March 23, 2000

Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
(Filed electronically in Word format: rule-comments@sec.gov)

RE: File No. SR-NASD-99-41

Dear Mr. Katz:

The North American Securities Administrators Association (NASAA)1 appreciates the opportunity to comment on the recent amendments to the new Rules 2360 and 2361 proposed by the National Association of Securities Dealers Regulation (NASDR) relating to the opening of day trading accounts.

Background:

NASAA has been actively involved in the day trading area and on August 9, 1999 published the Day Trading Project Group Report (hereafter known as the "Report").2 The Report examined regulatory issues surrounding day trading, including inadequate risk disclosure to day trading customers.3 The Report endorsed the NASD's proposed rules4 on appropriateness and risk disclosure with respect to day trading firms, as well as suggested enhanced protections for customers.5

NASAA voiced its support for the originally proposed NASD Conduct Rules 2360 and 2361 in our October 12, 1999 comment letter (hereafter known as the "Letter") to the Commission. We supported these originally proposed rules as integral to maintaining a fair and equitable marketplace for those individuals who wish to engage in day trading.

We respectfully offer the following comments on the proposed amendments:

Proposed Rule 2360:

NASAA believes that while the existing NASD Conduct Rule 2310 on suitability is applicable to day trading firms, it is not enough to address its inherent risks. NASAA strongly supports the addition to proposed Rule 2360(b) of specific factors to be used in the appropriateness determination. We agree with the analysis in the NASDR's `Statement of Purpose' that emphasizes the strong parallels between the risks of options trading and day trading. In addition to the language already incorporated from Interpretive Material 2860-2, NASAA also suggests the following language:

  1. Source of Funds Invested. This is proposed as an amendment to Rule 2360(b)(3). Information regarding the source of funds used for day trading should already be elicited when inquiring into the `Financial Situation' of the client under 2360(b)(3). However, because of the prevalence of day traders using borrowed money to fund their accounts, firms should be explicitly required to inquire as to the source of funds. This question would assist the firm in making an informed appropriateness determination. It would also help to limit the risk of financial exposure for both the firm and the customer.

NASAA also suggests integrating additional material from the option account-opening language found in NASD Conduct Rule IM-2860-2 (b)into the proposed Rule 2360(b). Specifically:

  1. Source or sources of background and financial information (including estimates) concerning the client. This additional language would ensure that a firm documents the source of the client's financial information. This would help a firm's principal to evaluate the reliability of information used to make the appropriateness determination, especially when the financial information is provided by a third party trader, rather than the client. The NASAA Report identified several problems with false or misleading information provided on customer new account documentation.

  2. Discretionary authorization agreement on file, name, relationship to customer and experience of person holding trading authority. This would ensure that the relationships between the day trading firm, the client, and any third parties are clearly defined and documented. This would also substantially decrease the possibility of exposure to financial risk for all parties involved, including the firm.

  3. Date disclosure document(s) furnished to customer. This would require the firms to document when the disclosure statement (as provided for in proposed Rule 2361) was given to the client. This requirement protects both the firms and the clients. This allows the firms to document when risk disclosure was made pursuant to the rule. This subsequently would protect the clients by ensuring that they receive risk disclosure prior to opening their accounts.

  4. Name of Registered Principal approving the account and date of approval. This rule requires the firm's principal who determined whether the day trading strategy was appropriate for the client and approved the account to record that approval in writing. Currently, under the NASD Conduct Rules, both option trading and margin borrowing require that a principal of the firm accept and approve the customer for that specific type of strategy. Requiring a specific registered principal's name would strengthen the proposed rule's intent to focus on a customer's appropriateness for a day trading strategy. This would also ensure that a specific identifiable principal has certified compliance with the proposed rules.

In reference to proposed rule provision 2360(g)(3), NASAA supports inclusion of this additional language: Provided that the web site is not actively promoting a day trading strategy. NASAA agrees that the "safe harbor" 2360(g) provides should be helpful in preventing application of the rules to firms that do not recommend or promote day trading services. NASAA also would like to ensure that this "safe harbor" does not become a "loophole" for Internet-based firms to skirt the proposed rule. It is fair to say that in and of themselves, activities such as `promoting lower execution costs based on multiple trades' or `having a Web site that allows the multiple entry of intra-day purchases and sales of the same securities' should not constitute promotion of day trading for the purpose of the proposed rule. However, NASAA would like to ask NASD Regulation to clarify that these activities may still be considered part of a plan to promote day trading when combined with other acts, such as suggesting to customers that making multiple intra-day trades is a profitable investment strategy.

