Day-Trading Faces Rivalry And Increasing Scrutiny
By REBECCA BUCKMAN and AARON LUCCHETTI
Staff Reporters of THE WALL STREET JOURNAL
October 8, 1998
Clouds are gathering over day-trading, a high-tech arm of the brokerage business that has boomed in recent years along with the bull market.
Day-trading firms, unlike online brokerage concerns such as E*Trade Group Inc., cater to individual investors who trade stocks full-time over sophisticated computer systems at the firms' offices, instead of from home computers. Customers make scores of rapid-fire transactions in a day in hopes of scalping profits from tiny price changes, and rarely hold positions overnight.
The renegade industry, which blossomed by using the Nasdaq Stock Market's automatic Small Order Execution System, or SOES, has been a pesky source of competition to established Nasdaq dealers. But now day-trading firms are scrambling to cope with competition from scores of new entrants, not to mention deep-discount Internet brokers or a stock market that has been going south for several weeks. In the past few weeks, three day-trading firms have suddenly gone under.
Regulators' Worry
At the same time, state securities regulators have stepped up their scrutiny of day-trading, worrying that smaller, fly-by-night firms are luring too many novice investors into the business and creating unrealistic profit expectations, sometimes with advertisements promising quick riches.
Part of a pitch for day-trading services
"This is an area where there seems to be an absolute vacuum of any regulatory oversight," says Philip A. Feigin, the Colorado securities commissioner who this month will become executive director of the North American Securities Administrators Association, an umbrella group for state regulators. But he stressed that so far, "the firms we've looked at have all been exceptions and not rules." Mr. Feigin heads a new task force set up this summer by Texas Securities Commissioner Denise Voigt Crawford to investigate day-trading issues after regulators received investor complaints. One concern is that firms may charge hefty upfront fees for training before investors find out they may not have the aptitude for the job.
Expensive Start
Officials of some top day-trading firms say such concerns don't apply to them. They claim scores of success stories, and say they turn away many more customers than they accept. "We don't put people through a cram course and then throw them to the wolves," says Luis Gonzalez, a principal at Cornerstone Securities Inc. in Austin, Texas. Cornerstone suggests investors have at least $100,000 to start trading, Mr. Gonzalez says, and eases clients into the business by allowing them to trade small share lots at first.
--------------------------------------------------------------------------------
The Big Names in Stock 'Day-Trading'
Some of the nation's largest and best-known day-trading outfits:
Firm Headquarters Outlook Size
All-Tech Inv. Group Montvale, N.J. Filed for an IPO 23 offices, about 1,300 customers
Cornerstone Sec. Austin, Texas Expanding 13 offices, about 400 customers
Broadway Trading LLC New York Expanding 3 offices, about 400 customers
Momentum Sec. Houston Expanding 9 offices, about 350 customers
On-Line Inv. Svcs. Jersey City, N.J. Expanding 13 offices, about 150 customers
Block Trading Houston Out of business At peak, 24 offices, about 500 customers
Source: the firms
--------------------------------------------------------------------------------
Cornerstone charges $2,500 for a souped-up computer, while All-Tech Investment Group Inc. of Montvale, N.J., offers 30 days of training for $5,000. In both cases, customers can recover the money through commission discounts, officials of these firms say.
Beyond the prospect of a regulatory crackdown, day-trading firms also face possible consolidation in the industry. Block Trading Inc. of Houston and Dina Securities of Wayne, N.J., both shut down in September. Insight Securities & Trading Inc. of Denver is no longer functioning as a broker-dealer, with its five offices now operating under the Cornerstone name.
Possible Problems
"I compare a lot of it to the Blockbuster Video thing. All of the sudden, everyone was running to open one," says Harvey Houtkin, chairman and chief executive officer of All-Tech, a day-trading firm founded in 1988. He says brokers such as Block and Dina may have cut commissions too steeply, accepted customers who didn't have enough capital or expanded too fast. A Block official says the firm couldn't offer customers the latest trading technology, so clients fled to other firms.
