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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Common Sense Investing
in the 21st Century Marketplace

Remarks by

Chairman Arthur Levitt

U.S. Securities & Exchange Commission

Investors' Town Meeting
Albuquerque, New Mexico
November 20, 1999

This is a remarkable time to be an investor. Any way you measure it our markets have been enjoying record-setting growth. We've seen new highs, record volumes, and a greater number of new investors than ever before in our country's history.

Understandably, there's a lot of euphoria among investors. The massive movement into our stock markets has provided new opportunities. But it has also increased the risks. While some of today's optimism is justified – some of it is not.

Remember: the strong gains over the last few years are the exception – not the rule. Over the longer term – measuring over the last 70 years or so – stocks have typically earned about 10 or 12 percent each year. Now, I'm certainly not making predictions. I'm just reminding you that it's important to have realistic expectations.

With the growth in on-line investing, more and more people, I fear, are entering our markets with overly aggressive expectations. And, with some of the on-line brokerage commercials that are showing up on T.V. these days – visions of owning your own island or amassing a small fortune overnight – it's easy to see how people can get caught up in the excitement.

The ease and speed of the Internet has empowered investors like nothing before. At the same time, the opportunity to invest on-line comes with a greater personal responsibility. We have noticed four common misconceptions about on-line trading.

The first is that although the Internet makes it seem as if you have a direct connection to the securities markets, you don't. When you push that enter key, your order is sent to your broker, who then sends it to a market to be executed. This process is usually seamless and electronic; it is not, however, guaranteed. Lines may clog; systems may break; orders may back-up.

Even when automated systems can handle a lot of investors who want to buy or sell the same stock at the same time, a line often forms. As you would expect, the price of that stock will then go up if there are more buyers, and down if there are more sellers. By the time you get to the front of the line, the price of the stock could be very different.

So, how do you protect yourself from a rapid change in the price of a stock? Part of the answer is by using a limit order. That's the second thing every investor needs to know.

A limit order buys or sells a security at a specific price – whether that be a maximum or a minimum threshold. On the other hand, a market order buys or sells the stock at whatever price the security happens to be at the time the order reaches the market. So, if you place a market order to buy an IPO stock at $9, you could end up paying $90 by the time your order is executed.

The third misconception is that an order is canceled when you hit the "cancel" button. The fact is, it's canceled only when the market receives the cancellation. And that may be too late if your order was already executed. Even if you get an electronic confirmation, that may only mean your request to cancel was received – not that your order was actually canceled.

Fourth, if you plan to borrow money from the broker to buy a stock, you also need to know the terms of the loan. When you buy on margin – as it is referred to – the stock you purchase is collateral for that loan. In volatile markets, investors who put up an initial margin payment for a stock may find themselves required to provide additional cash if the price of the stock falls.

But, some investors have been shocked to find out that the brokerage firm has the right to sell their securities – without any notification and potentially at a substantial loss to the investor. It's clear that if an investor fails to understand the details of his margin account, he does so at his own peril.

Today, investors have access to timely information that was virtually unthinkable just a few years ago. But, I'm surprised when I ask investors who, when, and what they consult before buying a stock. I've found that very few people read the company's annual report or mutual fund prospectus or do independent research.

If you aren't familiar with it already, I encourage you to visit EDGAR – the SEC's electronic database of filings by most public companies – at www.sec.gov. Type in a company's name and you can retrieve every report they have filed with the SEC in the past five years. You can find earnings information, who is on the company's board, how many shares they own, and if company insiders are buying or selling shares.

Now, some may ask, "Why go through the trouble of reading this material? I trust my friends. I trust the Wall Street analyst on T.V. or in the newspaper. I trust my instincts." Well, the answer can be found in something folksinger Pete Seeger once said when explaining the difference between education and experience. "Education," he said, "is when you read the fine print; experience is what you get when you don't."

As you do your research, ask specific questions about products and ask questions about those who sell them.

Let's start with money market funds. I have a few of their prospectuses here with me now. When I look at some of their names, I see reassuring words like "Trust" – "Liquid" – "Government" – "Cash" – "U.S." – "Ready Assets."

Well, I don't care if a fund is named "The Rock-Solid Honestly Safe U.S. Government Guaranty Trust Savings Fund." In any market investment, you stand a chance of losing your principal.

Let me underscore that last point. It's a fundamental fact of investing. You might even write it down, and remember it whenever you invest: With any investment, you stand a chance of losing your money.

When buying a mutual fund, find out about what kind of sales charge, or load, you'll pay – front-end load, back-end load, or no-load. Look at the cost of any annual asset-based charge – the so-called "12(b)1 fee." On top of that, you should consider the management fees and other expenses that you'll pay on your fund each year.