Proposed Rule 2361:

NASAA overall supports the proposed rule requiring that firms distribute the day trading risk disclosure statement. However, NASAA believes that (1) the rules should apply to both new and existing clients and (2) customers should sign the disclosure statement.

As currently written, proposed Rules 2360 and 2361 would apply to new customers only. NASAA continues to believe that these rules should apply to both new and existing customers, particularly in view of the abuses that have occurred to date. Firms should be required to ensure that day trading is appropriate for both categories of customers, and they should be required to disclose the risks to both new and existing customers.

In addition to the issues raised in our Letter regarding investor protection, NASAA would like to point out that making a distinction between new and existing customers may create difficult problems for firms and regulators. The high customer turnover at many day trading firms could make it difficult to determine who is an existing customer. In addition, existing customers may open new accounts with slightly different ownership or names, forcing the firms to determine which situations require risk disclosure and appropriateness determinations. In order to protect all investors and to provide a degree of certainty to the firms, NASAA recommends that the proposed rules apply to both existing and new customers.

Secondly, the proposed Rule 2361 would not require customers to sign or otherwise acknowledge receipt of the disclosure statement. As stated in our Letter, NASAA recommends that the member firm be required to obtain the customer's signature on the disclosure statement so that this acknowledgement of receipt would become part of the member firm's books and records.

NASD Regulation currently requires signatures and retention of documents for those customers who wish to engage in both option trading and margin borrowing. Since it is agreed that day trading as a strategy entails a high degree of risk, similar to option trading and margin borrowing, it is not inconsistent for the rule to require signatures and retention of the disclosure statement as part of the member firm's permanent records. This requirement would parallel current "truth-in-lending" laws that mandate that customers must attest to the fact that adequate disclosures have been made to them.

NASAA believes that this requirement would not place an undue burden on the firm establishing the day trading account. The firm is required to obtain the client's signature when the new account is opened, so having them sign one additional document designed to disclose risk and protect their financial interests should not be unduly burdensome. Additionally, the signature protects the firm by eliminating the question of non-disclosure to the client as an issue in arbitration. The support of the Electronic Trader's Association for a signed customer acknowledgement also suggests that the benefits of this procedure outweigh the potential inconvenience.

Regarding proposed Rule 2361(a), NASAA recommends that the original language of risk disclosure item #4 be retained. NASAA believes that the original language more closely comports with its title: "Day Trading requires knowledge of a firm's operations." Removing this language obfuscates the original intent of this item. Although the new language provides important risk disclosures, it does not replace the need for customers to understand their own firm's execution systems and evaluate the potential problems for themselves.

NASAA supports risk disclosure item #6, pertaining to risks associated with day trading on margin or short selling. NASAA recently submitted a comment letter on the NASD proposed amendment to Rule 2520 relating to margin requirements for day trading customers. NASAA endorses disclosures placing prospective clients on notice that day trading on margin substantially magnifies the already present financial risks. The NASAA Report also uncovered firm-wide abuses including circumvention of the margin regulatory structure and violations of SEC Rule 12b-5. NASAA appreciates the inclusion of this topic into the proposed disclosure statement. We hope that clients contemplating margin borrowing will do so only after deliberately considering the potential risks.

Conclusion

NASAA applauds the proposed NASD rules that protect the interests of the markets, firms and investors, who can if this rule is adopted pursue a day trading strategy fully informed of the risks.

NASAA appreciates the opportunity to provide guidance and comments in this area. If I can be of further assistance, please contact me directly at (317) 232-6690. Thank you.

Sincerely,


Bradley W. Skolnik
NASAA President
Indiana Securities Commissioner


Footnotes
1 The oldest international organization devoted to investor protection, the North American Securities Administrators Association, Inc., was organized in 1919. Its membership consists of the securities administrators in the 50 states, the District of Columbia, Canada, Mexico and Puerto Rico. NASAA is the voice of securities agencies responsible for grass-roots protection and efficient capital formation.
2 "Day-trading Project Group Report: Findings and Recommendations," August 9, 1999 is available at the NASAA web site: www.nasaa.org.
3 Ibid at 14.
4 Special NASD Notice to Members # 99-32 (NASD Regulation Requests Comments on Proposed Day-Trading Accounts), April 1999.
5 Report at 45.