S. Hrg. 106–505

DAY TRADING: EVERYONE GAMBLES BUT THE

HOUSE

HEARINGS

BEFORE THE

PERMANENT

SUBCOMMITTEE ON INVESTIGATIONS

OF THE

COMMITTEE ON

GOVERNMENTAL AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

FEBRUARY 24 AND 25, 2000

Printed for the use of the Committee on Governmental Affairs

(

ADING: EVERYONE GAMBLES BUT THE HOUSE

U.S. GOVERNMENT PRINTING OFFICE

64–133 cc WASHINGTON : 2000

S. Hrg. 106–505

DAY TRADING: EVERYONE GAMBLES BUT THE

HOUSE

HEARINGS

BEFORE THE

PERMANENT

SUBCOMMITTEE ON INVESTIGATIONS

OF THE

COMMITTEE ON

GOVERNMENTAL AFFAIRS

UNITED STATES SENATE

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

FEBRUARY 24 AND 25, 2000

Printed for the use of the Committee on Governmental Affairs

(

For sale by the Superintendent of Documents, Congressional Sales Office

U.S. Government Printing Office, Washington, DC 20402

(II)

COMMITTEE ON GOVERNMENTAL AFFAIRS

FRED THOMPSON, Tennessee, Chairman

WILLIAM V. ROTH, Jr., Delaware

TED STEVENS, Alaska

SUSAN M. COLLINS, Maine

GEORGE V. VOINOVICH, Ohio

PETE V. DOMENICI, New Mexico

THAD COCHRAN, Mississippi

ARLEN SPECTER, Pennsylvania

JUDD GREGG, New Hampshire

JOSEPH I. LIEBERMAN, Connecticut

CARL LEVIN, Michigan

DANIEL K. AKAKA, Hawaii

RICHARD J. DURBIN, Illinois

ROBERT G. TORRICELLI, New Jersey

MAX CLELAND, Georgia

JOHN EDWARDS, North Carolina

HANNAH S. SISTARE, Staff Director and Counsel

JOYCE A. RECHTSCHAFFEN, Minority Staff Director and Counsel

DARLA D. CASSELL, Administrative Clerk

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

SUSAN M. COLLINS, Maine, Chairman

WILLIAM V. ROTH, JR., Delaware

TED STEVENS, Alaska

GEORGE V. VOINOVICH, Ohio

PETE V. DOMENICI, New Mexico

THAD COCHRAN, Mississippi

ARLEN SPECTER, Pennsylvania

CARL LEVIN, Michigan

DANIEL K. AKAKA, Hawaii

RICHARD J. DURBIN, Illinois

MAX CLELAND, Georgia

JOHN EDWARDS, North Carolina

K. LEE BLALACK, II, Chief Counsel and Staff Director

LINDA J. GUSTITUS, Minority Chief Counsel and Staff Director

MARY D. ROBERTSON, Chief Clerk

(III)

C O N T E N T S

Opening statements: Page

Senator Collins ................................................................................................. 1, 67

Senator Levin .................................................................................................... 4, 68

Senator Durbin ................................................................................................. 10

Prepared statement:

Senator Akaka .................................................................................................. 121

WITNESSES

THURSDAY, FEBRUARY 24, 2000

Deborah M. Field, Counsel, Permanent Subcommittee on Investigations, on

detail from the Securities and Exchange Commission ...................................... 6

Alyce Wenzel, Mother of Scott Webb, former day trader who was shot by

Mark Barton in the Atlanta Office of Momentum Securities, Huntley, Illinois ........................................................................................................................ 12

Steve Buchwalter, Attorney for Amy Le, former customer of Providential

Securities, Encino, California .............................................................................. 14

Carmen Margala, former customer of All-Tech Direct, Oceanside, California ... 17

Sandra Harlacher, former customer of All-Tech Direct, Solana Beach, California ..................................................................................................................... 18

Justin Hoehn, Branch Manager, Momentum Securities, Atlanta, Georgia ........ 32

Fred Zayas, former Branch Manager, All-Tech Direct, Watertown, Massachusetts ....................................................................................................................... 32

