b. REDACTED: New Account Approval-B for Amit Berstein, September 114. a. SEALED EXHIBIT: New Account Approval-B for Lunker Invest- b. REDACTED: New Account Approval-B for Lunker Investments Cor- 115. a. SEALED EXHIBIT: New Account Approval-B for Flora Siman, July b. REDACTED: New Account Approval-B for Flora Siman, July 7, 1998 116. Letter from Lily A. Camet, Counsel for Momentum Securities, Inc., to Brian C. Jones, Investigator for the Permanent Subcommittee on Investigations, December 20, 1999 117. a. SEALED EXHIBIT: New Account Approval-B for Hung C. Chan, b. REDACTED: New Account Approval-B for Hung C. Chan, January 118. a. SEALED EXHIBIT: New Account Approval-B for Minder Singh, No- Page 852 * 853 854 855 858 b. REDACTED: New Account Approval-B for Minder Singh, November 859 119. a. SEALED EXHIBIT: New Account Approval-B for Larry L. Hartman, October 19, 1998 b. REDACTED: New Account Approval-B for Larry L. Hartman, Octo- 860 120. a. SEALED EXHIBIT: New Account Approval-B for Michael St. John Dinsmore, March 13, 1997 b. REDACTED: New Account Approval-B for Michael St. John 861 121. a. SEALED EXHIBIT: Momentum Securities, Inc., New Account Paperwork Check List for Charles R. Lande, Jr., July 19, 1999 b. REDACTED: Momentum Securities, Inc., New Account Paperwork 862 122. a. SEALED EXHIBIT: Momentum Securities, Inc., New Account Paperwork Check List for Manfred Pojar, July 1, 1999 b. REDACTED: Momentum Securities, Inc., New Account Paperwork 891 123. Momentum Securities, Inc., "Preliminary Results," February 1999 [selected pages reprinted in hearing record-full exhibit retained in the files of the Subcommittee] 921 124. Declaration of James William Lauderback, Vice President of Momentum Securities, Inc., January 12, 2000 934 125. Momentum Securities, Inc., "SEC Commentary 'Day Trading: Your Dollars at Risk,'" New Account Paperwork 935 126. Letter from James H. Lee, President, Electronic Traders Association (ETA), to Jonathan Katz, Secretary, United States Securities and Exchange Commission (SEC), October 11, 1999 937 127. Notice of Filing of Amendment No. 1 to the Proposed Rule Change 941 952 129. "Proposed Rule Change by National Association of Securities Dealers, Inc.," File No. SR-NASD-00-03, cover letter 958 130. Letter from Joan C. Waller, Counsel for Cornerstone, to Joseph M. Gonzales III, Investigator for the Texas State Securities Board, October 26, 1999 ..... 131. Letter from Joan C. Waller, Counsel for Cornerstone Securities, Corp., to K. Lee Blalack, II, Chief Counsel and Staff Director for the Perma X Page 132. NASD Regulation, Inc. arbitration claims for Sandra Harlacher, Carmen Margala, et al. (1999) 1005 133. SEALED EXHIBIT: All-Tech Branch Office Agreements 134. Written Supervisory Procedures for Summit Trading, Inc., last amended (March 19, 1999) 135. Training Manual, "The Fundamentals of Successful Day Trading," Cornerstone Securities Corporation, 1999 136. Momentum Securities, Inc., "House Systems and Trading Rules Ac- 137. Letter from Robert S. Bennett, Counsel for Momentum Securities, Inc., 139. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposi- 140. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Henry D. Fahman, December 15, 1999 ..... 141. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Harvey Houtkin, December 7, 1999 142. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of James H. Lee, December 22, 1999 143. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Barry Scott Parish, November 30, 1999 144. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Fred A. Zayas, December 16, 1999 145. Memoranda prepared by K. Lee Blalack, II, Chief Counsel and Staff 146. U.S. General Accounting Office Report, Securities Operations: Day Trad- 1066 1067 1073 1100 1140 148. The Lazy DayTrader home page, www.lazytrader.com. 149. Terra Nova New Account Form 1186 1187 150. "Case Study_Witnesses," chart prepared by the Permanent Subcommittee on Investigations 1188 151. "The Importance of Risk Capital," excerpt from Harvey I. Houtkin's book, Secrets of the SOES Bandit 1189 152. "Providential Day Trading Customer Account Forms That Fail to In- 1190 154. Letter from Sandra H. Harlacher to the Permanent Subcommittee on Investigations, March 1, 2000, regarding her February 24, 2000 Subcommittee testimony 155. Letter from Lori A. Richards, Director, Office of Compliance Inspections and Examinations, United