-Caveat Lector-
"Analysis concluded that over 70 percent of day-trading firms'
customers ``will almost certainly lose everything they invest.' ''
Most Day Traders Likely to Lose Money, Regulators Say
Washington, Aug. 9 (Bloomberg) -- Most day-trading customers
are likely to lose money in an industry troubled by questionable
loan practices, lax supervision and misleading marketing, state
securities regulators said.
The North American Securities Administrators Association
called for increased scrutiny of day trading, the fast-paced
investment style in which customers make dozens of rapid-fire
trades a day in hopes of profiting from small changes in stock
prices. After examining a sample of accounts at a day-trading
branch office, the regulatory group said 70 percent of the
traders studied there lost money.
``If day-trading firms want to become part of the
mainstream, they need to play by the same rules the rest of Wall
Street follows,'' said NASAA President Peter C. Hildreth, who is
also New Hampshire's director of securities regulation.
The report urged day-trading firms to better explain the
risks, and said securities regulators should step up inspections
of day-trading firms that train investors and charge them to use
state-of-the-art trading systems in their offices. Regulators
should also enforce limits on a trader's ability to buy stocks
with borrowed money, the report said.
The Securities and Exchange Commission and the National
Association of Securities Dealers responded by saying that they
are examining day-trading firms nationwide to assess their
compliance with securities regulations.
``Any violations of the federal securities laws uncovered in
these examinations will be forwarded to our enforcement
division,'' said SEC spokesman Chris Ullman. He said areas under
review include those touched on in the NASAA report: supervision,
disclosure, and margin rules.
Market Experience
The SEC is also weighing a proposal recently approved by
the National Association of Securities Dealers that would require
firms to screen prospective customers for whether their financial
circumstances and market experience are suited to day trading.
The NASAA report called on the SEC to ``speedily'' approve this
rule.
The pressures and risks of day trading were thrown into the
spotlight two weeks ago when Atlanta day trader Mark Barton
killed 12 people and wounded 12 others before killing himself. He
left a note that cited trading losses.
NASAA said its report was seven months in the making and is
based on the ``collective experience'' of the regulators in a
special task force on day trading. This experience includes their
reviews of registration applications, ``numerous examinations''
and investigations and enforcement proceedings. In the past 16
months, 10 day-trading firms have been charged with fraud,
deceptive marketing or improper registration by regulators in
Massachusetts, Texas, Wisconsin and Indiana.
Prospective Clients
The Electronic Traders Association, an industry group,
says its member firms make clear to prospective clients that
there are risks -- and that only disciplined, market-savvy people
should try day trading, and then only if they have money they can
afford to lose.
``We appreciate the work the NASAA has done,'' said Saul
Cohen, counsel to the ETA. ``All day trading firms can and must
strive to improve their disclosure mechanisms and their ethical
mechanisms.''
Others in the day-trading world say they are victims of a
Wall Street old guard threatened by the electronic access that
allows individual investors to bypass brokers, thereby
``democratizing'' the industry.
There are no independent estimates on the number of day
traders. The ETA estimates there are 4,000 to 5,000 active day
traders, and the report identified 62 firms and 286 branch
offices. Among the biggest are Heartland Securities Corp. in New
York, Mount Pleasant Brokerage Services in Charleston and
Momentum Securities in Houston. The Atlanta branch office of
Momentum is where Barton began his rampage before moving on to
the local branch of the All-Tech Investment Group Inc.
The NASAA report includes an analysis by consultant Ronald
L. Johnson of accounts at All-Tech's Massachusetts branch office,
which was the subject of a December 1998 enforcement action and
subsequent settlement. The analysis concluded that 70 percent of
the customers lost money, and Johnson said the same proportion of
people who try day trading ``will almost certainly lose
everything they invest.''
His analysis focused on 4,093 trades in 26 accounts. Most
of the accounts in the analysis that made money, the consultant
said, were ``highly dependent'' on a single winning trade for
their positive performance, raising questions about whether those
traders would be successful over time. In some cases, the study
said, results may have been skewed in the advertising to make
rapid-fire trading look more profitable: the statistics on day-
trading profits didn't count stocks that were held for longer
periods, and some traders showed a tendency to hold on to losing
investments for days or weeks.
Only three of the accounts evidenced results and trading
techniques suggesting they could even profit from short-term, as
opposed to intra-day trades.
``Only one of the customers successfully day-traded, and
this account did not realize returns commensurate with the
risks,'' Johnson said.
Average Account
He said the average account had a cost-to-equity ratio of
56 percent, meaning that the trader would have to make a 56
percent return on his starting capital over a year in order to
offset his costs, which include commissions charged by the firm
and margin costs.
The ETA said it questioned ``the validity of a study that
focuses on only one branch office of 287 branches of one firm of
67 firms.''
Officials at Montvale, New Jersey-based All-Tech declined
comment.
Senator Charles E. Schumer, a New York Democrat, said he
will introduce legislation to require day-trading firms to
``clearly and conspicuously'' disclose the risks to their
customers.
The report by state regulators said day-trading firms need
customers, and the commissions they generate, to cover their high
capital and operating costs, which it estimated at $30,000 per
customer. To keep customers and commissions, some firms promote
and arrange inter-customer loans to help them meet margin calls -
- a requirement that a certain amount of collateral be kept in
accounts that trade with borrowed money.
Customer-to-customer loans aren't improper by definition.
The report, though, said day-trading firms are abusing the
practice to skirt the intent of margin-lending rules. It called
on the National Association of Securities Dealers to explicitly
ban such lending practices to prevent customers from trading
beyond their means.
The report also said that customers at day-trading firms are
sometimes encouraged to get money from third parties in order to
trade -- a practice that perhaps should require the firms to
register as investment advisers.
Aug/09/1999 19:18
For more stories from Bloomberg News, click here.
(C) Copyright 1999 Bloomberg L.P.
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