Massachusetts Again Targets
Actions of Day-Trading Firms
By RUTH SIMON and REBECCA BUCKMAN
Staff Reporters of THE WALL STREET JOURNAL
Heard on the Street Column
July 9, 1999
The lure of "day trading" has turned some small investors into highly leveraged, active speculators. But are the brokerage firms that cater to this trading style going too far?
Massachusetts securities regulators fired the latest salvo in their attack against day-trading firms, accusing Landmark Securities Corp. of Houston of engaging in illegal lending activities outside of normal margin-lending programs and violating suitability requirements. Matthew Nestor, director of the Massachusetts Securities Division, said there could be more than $100 million in transfers between customer accounts.
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Day-Trading Assault
Massachusetts has filed several complaints about various practices at "day trading" companies over the past nine months. Here are the complaints filed and their status.
October 1998: Block Trading Inc.; Settled; Block now in bankruptcy.
November 1998: Bright Trading Inc.; Settled; Bright paid $30,000 in fines.
December 1998: All-Tech Investment Group Inc.; Settled; All-Tech paid a $50,000 fine and $228,000 to reimburse customers.
January 1999: On-Line Investment Services Inc.; Settled; On-Line and a branch manager paid $20,000 in fines.
March 1999: TCI Corp.; Securities division's cease and desist order with regard to an investment program continues; matter referred to state attorney general.
July 1999: Landmark Securities Corp. Filed Thursday.
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The administrative complaint filed with the Massachusetts Division of Securities seeks to revoke the Massachusetts registration of Landmark and of Scott Kurland, the manager of the firm's Boston office. Landmark and Mr. Kurland face a $10,000 fine for each alleged violation, Mr. Nestor said.
The complaint is the sixth filed against day-trading firms by regulators in Massachusetts, which has been the most active state in going after what it considers to be questionable practices at day-trading shops. The firms cater to investors who tend to make rapid-fire trades to capture tiny price differentials in stocks.
The lending practices of day-trading firms have come under increasing scrutiny from federal and state regulators who are concerned that loans made from customers or from people associated with the trading firms to other customers may allow some day traders to continue trading when they no longer have enough capital. Regulators are also concerned that individual borrowers and lenders may not understand the risks of these loans.
These lending practices may allow firms "to keep accounts alive to generate commissions," Mr. Nestor said. Federal regulators, including Securities and Exchange Commission Chairman Arthur Levitt, have spoken out against the dangers of individuals trying to mimic the rapid-fire electronic trading of professionals.
As an example of these lending practices, Massachusetts regulators alleged Landmark allowed one customer to open a day-trading account even though he "had an annualized income of $15,000, a net worth of $10,000 to $15,000, and no prior investing experience," according to the complaint. Also according to the complaint, Mr. Kurland misrepresented the customer's financial position, indicating on the new-account form that the customer had income of $25,000 and a net worth of $50,000.
Nearly $2.7 million from other customers was transferred into this customer's account between August 1998 and May 1999, the complaint alleged. Mr. Nestor said he believes the money was used to meet margin calls -- which occur when customers have insufficient funds in their accounts to meet lending requirements -- and to fund the customer's trading. Mr. Nestor said the customer, a 1998 college graduate who previously worked part-time as a bartender, has told regulators he lost money last year.
Mr. Nestor said he didn't know how much money has been lost by customers in Landmark's Boston office, but added that he has evidence that the majority of Landmark customers did lose money.
Mr. Nestor also said the illegal transfers between customer accounts could total tens of millions of dollars and possibly more than $100 million. The loans typically carried "usurious" interest rates of 0.1% overnight or 36.5% on an annualized basis, the complaint said.
In a statement, Landmark said it was "cooperating fully" with the state's investigation. "Our Boston office houses successful customers, none of which have made any complaints about our operations and practices to regulators. We have ensured that all of our customers are aware of the risks associated with day trading," the statement said.
