EXHIBITS Exhibit Day Trading Practices: Summarizing number of accounts, advertising, loans, off-site clients and third party trading..... Day Trading Examination Results: Net gains and losses. Tab A B Day Trading Practices: Summarizing ranges of net losses and Day Trading Detail Report: Detail listing of all accounts analyzed, sorted by profit and loss .D Day Trading Detail Report: Detail listing of all accounts analyzed, sorted by number of months open...... .E REPORT TO THE UNITED STATES SENATE EXECUTIVE SUMMARY In September 1999 the examination section of the Washington State Securities Division' undertook the task of conducting field examinations of all day trading firms with branches in the State of Washington2. The examinations focused on gathering information regarding alleged predatory practices by day trading firms. From September through November 1999, the Securities Division examined seven day trading firms doing business in the State of Washington. Three areas of regulatory concern arose from the examination of these firms: (1) Extensive Customer Losses (2) Unregistered Broker-Dealer and Investment Adviser Activity and (3) Questionable Loans to Customers. Customer Losses: Information gathered from the exams indicates that the majority of customers (77%) who participated in day trading at these firms lost money. Customers lost an average of $36,000, with some customer losses reaching over $600,000. Unregistered Activity: The Securities Division found that one firm appeared to be engaging in broker-dealer activity without being registered. The Securities Division also found certain persons trading accounts for other customers were not registered as investment advisers. Questionable Loan Activity: The Securities Division found questionable loan <activity at three firms. These loans appeared to be attempts to circumvent margin limits. Enforcement Actions: Specific findings regarding questionable lending, unregistered broker-dealers and investment advisers have been referred to the Securities Division's Enforcement Division for further investigation and possible regulatory action. 1 The Securities Division is a Division of the Department of Financial Institutions. The Division of Securities was established in the early 1930's and now administers the Securities Act, Franchise Investment Protection Act, Business Opportunity Fraud Act, and Commodities Act. The primary mission of the Division of Securities is to protect Washington State residents from the dishonest or fraudulent practices of people offering and selling securities and investment advice. The Division accomplishes this mission through a variety of regulatory and enforcement tools, including registration and examination requirements of broker-dealers and investment advisers. 2 The firms reviewed were Action II, All-Tech Investment Group Inc., Bright Trading, Cornerstone Securities Corporation, Day Trade Technologies, On-Line Investment Services, and Richmark Capital THE PROJECT The examination team was assigned the responsibility of inspecting the activities of day trading firms for sales practice violations, questionable loans or guarantees, thirdparty trading and unsuitable trading accounts. The team was also given the task of looking into possible unregistered broker-dealer and investment adviser activities, short sale violations, and any evidence of misleading advertising. Assignments and Choice of Firms: A review of our registration records and advertising indicated there were seven day trading firms with branches located in the State of Washington. All examined day trading firms were located in or near the Seattle metropolitan area. The firms were divided among three members of the examination team; a Securities Division enforcement attorney was assigned to oversee the legal aspects of the assignment. Those members representing the audit team were Mr. Gene Nakano, Mr. Gary Smith, and Ms. Joanne Jones. Ms. Kristina Kneip represented the enforcement staff. These examinations were conducted during the months of September, October and November, 1999. Certain facets of those examinations have been referred to Enforcement for further investigation and possible regulatory action. Project Findings: Of the seven day trading firms examined by the audit team, two firms accounted for more than 80 percent of the 5853 day trading accounts serviced by the firms. In part, the reason for their dominance in the area is that they have been in the community longer than the other day trading firms. Types of Customer and Accounts: Of the 585 customer accounts serviced by day trading firms in the Puget Sound Region, 481 are actively traded"; the remainder are either closed or maintain long-term investment positions. Four of the seven firms examined cater only to day trading customers. Three of the firms have some accounts held by longer-term investors. Off-site Trading: Three of the seven firms examined provided their customers with the opportunity to trade at an "off site" location as well as at a trading room location supervised by the firm. One firm provided only “off-site" trading. Three hundred and sixty customers took advantage of “off-site” trading. Customers trading "off-site" were found to be as active as on site traders. Accounts Reviewed: Monthly statements for 124 open and active day trading accounts were reviewed and analyzed as part of the examination process. The analysis shows the net profits and losses for those accounts, the time period the accounts were open and the beginning balances for the accounts. 6 Net Profits and Losses: Of the accounts examined, 96 (or 77%) were found to have net losses. Of these accounts, 9 had losses over $100,000." The highest loss discovered was $641,000. The average net loss in these accounts was calculated to be $36,043," Of the accounts examined, 28 (or 23%) were calculated to have net profits. 10 Only two accounts were found to have gains of over $100,000." The highest profit discovered was $160,100.12 The average net profit in these accounts was calculated to be $21,983.13 14 Time Period: Accounts reviewed ranged from those open for one month to accounts traded for as long as 25 months. Some closed accounts were also reviewed, but these accounts remained open for short periods of time. After having suffered trading losses, many accounts were closed within six months after they were initially opened. The length of time an account was open and active did not appear to have a correlation with the success of the account. Beginning Account Balances: Most of the firms examined claimed to have a $20,000 minimum opening account balance threshold. Examination of customers monthly statements showed that opening balances for accounts ranged from as little as $6,000 to as much as $1,800,000." These opening balances were composed of both cash and securities. In accounts where the opening balance was over $100,000 the deposit was generally made up of securities from another broker-dealer. Questionable Activity: Loans to Customers: Activity involving loans to customers was examined at each firm. 16 The most common type of loan situation found involved the firms facilitating loans between customers through journal entry notations. This was revealed to |