Barry Parish, former Branch Manager, All-Tech Direct, San Diego, California 32

Huan Van Cao, day trader at Providential Securities, Fountain Valley, California ..................................................................................................................... 33

FRIDAY, FEBRUARY 25, 2000

Lori A. Richards, Director, Office of Compliance, Inspections and Examinations, Securities and Exchange Commission, Washington, DC ........................ 70

Barry R. Goldsmith, Executive Vice President, Enforcement, NASD Regulation, Inc., Washington, DC .................................................................................. 72

Deborah R. Bortner, Director, Securities Division, Washington State Department of Financial Institutions, Olympia, Washington ...................................... 75

Harvey I. Houtkin, Chief Executive Officer, All-Tech Direct, Montvale, New

Jersey .................................................................................................................... 91

Henry D. Fahman, President and Chief Executive Officer, Providential Securities, Fountain Valley, California ...................................................................... 94

James H. Lee, President, Momentum Securities, Houston, Texas ...................... 96

ALPHABETICAL LIST OF WITNESSES

Bortner, Deborah R.:

Testimony .......................................................................................................... 75

Prepared statement .......................................................................................... 206

Buchwalter, Steve:

Testimony .......................................................................................................... 14

Prepared statement .......................................................................................... 128

Cao, Huan Van:

Testimony .......................................................................................................... 33

Fahman, Henry D.:

Testimony .......................................................................................................... 94

Page

IV

Field, Deborah M.:

Testimony .......................................................................................................... 6

Prepared statement .......................................................................................... 122

Goldsmith, Barry R.:

Testimony .......................................................................................................... 72

Prepared statement .......................................................................................... 179

Harlacher Sandra:

Testimony .......................................................................................................... 18

Prepared statement .......................................................................................... 133

Hoehn, Justin:

Testimony .......................................................................................................... 32

Houtkin, Harvey I.:

Testimony .......................................................................................................... 91

Lee, James H.:

Testimony .......................................................................................................... 96

Prepared statement with attachments ........................................................... 212

Margala, Carmen:

Testimony .......................................................................................................... 17

Prepared statement .......................................................................................... 131

Parish, Barry:

Testimony .......................................................................................................... 32

Prepared statement with attachments ........................................................... 135

Richards, Lori A.:

Testimony .......................................................................................................... 70

Prepared statement with an attachment ....................................................... 174

Wenzel, Alyce:

Testimony .......................................................................................................... 12

Prepared statement .......................................................................................... 126

Zayas, Fred:

Testimony .......................................................................................................... 32

EXHIBITS

Page

* May Be Found In The Files of the Subcommittee

1. Advertisements of On-Site Trading, Inc. ........................................................ 242

2. Letter from Frank van der Lugt, Medipoint Data Systems, to K. Lee

Blalack, II, Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations, and Linda J. Gustitus, Minority Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations,

September 17, 1999 .......................................................................................... 244

3. Letter from Louis Russo, Taking Profits Publishing, to the Permanent

Subcommittee on Investigations staff, September 20, 1999 .......................... 247

4. Letter from Richard Kane, Coastal Technologies Group, to K. Lee Blalack,

II, Chief Counsel and Staff Director for the Permanent Subcommittee

on Investigations, September 9, 1999 ............................................................. 248

5. Letter from Kathy K. Cregan, CFO, 1800RETIREMNOW.com, Inc., to

Eileen Fisher, Investigator for the Permanent Subcommittee on Investigations, November 10, 1999 .......................................................................... 249

6. ‘‘Copies of Trades Made During the Live Course,’’ Precision Management

Group, Inc. ......................................................................................................... 251

7. Letter from Brian Zavodnik, WinningDayTraders, to K. Lee Blalack, II,

Chief Counsel and Staff Director for the Permanent Subcommittee on

Investigations, undated .................................................................................... 262

8. Letter from Ralph S. Janvey, Counsel for RML Trading, Inc., to K.

Lee Blalack, II, Chief Counsel and Staff Director for the Permanent

Subcommittee on Investigations, and Linda J. Gustitus, Minority Chief

Counsel and Staff Director for the Permanent Subcommittee on Investigations, September 29, 1999 ................................................................................ 267

