Oral Statement Concerning
By Lori Richards
Director, Office of Compliance Inspections and Examinations
U.S. Securities & Exchange Commission
Before the Senate Permanent Subcommittee on Investigations,
Committee on Governmental Affairs
February 25, 2000
Chairman Collins, Ranking Member Levin, and Members of the Subcommittee:
Good morning. I am pleased to appear before the Subcommittee on behalf of the Securities and Exchange Commission to outline our recent actions with respect to day trading. I am Lori Richards, Director of the examination program at the Commission.
The Commission has sought to address concerns about day trading in a four-part strategy: 1) by conducting an examination sweep of day trading firms to evaluate compliance with the law and to gather information about this new industry; 2) by fostering investor education about the risks of day trading; 3) by considering regulatory changes; and 4) by bringing enforcement cases where appropriate.
I am pleased today to provide you with a Report summarizing the findings from the first part of that initiative the Report summarizes our findings from our examination sweep of firms offering day trading to the public. From October 1998 through September 1999, in coordination with the NASD, we examined 67 firms offering day trading to the public.
I would like to take a moment to briefly summarize what we have found in these examinations. While the examinations did not reveal widespread fraud, they did reveal a number of serious violations warranting referral to the Commission's Division of Enforcement. These violations included net capital, short sale, and margin violations. The examinations also revealed deficiencies in advertising, supervision, and registration rules. As a result of these examinations, we have concluded that many day-trading firms need to enhance their compliance with securities regulations. The inability of some firms to monitor their compliance with capital, margin, and the short sale rule, or to maintain adequate books and records raises serious concerns. All of the firms at which deficiencies were found have been cited in deficiency letters, or in the most serious cases, referred to our Division of Enforcement.
In September, Chairman Levitt told this Subcommittee that he was concerned about the potential for individuals to be seduced by promises of easy profits by day trading, without fully understanding the risks. During our examinations, we reviewed the information that firms were providing to customers concerning the risks of day trading. We found that as of the time of the examinations, most firms provided little or no information to their customers concerning the risks of day trading. A recent review indicates, however, that many day trading firms have vastly improved the risk disclosure information they provide to potential customers. Clearly, the industry is responding to regulators' concerns, and certainly the work of this Committee and the media have highlighted the risks associated with day trading.
I would also like to address another area of concern margin lending. During examinations, we focused on a number of lending practices of the firms direct lending by the firm, lending through associated persons, and the arranging of loans by the firm between customers and between third parties and customers. By using leverage, day traders hope to increase their potential profit from small movements in the price of stocks. Unfortunately, leverage can also substantially increase losses often beyond what day traders can afford to lose. We are concerned that many day traders do not fully appreciate that by borrowing to buy securities they can actually lose more than their initial investment.
This is why our collective efforts to educate investors are so important. Today, we are continuing to do that by posting another notice on our investor education web site. Along with our investor alert concerning the risks of day trading, we have posted investor tips concerning the risks of buying stock on margin.
We're also focusing on securities rules and how we can address concerns about day trading by tightening up regulations. The NASD, NYSE and other SROs have taken a number of steps and have proposed rules that would restrict margin for day traders, require day-trading firms to disclose the risks of day trading to potential customers and to determine whether day trading is appropriate for customers.
Finally, our Division of Enforcement is continuing to investigate several referrals that stem from our exam sweep, and recently brought two cases against day-trading firms for lending violations.
The SEC will continue to focus resources on day trading we will be conducting additional targeted examinations, continuing to evaluate whether regulatory changes are appropriate in light of industry practices, continuing work to educate investors about the risks of day trading, and we will bring enforcement actions where appropriate.
As Chairman Levitt told this Subcommittee last September we are committed to do everything we can to ensure that day trading firms are operating within the boundaries of the law and we hope that individuals considering this type of trading strategy do their homework on the risks of day trading before risking their money.
Thank you. I am happy to respond to any questions you might have.