States Securities and Exchange Commission to Senators Collins and Levin, March 21, 2000, regarding margins loans and letters of authorization 1191 1192 1193 156. Letter from James H. Lee, Momentum Securities, Inc., to Senator Carl Levin, March 6, 2000, regarding views on the profitability of Momentum DAY TRADING: EVERYONE GAMBLES BUT THE HOUSE THURSDAY, FEBRUARY 24, 2000 U.S. SENATE, PERMANENT SUBCOMMITTEE ON INVESTIGATIONS, Washington, DC. The Subcommittee met, pursuant to notice, at 9:30 a.m., in room SD-342, Dirksen Senate Office Building, Hon. Susan Collins, Chairman of the Subcommittee, presiding. Present: Senators Collins, Levin, and Durbin. Staff Present: K. Lee Blalack, II, Chief Counsel and Staff Director; Mary D. Robertson, Chief Clerk; Deborah Field, Counsel, Detailee/ŠEC; Brian C. Jones, Investigator; Wesley Phillips, Detailee/GAO; Eileen M. Fisher, Investigator; Elizabeth Hays, Executive Assistant; Linda J. Gustitus, Minority Chief Counsel and Staff Director; Bob Roach, Counsel to the Minority; Felicia Knight and Steve Abbott (Senator Collins); Anthony Pitago (Senator Specter); Anne Bradford (Senator Thompson); Nanci Langley and Glenn Sauer (Senator Akaka); Marianne Upton, Darla Silva, and Jadie O'Dell (Senator Durbin). OPENING STATEMENT OF SENATOR COLLINS Senator COLLINS. Good morning. The Subcommittee will come to order. Today, the Permanent Subcommittee on Investigations continues its examination of day trading. Last fall, the Subcommittee began its investigation with an overview hearing. After several months of investigation, we will now draw back the curtain and provide an in-depth look at the practices of three day-trading firms representative of the industry. Day trading involves taking positions in stocks for very short periods of time, usually minutes or hours, but rarely longer than a day. Day traders seek small increments of profits from moment-tomoment fluctuations in the price of a stock. The firms that cater to day traders provide their customers with high-speed computer access and real-time market quotes, both of which are necessary to take advantage of small changes in stock prices. Over the course of 8 months, the Subcommittee has investigated 15 day-trading firms which reported a total of about 12,700 day trading accounts. While a day trader could open more than one account, the Subcommittee's review indicates that the number of day traders is significantly higher than most of the earlier estimates. For example, at our hearing last fall, we heard testimony that there were about 5,000 day traders at approximately 60 firms. Our analysis suggests that the number is at least double that. Commission income, which is normally generated on a per trade basis, is the primary source of revenue for most day-trading firms. The day-trading firms we investigated charged an average commission of $16 per trade. In the aggregate, those firms estimated that the average customer executes about 29 trades each day. Consequently, the average day trader must generate a minimum trading profit of over $450 each and every day simply to break even. On an annualized basis, assuming 20 trading days per month, that means the average day trader must generate a trading profit of more than $111,000 to achieve profitability for the year. As the testimony today will show, most day traders are not breaking even. In fact, they are losing money, big money. The consumers who will testify before us today, for example, lost tens of thousands of dollars. The same cannot be said, however, for the day trading industry. It seems to be doing quite well. The 15 firms that we examined reported aggregate gross revenues of over $491 million in 1999 and aggregate profits of about $144 million. The Subcommittee found that the industry is growing by leaps and bounds. Indeed, the revenues of day-trading firms that we analyzed grew by a whopping 276 percent from 1997 to 1999. Everyone, even the industry, appears to agree that day trading is highly speculative and extremely risky. Both the Chairman of the SEC and the President of NASAA, that is the State Securities Regulators Association, went so far as to call day trading gambling during the Subcommittee's hearing last fall. The Electronic Traders Association, the trade organization for the industry, objects strongly to that analogy, contending that day trading requires skill, stateof-the-art