Mr. Kurland's attorney, Michael Unger, said Massachusetts regulators may have been overzealous in their case against his client. "There were many procedures in place in the office which were totally legal, but what you take away from the complaint makes it sound like there's all sorts of money moving around in a surreptitious fashion," he said.
Mr. Unger declined to respond to specific allegations, but said the loans Mr. Kurland allegedly facilitated were "as best as I can tell ... up-front transactions known by the participants and approved by the participants." Mr. Unger added, "there's never been a single customer complaint against Mr. Kurland," who he said is 24 years old. Mr. Kurland intends to fight the charges at least for now, Mr. Unger said.
Landmark's Web site says investors can participate in day trading either as "a trader ... who makes the trading decisions and executes his own trades for profit" or as "an investor" who funds a trader's account, "either as a loan to the trader, or as equity, with a percentage of the trading profits."
The Web site also says "there is no license or experience required to become a day trader." It adds that "Landmark Securities has no account minimum" for investors who wish to trade there, "although $50,000 is strongly recommended." According to the site, "the majority of Landmark Securities customers make their living by day trading."
Investors generally can borrow as much as 50% of the value of the stocks they own, under margin requirements set by the Federal Reserve Board. Separate rules, known as "maintenance requirements," determine how much debt an investor may hold once the purchase is complete. If stock prices fall below prescribed levels, an investor may have to deposit additional cash or securities in the account or the broker could sell securities in the account.
Brokerage firms are barred from lending money in excess of margin rules. But three years ago, the Federal Reserve Board amended its margin-lending rules in a way that permits firms to arrange loans from one customer to another or to find third parties who would lend to their customers.
According to the Massachusetts complaint, Mr. Kurland "promoted and orchestrated loans between Landmark's customers" in the Boston office so they could meet margin calls; forged and used photocopied customer signatures so that money could be transferred between accounts without customer knowledge; and accepted transfer forms that he should have known carried signatures forged by others. Loans were also made between Landmark customers in Boston and New York, the complaint said.
The complaint also alleged Mr. Kurland borrowed money from, lent money to and entered into profit-sharing agreements with customers in the Boston office through Equity Traders LLC, a firm he had an ownership interest in. Principals and employees of brokerage firms aren't supposed to make loans outside the margin program. Regulators also alleged that Equity Traders violated securities laws by unlawfully issuing unregistered securities to raise funds to fund the loans and profit-sharing arrangements.
William Gens, an attorney for Equity Traders, said that Mr. Kurland "has an equity interest" in the firm and that "there were lending arrangements." He said that "whether those are illegal or not is possibly going to be the subject of a judicial determination." Mr. Gens added that whether the promissory notes issued by the firm are securities "is a gray area."
In addition, according to the complaint, Landmark failed to supervise Mr. Kurland or to fire him after it found that he had failed to comply with suitability requirements and made misrepresentations to the firm's compliance office.
"We're very concerned that there seem to be some elements of the day-trading industry that are refusing to police themselves," Mr. Nestor said. He added that "the allegation that the firm knew about the problems and failed to correct them is extremely troubling."
Landmark has 14 branch offices, including one in New York City, Landmark president Jay Gillock said in an interview earlier this week. Mr. Gillock didn't return calls seeking comment Thursday.
Landmark's New York office, at 499 Park Ave. in Manhattan, is closely tied to another trading company, Tradescape.com, that last week received a $40 million infusion of cash from two big investors: Japan's Softbank Corp. and J.W. Childs Associates LP, a Boston private-equity firm.
Mr. Gillock said Tradescape, a company that mainly sells day-trading software to other brokerage firms, grew out of Landmark's New York office. Tradescape is also located at 499 Park Ave.
A Softbank spokesman and an official at J.W. Childs didn't return phone calls.
In a statement issued earlier this week in response to questions about ties between the two firms, Tradescape said it "has no ownership interest in Landmark Securities." But it added "an affiliated entity has a service contract with Landmark whereby the affiliated entity provides software and technical support to Landmark. In the New York branch office of Landmark, the affiliated entity also provides facilities and administrative personnel."
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