Mr. Houtkin says day-trading remains robust, even though the percentage of Nasdaq trades executed through SOES has dropped to just over 4% from about 7% at the start of last year, when new Nasdaq trading rules went into effect. The rules cut the "spreads" for Nasdaq stocks, or the difference between the prices at which dealers will buy or sell them.
Despite the recent market downturn, which poses a clear threat to many traders' profits, Mr. Houtkin says the day-trading business remains so healthy that his firm is still planning an initial public offering.
Questioning by Regulators
But increasingly, securities regulators are questioning just how healthy the business is for the average investor. Ms. Crawford, the Texas regulator, says she has heard radio spots touting day-trading as "a way to make a lot of money in a short time. The problem is, day-trading is something investors of modest means should not be engaging in." Financial publications are full of ads for day-trading firms, training and tips, including one inviting newcomers to "$Get Rich$ Day Trading."
Many day-traders, some of them ex-stockbrokers, easily adapt to the fast-paced, almost arcade-like environment of SOES shops. But others are less savvy. Fred and Alicia Sharp of Marshall, Texas, who had never before invested in the stock market, have filed an arbitration complaint with the National Association of Securities Dealers against Block Trading for allegedly persuading their 25-year-old daughter that day-trading was a safe way to invest half their savings.
The daughter, an inexperienced investor, lost nearly $50,000 of her parents' money in just a few months trading at Block, according to the Sharps' lawyer, William Shepherd of Houston. In the complaint, the Sharps allege that their money was invested "in a highly leveraged manner and incredibly churned, on margin, through millions of dollars in transactions, with tens of thousands of dollars in commissions and fees charged to their accounts." Block declines to comment.
Trouble in Texas
The Sharps' complaint raises another thorny issue: Whether investors who aren't licensed as brokers or investment advisers should be allowed to trade using others' money. One Texas firm, Exchange House Inc., shut down last year after regulators alleged that traders there acted as unregistered dealers and agents for more than 20 wealthy Colombian clients.
Still, the state securities commission never alleged any fraud, notes Jim Parker, the Austin attorney who represented the firm in its settlement with the state.
"I don't think there are any clear delineations on when day-traders cross the line from customer to sales agent," says John Ramsay, deputy general counsel of the NASD's regulatory arm, which oversees most day-trading firms. "But at some point, if a person is trading for other people and providing advice," questions come up.
While traders could be working on behalf of "innocent customers," they also could be trading for former brokers barred from the industry on disciplinary grounds, adds Mr. Feigin, the Colorado regulator.
Most day-trading firms in Texas, including Cornerstone, don't allow people to trade funds for outside parties, citing their state's strict stance against the practice. But in other states, regulations are more murky. New Jersey Securities Commissioner Franklin Widmann says only that his state is looking into third-party day-trading, a practice that occurs at firms such as All-Tech and On-Line Investment Services Inc. of Jersey City, N.J.
All-Tech's Mr. Houtkin says he sees nothing wrong with a customer's trading money for one or two other people, particularly relatives. On-Line Investment's president and chief executive, Gregory Hold, says, "We avoid and do not wish for a customer trader to secretly act as a broker behind our back."
Andrew Lias, an All-Tech trader from Harriman, N.Y., who used to manage a Harley Davidson dealership, says he spent a few months in the mid-1990s trading a $200,000 account entrusted to him by a Chicago heart surgeon, whom Mr. Lias met at a day-trading training session. The surgeon, Mohan Rao, wanted to play the market himself but didn't trust his own abilities, according to Mr. Lias.
Mr. Lias took the money because he felt Dr. Rao was a "suitable" customer, or one with enough money not to miss it if things went wrong. Mr. Lias made about $10,000 for his client before Dr. Rao closed the account a few months later.
|