9. NASAA Press Release, ‘‘ ‘Day trading’ craze should give investors pause,

state securities regulators warn,’’ November 25, 1998 .................................. 270

10. Arthur Levitt, Jr., U.S. Securities and Exchange Commission Chairman,

‘‘Plain Talk About On-Line Investing,’’ speech to the National Press Club,

May 4, 1999 ....................................................................................................... 272

Page

V

11. Syllabus, ‘‘Professional Traders Group, Training Seminar,’’ January 4,

1999–January 29, 1999 .................................................................................... 278

12. Insider Trading Inc., Training Manual, ‘‘Teachdaq School of Stock Market

Training: Day Trading 301,’’ at Review Trading Rules [selected pages

reprinted in hearing record—full exhibit retained in the files of the Subcommittee] ......................................................................................................... 280

13. On-Site Trading, Inc., ‘‘Introduction To Trading’’ Training Manual [selected pages reprinted in hearing record—full exhibit retained in the

files of the Subcommittee] ................................................................................ 283

14. Training Manual, ‘‘Trading Psychology,’’ The Stockcam Institute, Inc. [selected pages reprinted in hearing record—full exhibit retained in the

files of the Subcommittee] ................................................................................ 291

15. All-Tech’s Boca Raton ‘‘Branch Office Survey,’’ June 22–24, 1997 ............... 296

16. All-Tech’s Seattle ‘‘Branch Office Survey,’’ June 5, 1997 .............................. 302

17. All-Tech’s Chicago ‘‘Branch Office Survey,’’ June 4, 1997 ............................. 308

18. Letter from Susan H. Tregub, Counsel for Hahna Global Securities, to

Wesley M. Phillips, Investigator for the Permanent Subcommittee on

Investigations, December 3, 1999 .................................................................... 314

19. Letter from Laurence Briggs, Chief Executive Officer, InvestIn.com Securities Corp., to K. Lee Blalack, II, Chief Counsel and Staff Director

for the Permanent Subcommittee on Investigations, and Linda J.

Gustitus, Minority Chief Counsel and Staff Director for the Permanent

Subcommittee on Investigations, November 18, 1999 ................................... 327

20. Tradescape’s ‘‘Trader Performance Analysis,’’ January-June 1999 .............. 338

21. ‘‘Trader Statistics,’’ www.broadwaytrading.com ............................................ 340

22. SEALED EXHIBIT: Broadway Trading, Inc., Profitability Data for 1998 .. *

23. Securities Division, Washington State Department of Financial Institutions, Report to the United States Senate Permanent Subcommittee on

Investigations: ‘‘Day Trading Practices in Washington State, SeptemberNovember 1999,’’ February 10, 2000 ............................................................... 365

24. Letter from David Laurent, Chief Operating Officer, Andover Brokerage,

LLC, to K. Lee Blalack, II, Chief Counsel and Staff Director for the

Permanent Subcommittee on Investigations, November 15, 1999 ............... 395

25. Generic letter from Harvey Houtkin, undated ............................................... 397

26. Letter from Stephanie Rosenblatt, Esq., Counsel for All-Tech, to K. Lee

Blalack, II, Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations, and Linda J. Gustitus, Minority Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations,

November 12, 1999 ........................................................................................... 398

27. Letter from Stephanie Rosenblatt, Esq., Counsel for All-Tech, to K. Lee

Blalack, II, Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations, and Linda J. Gustitus, Minority Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations,

January 20, 2000 .............................................................................................. 414

28. All Tech Investment Group Corporate Organization Chart, August 16,

1999 .................................................................................................................... 416

29. Harvey I. Houtkin, CRD No. 251066 .............................................................. 417

30. Mark D. Shefts, CRD No. 709147 ................................................................... 444

31. In re: All-Tech Investment Group, Inc. and Mark Sheets [sic], 1990 N.J.

Sec. LEXIS 171, (No Number in Original), June 25, 1990 ............................ 496

32. In re: Domestic Securities, Incorporated, 1989 N.J. Sec. LEXIS 404, (No

Number in Original), April 25, 1989 ............................................................... 498

