Day traders need more protection against abuses, say state regulators

WASHINGTON (May 28, 1999) — Stock day traders need more disclosure about the risks of hyperactive trading—to protect themselves and stem further abuses in the industry, a group of state securities regulators said today.

The North American Securities Administrators Association (NASAA) endorsed new rules proposed by the National Association of Securities Dealers (NASD) that enhance the obligation of day trading firms to disclose risks to day traders.

NASAA, however, urged that the rules go further. “Based on abuses that have occurred to date,” NASAA said in a May 28 letter to the NASD, “day trading firms should be required to ensure that day trading is suitable for both new and existing customers.” The NASD rule, as currently proposed, would cover only new customers.

Firms should also be required to determine the source of funds to be used by day traders. “Certain day trading firms have encouraged customers to use borrowed funds and funds of third parties,” NASAA said. “Adoption of this requirement would help stem the abuses that have occurred.”

State regulators further suggested that disclosure statements, to be signed by customers and retained by the firms, should caution “against the use of any borrowed funds.” The NASD rule currently mentions just student loans and second mortgages.

In addition, the disclosure about short selling should spell out that the customer risks losses beyond the value of their account, exposing other assets such as homes to the risk of loss. “This risk, which is theoretically unlimited, is often not understood by non-institutional customers,” NASAA said.

Finally, NASAA urged that firms be required to back up any “representations concerning the profitability” of day trading with “facts.”

Beginning last year, state securities regulators in Massachusetts, Texas and elsewhere took a series of enforcement actions against day trading firms, for misleading advertising, unregistered activity, mishandling of customer funds and other violations of securities laws.

The comment letter was signed by David E. Shellenberger, chief of licensing, Massachusetts Securities Division and chairman of the NASAA Project Group on Day Trading.

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1999 Headlines, Newsroom