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Time: 6:02:19 AM
February 4, 1999
This is an unusual letter addressed to Chief Executive Officers at a pivotal time in the securities markets. The sometimes frenetic activity in the marketplace so far this year has created an environment that warrants special note. With a broader range of individual investors in the marketplace, increased use of technological tools for trading, and the expansion of trading activity such as day trading, we are experiencing dynamics which may have a lasting impact on self-regulation. Self-regulation has been a privilege of this industry, and has always carried with it a responsibility for member firms to preserve the quality and integrity of the market. This commitment has never been more important than it is today.
Our current concern relates to reports of investor dissatisfaction with service and execution, and of additional risk exposure, both for customers and for our member firms. One good example is the rising number of day traders, customers who may not be able to absorb the risk entailed in leveraged strategies. Many firms have done a good job of responding with higher margin requirements to discourage improper risk exposure, while a few have not. Unless they react now, we increase investor risk with some losing savings that they cannot afford to lose. While the old suitability notion may be difficult to apply in the face of today's technology, our firms still need to be certain they are maintaining an environment that does not encourage investors who have little experience, background or financial wherewithal to engage in high risk activity. Educating the investor is a key investors must be made to understand what they are getting into.
We are also concerned about indications that some firms may be extending credit inappropriately. There have been reports that a few firms are establishing pools into which they place customers' capital, allowing traders to use not only their own money for trades, but also the capital of others in the pool. We are also being told that some firms are encouraging their customers to cover for each other's debts at the end of the day so that everything looks fine by the time regulators scrutinize their books. While certain of this activity may technically be within the letter of the law, it is not within the spirit of what should be our mutual goal of protecting investors. Most firms are fully compliant with margin and other requirements, and we will address those firms that are not complying with the rules.
We also need to be certain that advertising and promotional materials are not setting unrealistic expectations about the opportunity to profit through day trading or about investor's ability to "instantaneously" access markets during these volatile times.
Today's conditions suggest an increased responsibility for regulatorsfor us, and for state and federal authoritiesto be extra vigilant; but nothing can help more than investor education. Investors must be properly warned about the risks they may be taking in this environment with unprecedented levels of day trading.
We are interested in hearing from you about other practices that you are seeing that you believe are a problem. We have set up a page on the NASD Regulation website at www.nasdr.com for you to email us with what you and your organization are seeing.
If each of us does whatever we need to do in our areas of influence to reinforce investor protection during this extraordinary period, we will once again prove that self-regulation is the foundation for market integrity. As always, I appreciate your help.
Very truly yours,