require a firm that has recommended a day-trading strategy to an individual to approve the individual's account for day trading. As part of the account approval process, the firm would be required to determine that the strategy is appropriate for the customer and to provide a disclosure statement to the customer discussing the risks of day trading.
A companion Special Notice to Members issued today, Special Notice to Members 99-33, discusses current margin requirements and steps that firms are taking to increase maintenance margin requirements for certain volatile stocks. Special Notice to Members 99 - 33 also solicits comment on the use of margin during volatile market conditions, as well as the use of margin by individuals engaging in day-trading activities.
Questions concerning this Special Notice may be directed to Patrice M. Gliniecki, Assistant General Counsel, Office of General Counsel, NASD Regulation, at (202) 728-8014.
The increased popularity of day trading by individuals poses unique investor protection concerns. Individuals engaging in day-trading activities often trade their accounts aggressively, hoping to profit from intra-day price movements in securities. However, the ability to engage effectively in day trading requires not only sufficient capital, but also a sophisticated understanding of securities markets and trading techniques. Even sophisticated investors engaging in day-trading activities should be aware that the risk of loss of capital can be very high. For persons without this sophistication, the risk of loss can be even higher.
To address these concerns, NASD Regulation is soliciting comment on two proposed rules that would clarify and enhance the responsibilities of members that recommend day trading to individuals. The text of the proposed rules follows this Special Notice.
Proposed Approval Procedures For Day-Trading Accounts
The proposed rules would require a member that has recommended an "intra-day trading strategy" to a customer who is a natural person to approve that customer's account for day trading prior to effecting an initial day-trading transaction for the customer. The proposed rules would define an "intra-day trading strategy" as "an overall trading strategy characterized by the regular transmission by a customer of multiple intra-day electronic orders to effect both purchase and sale transactions in the same security or securities." The account approval would be required to be in a written document, which would be subject to the National Association of Securities Dealers, Inc. (NASD® or Association) general recordkeeping requirements.
To approve a customer's account for day trading, the member would be required to determine that an intra-day trading strategy is appropriate for the customer. In making this determination, the member would be required to "exercise diligence to ascertain the essential facts relative to the customer." This would expressly include a review of the customer's financial situation, investment experience, and investment objectives. For purposes of the proposed rules, day trading generally would not be appropriate for someone of limited resources and investment or trading experience, and low risk tolerance.
Proposed Risk Disclosure Statement
The proposed account approval procedures also would require the member, prior to effecting an initial day-trading transaction, to provide a disclosure statement to the customer discussing the unique risks posed by this activity. The disclosure statement would include several points that a customer should consider before engaging in day trading, including that the customer should be prepared to lose all of the funds that he or she uses for day trading and that day trading on margin may result in losses beyond the initial investment. The proposed rules also would allow a firm to develop an alternative risk disclosure statement, provided that the alternative statement was substantially similar to the mandated disclosure statement and was filed with, and approved by, the NASD's Advertising Department.
The proposed rules do not define the term "recommendation" in the context of day-trading activities. In general, a member would be recommending a day-trading strategy for purposes of the proposed rules if it affirmatively promoted day trading through advertising, training seminars, or direct outreach programs, and an individual engaged in day trading in response to these solicitations. The fact that customers of a firm generally were engaged in day trading would reinforce a determination that the firm had promoted itself in this way. However, merely providing general investment research or having a Web site that allows the multiple entry of intra-day purchases and sales of the same securities would not constitute a recommendation under the proposal.
NASD Regulation is interested in receiving views as to alternative approaches to addressing the investor protection concerns raised by individuals engaging in daytrading activities. For example, the proposal could be revised to apply to a broader range of firms. In particular, the proposed requirements could apply to any firm that promotes day trading in any manner, rather than be limited to those firms that have "recommended" an intra-day trading strategy to an individual.
In addition, the proposal could be revised to reach additional categories of customers, such as any customer that indicates an intent to engage in day-trading activities. The scope of the proposal also could be restricted to reach only those persons that a firm individually solicits to engage in a day-trading strategy. Moreover, an alternative to the proposal would be to require that risk disclosure statements be provided to every individual who opens an on-line trading account.
Request For Comment
NASD Regulation encourages members and other interested parties to comment on all aspects of the proposed rules. We also specifically solicit comment on the following issues:
Comments should be mailed to:
Joan C. Conley
Office of the Corporate Secretary
NASD Regulation, Inc.
1735 K Street, NW
Washington, DC 20006-1500
or e-mailed to:
Important Note: The only comments that will be considered are those submitted in writing or via e-mail.
Comments must be received by May 31, 1999. Before becoming effective, any rule change must be adopted by the NASD Regulation Board of Directors, may be reviewed by the NASD Board of Governors, and must be approved by the Securities and Exchange Commission.
Text Of Proposed Rules
Rule 2360. Approval Procedures for Intra-Day Trading Accounts
Rule 2361. Intra-Day Trading Strategy Disclosure Statement
You should consider the following points before engaging in day trading activities. For purposes of this notice, "day trading" means the transmission by you of multiple intra-day electronic orders to effect both purchase and sale transactions in the same security or securities.
- Day trading is extremely risky. You should be prepared to lose all of the funds that you use for day trading. In particular, you should not fund day trading activities with retirement savings, student loans, second mortgages, emergency funds, funds set aside for purposes such as education or home ownership, or funds required for current income to meet your living expenses.
- Be cautious of claims of large profits from day trading. You should be wary of advertisements or other statements that emphasize the potential for large profits in day trading. Day trading can also lead to large and immediate financial losses.
- Day trading requires knowledge of securities markets. Day trading requires indepth knowledge of the securities markets and trading techniques and strategies. In attempting to profit through day trading, you must compete with professional, licensed traders employed by securities firms. You should have appropriate experience before engaging in day trading.
- Day trading requires knowledge of a firm's operations. You should be familiar with a securities firm's business practices, including the operation of the firm's order execution systems and procedures. You should confirm that a firm has adequate systems capacity to permit customers to engage in day trading activities.
- Day trading may result in your paying large commissions. Day trading may require you to trade your account aggressively, and you may pay commissions on each trade. The total daily commissions that you pay on your trades may add to your losses or significantly reduce your earnings.
- Day trading on margin or short selling may result in losses beyond your initial investment. When you day trade with funds borrowed from a firm or someone else, you can lose more than the funds you originally placed at risk. A decline in the value of the securities that are purchased may require you to provide additional funds to the firm to avoid the forced sale of those securities or other securities in your account. Short selling as part of your day trading strategy also may lead to extraordinary losses, because you may have to purchase a stock at a very high price in order to cover a short position.