Over time, expenses and fees can really add up. On an investment held for 20 years, a 1 percent annual fee will reduce the ending account balance by 18 percent. Our web-site has a Mutual Fund Cost Calculator to help you estimate and compare the costs of owning mutual funds.

Whatever investment products you choose – stocks, bonds, mutual funds – be sure to comparison shop before you buy. And if you use a financial professional, make sure you're getting the kind of advice and management that are really worth the price. Unfortunately, I've known people to spend more time comparison shopping for paper towels than for investments. There's no excuse for that.

Here's a very important question if you have a broker: How does he or she gets paid? Commissions reward a broker for the quantity of the trades, not necessarily the quality. And some firms offer such alternatives as a flat fee, or a percentage of the assets under management.

Brokers are sometimes paid more for selling mutual funds, for example, rather than stocks – or paid more for selling the in-house brand of mutual funds rather than another. That's certainly in his interest. Perhaps even in the firm's interest. But it may not be in your interest.

Ask your broker: Do you make more if I buy this stock, bond, or fund than if I buy another? If you weren't making extra money, would your recommendation still be the same? And when a broker tells you the price for which he'll sell your a stock, ask how much he'll pay to buy the same stock from you. You'll find there's always a "spread" between the selling and buying price.

And here's another issue that investors should be aware of: How many of you have ever heard of payment-for-order-flow? It's where exchanges will pay a broker to send your order to them. And payment-for-order-flow can significantly impact the price you pay for the stock.

Ask your broker about his firm's order routing practices or look for that information in your account agreement. You can also write to your broker to find out the nature and source of any payment-for-order-flow. Ask him how his firm gets price improvement – that is, a better price than the currently displayed quote. Consider this information in deciding with which firm you will do business. You can also go the SEC's web-site to find more information on payment-for-order-flow and best execution.

My best advice to you boils down to two words: Ask questions. The SEC and many of our partners have brochures in Spanish and English at the exhibit booths.

Now, how many of you have seen analysts from Wall Street firms on television talking about one company or another? I'm willing to bet that not many of you have thought twice about that person's recommendation to buy or sell a particular stock. But, you should.

Most analysts work for firms that have business relationships with the same companies these analysts cover. And analysts' paychecks are typically tied to the performance of their employers. You can imagine how unpopular an analyst would be who downgrades his firm's best client. Is it any wonder that today, a "sell" recommendation from an analyst is as common as a Barbara Streisand concert?

As investors, you are confronted with a dizzying number of choices and opportunities. And those options can easily overwhelm and intimidate the most financially savvy person. In this day and age, there simply is no substitute for a person's awareness and wariness.

Don't fall for the illusion of easy money. And don't be pressured by an aggressive salesman or enticed by a fancy web site promising that you'll make a fortune with one quick gamble. That leads to the last of my themes today: how to be alert to some of the dangerous practices in the marketplace.

While the scams we have seen on the Internet are the same basic frauds that have always accompanied the flow of money, the Internet's speed, low cost and relative anonymity give con artists access to an unprecedented number of innocent investors.

No investor, no matter how sophisticated, is immune from fraud. Does anyone here remember the names Len Storch or Terry McCully?

A few years ago, McCully was the City Finance Manager in Clovis, New Mexico. The town was experiencing financial hard times when Storch arrived on the scene with an investment opportunity. McCully took the bait, and invested four million dollars of the city's money in a complicated financial scheme. The investment was supposed to return 72 percent a year and be as "safe as a Certificate of Deposit." But it was no such thing. Instead, it was a scam. The city lost all but 500 thousand dollars of its original four million dollar investment. The former City Manager has already pled guilty to 11 felony counts for his role in the rip off. The investigation of Mr. Storch continues.

The classic warning sign of fraud is a high-pressure sales pitch – usually over the phone – where the salesman may pretend that he has inside information about a small company that, he says, "just can't miss." The scam puts pressure on you to send money right away, before you've had much time to think. And it almost always promises quick, easy, astronomical profits.


All over this country, this city, and in this very room, there are important stories. Not necessarily stories that make the evening news or the newspaper headlines. But stories of people who work day in and day out for a better life and a better future. And many of these important but untold stories are as profoundly simple as sending a daughter to college, buying a first home, taking care of a sick parent, or helping a sibling through a tough financial spot.

With so much at stake, all of us must do our part to realize the promise of our markets, and more importantly, the promise of our lives. All of you have the power and means to be the most informed generation of investors in the history of our capital markets. The ease of today's technology isn't an excuse to do less. It's an opportunity and a mandate to do more; to learn more; to be aware of more; to be informed of more and to achieve more – as individuals and as a country.

Thank you very much.