Momentum Securities, LLC
1800 Bering, Suite 750
Houston Texas 77057
Member: NASD and SIPC
May 11, 2000
Mr. Jonathan Katz
United States Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549
Re: File No. SR-NASD-00-03
Dear Mr. Katz:
Momentum Securities, LLC (Momentum) is pleased to submit this comment letter with respect to the NASDR's proposed rule changes to amend NASD Rule 2520 relating to margin requirements for day-trading customers (File No. SR-NASD-00-03) (Margin Proposal).1 Momentum currently has over 2,000 customer accounts, making it one of the largest firms specializing in day trading.
While Momentum appreciates the NASDR's efforts in designing the Margin Proposal, we generally oppose the NASDR's approach in its proposed rule changes. We do not believe that the risks associated with the increasing use of leverage are limited to customers deemed to be "pattern day traders." We disagree, therefore, with the NASDR's proposal to amend its margin rules by differentiating the risks of "pattern day traders" from other customers. Any amendments to address the risks of leverage should reflect the amount of leverage that a customer requests, not their trading habits. Thus, we are of the view that the Margin Proposal does not best fulfill its stated objectives of protecting the safety and soundness of member firms and ensuring the overall financial well being of the securities market. Alternatively, we suggest that the NASDR would better achieve these objectives by recasting the proposed amendments to reflect the risks of increased leverage used by all customers, not just "pattern day traders."
As noted in our General Comment, Momentum is of the view that any amendments to the margin rules should focus on the amount of leverage that a customer uses. We, therefore, oppose the requirements in proposed paragraph (f)(8)(B)(iv), which make the higher proposed minimum equity requirements applicable only to "pattern day traders." Again, we believe that the minimum equity requirements should be dependent upon the amount of leverage that a particular
customer requests or uses. For example, a customer that is approved by a firm to use 2-to-1 leverage should be required to meet the current minimum equity requirement of $2,000. Likewise, any customer that seeks and receives approval for 4-to-1 buying power should be subject to the proposed higher minimum equity standard of $25,000. We believe that this approach would more closely correlate the lending risks with the risks presented by the borrower.
Momentum opposes the definition of "pattern day trader" in proposed paragraph (f)(8)(B)(i). The proposed definition runs the risk of including customers that trade actively for discreet periods. These customers would not typically be considered to be "day traders," yet the definition may encompass these customers in its objective criteria. As a result, they would incidentally be picked up by the proposed definition. The customer then would be required to comply with the more stringent requirement of providing the $25,000 minimum equity, without necessarily presenting the risks that the NASDR seeks to address. We believe that these incidental day traders continue to present the same risk that they did prior to temporarily meeting the proposed definition of "pattern day trader." Indeed, the customer has not even requested the increased 4-to-1 buying power.
Momentum further opposes the proposed definition due to the burden that it would impose on firms. To identify persons that must be treated as "pattern day traders," the proposed margin rules would cause firms to develop and implement new screening procedures. Without such procedures, a firm may not identify customers that have tripped the definition. The firm would then suffer the risk of missing the margin calls that would otherwise be required by the Margin Proposal. Many firms, including Momentum, would need to invest significant resources for system changes to avoid unintentional violations of the proposed rule. These costs would not produce a corresponding benefit of greater safety and soundness in the securities markets, since the risks of lending to the customer have not changed as a result of this temporary increase in trading.
The proposed rule would also require a firm to assess the increased minimum equity requirements ($25,000) for any customer that it "knows or has a reasonable basis to believe" will engage in pattern day trading. While we are generally opposed to the proposed definition of "pattern day trader," we are particularly opposed to applying the definition in this manner. The standard proposed in this clause would require a firm to subjectively consider the manner of trading that it anticipates a new customer will pursue. This evaluation would be burdensome and would not further the stated objectives of the NASDR.
Momentum opposes the proposed "special maintenance deficiency" prescribed by paragraph (f)(8)(B)(iv)(b)(1) of the Margin Proposal. As proposed, any customer exceeding his or her buying power would be subject to a margin call calculated using all of the trades made by the customer during that day. The customer would then be limited under this provision to buying power of two times the customer's margin excess, calculated by using all of the customer's
trades on that day, until the margin call is met. The customer would have five days to meet the margin call. In addition, paragraph (f)(8)(B)(iv)(b)(2) prohibits a "time and tick" calculation for margin call purposes. (The proposed paragraph notes that a "time and tick" calculation uses the highest open position.)
We believe that this proposed requirement is overly burdensome and punitive in nature. A customer should be assessed a margin call once he or she exceeds his or her approved margin level, using a "time and tick" calculation. The delinquent customer should then have the allotted five days to meet this call. By assessing a special margin call using the total trades on the day, the proposed rule creates an unnecessary burden on the customer that does not produce an equivalent benefit to the market.
We recommend countering the risk presented by a customer that fails to meet his or her margin call with a harsher penalty. In this regard, we recommend severely limiting the leverage available to a customer that fails to meet the margin call. For example, the customer could be limited to trading on a cash available basis for 90 days if he or she fails to meet the call within the five days.
We oppose the proposed two-day holding period for funds deposited to meet a margin call. The NASDR states that this addition would prevent customers from making "illusory" deposits of funds. We believe that two days is an unnecessary and burdensome holding period to fulfill this objective. Firms should be permitted to determine the adequate holding period for customer funds based on an internal risk assessment of a particular customer. Otherwise, encumbering customer capital for the proposed period could be inordinately burdensome with respect to the customer's history.
Momentum partially supports proposed paragraph (f)(8)(B)(iv)(d), which prohibits firms from using guaranteed accounts to meet the minimum equity requirements. However, we oppose the extension of this prohibition generally to "pattern day traders." A customer that would otherwise be deemed to be a "pattern day trader" should not be subject to this prohibition if he or she does not use greater than 2-to-1 leverage. As with our earlier comments, we are of the belief that this prohibition should apply to any customer (whether or not a "pattern day trader") that elects to use the available 4-to-1 buying power.
Momentum supports the NASDR's effort to reduce the risks presented by increasing amounts of leverage in the securities market, however, we do not believe that exclusively targeting "pattern day traders" appropriately advances this effort. By increasing the requirements for customers that seek expanded buying power (i.e., 4-to-1 buying power), the NASDR would better match the rules with the stated objectives for the rules.
We appreciate the opportunity to share our comments. Momentum would welcome the opportunity to meet with the staff to discuss our comments in greater detail. If we can be of further assistance, please do not hesitate to call me at (713) 706-3300 ext. 227.
James H. Lee
1 Securities Exchange Act Release No. 42418 (Feb. 11, 2000), 65 FR 8461.