33. In re: Domestic Securities, Incorporate and Harvey I. Houtkin, 1990 N.J.

Sec. LEXIS 170, OAL Docket No. BOS 03957–89, June 26, 1990 ................ 516

34. Re: Approval of the pending application for registration of All-Tech, 1993

Fla. Sec. LEXIS 49, Admin. No. 93.471.DOS, December 7, 1993 ................. 518

35. All-Tech Investment Group, Inc.’s Branch Office Manual, ‘‘Branch Procedures’’ [selected pages reprinted in hearing record—full exhibit retained

in the files of the Subcommittee] ..................................................................... 522

36. Fred A. Zayas, CRD No. 2816153 .................................................................... 542

Page

VI

37. Experienced Customer Letter of Understanding for Carmen Margala,

September 10, 1998 .......................................................................................... 544

38. Customer Letter of Understanding for Yusef Liberzon, October 12, 1998 .. 545

39. a. SEALED EXHIBIT: New Account Approval-B for Carmen Margala,

September 11, 1998 ..................................................................................... *

b. REDACTED: New Account Approval-B for Carmen Margala, September 11, 1998 ........................................................................................... 546

40. All-Tech ‘‘Frequently Asked Questions,’’ undated .......................................... 547

41. All-Tech ‘‘Experienced Trader Qualification,’’ undated ................................. 552

42. a. SEALED EXHIBIT: New Account Approval-B for Georgia Sweet

Bovee, July 13, 1998 .................................................................................... *

b. REDACTED: New Account Approval-B for Georgia Sweet Bovee, July

13, 1998 ........................................................................................................ 553

43. a. SEALED EXHIBIT: New Account Approval-B Form for Yusef

Liberzon, October 12, 1998 ......................................................................... *

b. REDACTED: New Account Approval-B Form for Yusef Liberzon, October 12, 1998 ................................................................................................. 554

44. Marilyn Sherman, ‘‘Funds Transfer Authorization,’’ June-August 1999 ..... 555

45. E-mail messages from Angus Beal to Georgia Bovee, et al. ......................... 567

46. E-mail message from Stephanie Rosenblatt, Counsel for All-Tech, to

Deborah Field, Counsel for the Permanent Subcommittee on Investigations, January 18, 2000 .................................................................................... 586

47. All-Tech training material entitled ‘‘Reasons to Initiate a Trade’’ ............... 587

48. Harvey I. Houtkin and David Waldman, Secrets of the SOES Bandit

(1999) ................................................................................................................. *

49. Rushmore Financial Services, Inc.—‘‘Disclosure Statement’’ ........................ 588

50. All-Tech Training Group, Inc.—‘‘Disclosure Statement’’ ............................... 589

51. Account Decline Letter from Mark Shefts to Sandra Harlacher [sic], November 28, 1997 ................................................................................................ 590

52. All-Tech Training Group, Inc. Manual, ‘‘Welcome to All-Tech Training

Group’’ ................................................................................................................ 591

53. San Diego ‘‘Branch Office Survey,’’ August 4, 1997 ....................................... 592

54. All-Tech document entitled ‘‘Supervision,’’ August 23, 1999 ........................ 597

55. a. Commonwealth of Massachusetts, Securities Division, ‘‘Administrative

Complaint,’’ Docket No. R–98–77, December 10, 1998 ............................. 601

b. Commonwealth of Massachusetts, Securities Division, ‘‘Amendment

to Administrative Complaint,’’ Docket No. R–98–77, May 3, 1999 ......... 633

56. Commonwealth of Massachusetts, Securities Division, ‘‘Stipulated Order,’’

Docket No. R–98–77, May 3, 1999 (for Respondents All-Tech, Messrs.