technology, and hard work. That may be true, but many day traders seem comfortable with the comparison to gambling. The president of 1 day-trading firm was quoted in the press as saying that day trading is like blackjack. Documents obtained by the Subcommittee also indicate that some firms consider day trading to be essentially gambling. I would draw everyone's attention to the exhibit we have posted.1 This is a listing of trading tips from a day-trading firm called Insider Trading. You will note that Insider Trading cautions its customers not to get greedy. It states, "When you reach your goal, stop and quit trading. Try not to be greedy and still trade. Remember you are gambling and most likely will lose what you have made." I believe that day trading can be fairly compared to certain types of gambling. For inexperienced traders, it is little more than a game of chance. I reached this conclusion based primarily on data showing that only a small percentage of day traders ever make money. Our investigation indicates that the small percentage of day traders who are successful generally start with large amounts of risk capital and substantial experience. The best evidence that we have suggests that a significant majority of all day traders, more than 75 percent, lose money, and for the novice under-capitalized trader, there is almost no chance of success. A document produced to the Subcommittee by the firm All-Tech Direct sums up my concern about the profitability of day trading. When the branch manager for All-Tech's Seattle office was asked to comment on the progress of his 51 customers, he wrote, "Overall, good. We need to have a couple of people making money." In fact, when interviewed by the Subcommittee staff, the branch manager estimated that only 10 percent of his Seattle customers were profitable. Even more striking, the branch manager of the Los Angeles office of another day-trading firm, Providential Securities, stated that none-none-of his office's day-trading clients ever made money. In fact, he estimated that the average customer lost approximately $50,000. Because of the poor success rate of most day traders, one might wonder how is it that the industry has grown? After all, why would people give up good secure jobs or put their savings at risk to pursue a day-trading career when their chances of making money were very small? The reason, of course, is that most people who lost money, including the customers that we will hear from today, simply did not fully appreciate the risk. While some day-trading firms give their consumers very good risk disclaimers, on the whole, the industry has failed to disclose adequately just how risky this speculative activity is. Many daytrading firms improved their written risk disclosures only after regulatory and Congressional scrutiny increased the last year, and as today's testimony will show, written risk disclosures are often contradicted by oral statements that minimize the risk through promises of big profits or cannot lose systems. Even when the written risk disclosures are provided, they are often undermined by deceptive advertising or other hype. As an example of this, I would refer to Exhibit No. 148.1 In this instance, this is the Web site for Lazy Day Trader. It entices potential customers with an unbalanced and exaggerated testimonial which says, “This is the only business I know of where there is absolutely no limit ever as to how much I can earn. I am doubling my money every 3 months buying and selling stocks. I have developed a simple method to determine what to buy and sell, how much, and when to buy and sell, which everyone can follow. You can start with as little as $2,500 and still make money." It goes on to say, "You do not even have to understand economics, the stock market, or international finance." In other words, what this Web site is holding out is the promise that with very little capital and no understanding of the markets, the average person can get rich by following Lazy Day Traders' cannot lose system. If only it were that easy. What is most disturbing about these types of misleading claims is that they often appeal to the very people who have limited investment experience. Press reports have noted that day trading attracts many young people because it is computer intensive, fast paced, and offers the tantalizing prospect of quick riches. |