SEC, NASD Probe Electronic Trading Focus Is on Day-Trades, Online Brokers
By Ianthe Jeanne Dugan
Washington Post Staff Writer
Saturday, May 1, 1999; Page E01
The Securities and Exchange Commission and the National Association of Securities Dealers have begun a major probe of day-trading firms and online brokerage houses, often parking teams of investigators inside firms for weeks at a time. The project, according to several firms visited by regulators, appears designed to gauge the effect of electronic trading on the markets, shape new regulations and search for violations of existing ones.
More than 10 day-trading firms, which host people who hop in and out of stocks all day long, have been visited by examiners in recent weeks, along with major online brokerages, including E-Trade Group Inc. and Charles Schwab Corp., Wall Street officials said. The auditors typically arrive on short notice in teams of at least two people and then remain in the office for weeks as they sift through mounds of documents, observe trades and monitor World Wide Web sites and advertising.
"I don't know of a single day-trading firm or online brokerage that has not been visited recently by regulators," said James Lee, president of the Electronic Traders Association, a trade group. Two auditors from the NASD, which regulates its members, spent three weeks at the Houston headquarters of Lee's firm, Momentum Securities Inc., through mid-April, examining thousands of electronic trades and account-opening procedures, Lee said.
Two more representatives were stationed at Southwest Securities in Dallas, which serves as a back-office operation for many day-trading firms, holding clients' funds and clearing transactions. A source said the regulators asked Southwest for files on all of its customers' accounts.
The SEC and NASD declined to comment on the scope or purpose of the project, but an SEC spokesman confirmed it is underway.
"The SEC has been reviewing the policies and practices of day-trading and online trading firms for compliance with securities laws," the spokesman said. "Some of these include execution issues," he said, referring to how quickly firms process orders, "as well as disclosure of risk to customers."
Sources said the SEC's market regulation and enforcement divisions are working together on the probe. Regulators also are examining whether firms have made bogus claims on their Web sites and have violated limits on making loans for securities trades to customers, sources said.
One of the earliest examinations was on a snowy morning in late February, when two SEC officials arrived at the Montvale, N.J., offices of All-Tech Investment Group Inc., which is among the biggest day-trading firms.
This came as an unpleasant surprise to All-Tech's founder, Harvey Houtkin, a veteran dubbed "the father of day-trading" by some investors who followed him into the industry after reading a book he wrote on profiting on differences between the purchase and sale prices of stocks in the Nasdaq Stock Market. "My hemorrhoids were tingling," Houtkin recalled of the regulators' arrival. Still, he gave the man and woman cups of coffee and a cluttered office next to his corner one.
The examiners, occasionally joined by a third colleague, stayed five weeks, according to Houtkin's records. They pored over documents tracking the headquarters and 25 other offices Houtkin has throughout the country. They watched 80 people trade stocks on-site and gleaned information on how thousands of All-Tech customers were borrowing money to trade, what stocks they were trading and transfers between accounts, Houtkin said. "They asked for a million different papers," he said.
The joint project has taken regulators from small shops to large public companies. Examiners have told the firms that they are trying to understand how the burgeoning electronic offshoot of Wall Street operates and how it affects the markets. When completed in coming months, the audits are expected to help guide new regulations on a variety of practices, including advertising and lending.
Many firms fear the audits also will result in headline-grabbing charges of securities-law violations. "Everybody's looking around wondering who's going to be on the front page," Houtkin said. "I hear they're about to launch a major attack on the industry. They're looking for anything -- from not dotting an 'i' to administering loans."
The day-trading industry has been under intense fire as it has grown rapidly because of new technology and securities rules. With dozens of firms throughout the country, it accounts for 15 percent of Nasdaq's volume. Including people trading stocks at home, online trading accounts for about a quarter of all Nasdaq's volume.
In recent months, regulators from several states have charged fraud and false advertising practices at some day-trading firms. Lee said he hopes the probe will restore credibility to the industry. "If there are problems out there and they weed out the bad apples, maybe it will do the industry some good," he said. "And the more they know about the industry as they shape new regulation for a new era, the better."
Among issues being debated are new rules for "suitability," one of the most fundamental tenets of the securities industry. Firms are supposed to know their customers, the risks customers are willing to take and their financial strength.
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