Shefts, Houtkin and Lefkowitz) ....................................................................... 636

57. Commonwealth of Massachusetts, Securities Division, ‘‘Stipulated Order,’’

Docket No. R–98–77, May 19, 1999 (for Respondents Messrs. Zayas,

Belbel and Powell) ............................................................................................ 638

58. a. In re All-Tech, Docket No. R–98–77, ‘‘Offer of Settlement,’’ May 3,

1999 ............................................................................................................... 640

b. In re All-Tech, Docket No. R–98–77, ‘‘Offer of Settlement,’’ May 10,

1999 .............................................................................................................. 644

59. Letter from Stephanie Rosenblatt, Counsel for All-Tech, to Debra Fields,

Esq. [sic], Counsel to the Permanent Subcommittee on Investigations,

January 4, 2000 ................................................................................................ 645

60. Letter from Stephanie Rosenblatt, Counsel to All-Tech, to Deborah Field,

Esq., Counsel to the Permanent Subcommittee on Investigations, January

18, 2000 ............................................................................................................. 647

61. Internal Memorandum from Franklin I. Ogele, Chief Compliance Officer

for All-Tech, to Steven Plotnick, Branch Office Manager, re: Detroit

Branch Audit, May 6, 1999 .............................................................................. 649

62. Internal Memorandum from Franklin I. Ogele, Chief Compliance Officer

for All-Tech, to Fabian Norwood and Frederick Vetter, re: Falls Church,

VA Branch Audit, June 28, 1999 ..................................................................... 654

Page

VII

63. Internal Memorandum from Franklin I. Ogele, Chief Compliance Officer

for All-Tech, to David Niedekrome (BOM) and Michael Benson, Branch

Office Manager, re: Seattle Branch Audit, July 27, 1999 ............................. 659

64. Frederick M. Benson, CRD No. 2876856, ‘‘Employment History’’ ................ 666

65. Typed notes, September 22, 1998, produced by Georgia Bovee .................... 674

66. Boston ‘‘Branch Office Survey Results,’’ June 18, 1997 ................................. 675

67. Internal Memorandum from Franklin I. Ogele, Chief Compliance Officer

for All-Tech, to David Thompson, Branch Manager for Dallas, Texas

Branch File, re: Dallas Branch Audit, June 25, 1999 ................................... 685

68. Letter from Providential Securities, Inc. to Wesley Phillips, Investigator

for the Permanent Subcommittee on Investigations, undated ...................... 689

69. Letter from Henry D. Fahman, CEO, Providential Securities, Inc. to

Wesley M. Phillips, Investigator for the Permanent Subcommittee on

Investigations, December 3, 1999 .................................................................... 690

70. Henry D. Fahman, CDR No. 1952649 ............................................................. 692

71. Letter from NASD Regulation, Inc., NASD Arbitration No. 98–03309,

August 11, 1999 ................................................................................................ 697

72. Kwang Ho Kim (also known as Keith Kim), CRD 1752502 .......................... 707

73. ‘‘Customer Acknowledgment of Risk,’’ Providential Securities, Inc. ............. 709

74. Amy Le, ‘‘Acknowledgment of Liability,’’ Hahna Global Securities, June

6, 1998 ............................................................................................................... 713

75. Providential Securities advertisement ............................................................ 714

76. Letter from Stephen P. Harbeck, General Counsel, Securities Investor

Protection Corporation (SIPC), to Wesley M. Phillips, Investigator for

the Permanent Subcommittee on Investigations, November 30, 1999 ......... 715

77. Holly C. Clark, Written Complaint to Oregon’s Division of Finance and

Corporate Securities, August 26, 1999 ............................................................ 716

78. Providential Securities, Inc., General Supervisory Procedures and Compliance Manual, October 1998 [selected pages reprinted in hearing record—

full exhibit retained in the files of the Subcommittee] .................................. 722

79. a. SEALED EXHIBIT: New Account Approval-B for Kiem Van Dao, July

26, 1999 ........................................................................................................ *

b. REDACTED: New Account Approval-B for Kiem Van Dao, July 26,

1999 .............................................................................................................. 723

80. a. SEALED EXHIBIT: New Account Approval-B for Hon V. Bui and

Huong H. Ly, April 6, 1999 ......................................................................... *

b. REDACTED: New Account Approval-B for Hon V. Bui and Huong

H. Ly, April 6, 1999 .................................................................................... 724

81. a. SEALED EXHIBIT: New Account Approval-B for Bedar Samee, February 1, 1999 ................................................................................................ *

b. REDACTED: New Account Approval-B for Bedar Samee, February

1, 1999 .......................................................................................................... 725

82. a. SEALED EXHIBIT: New Account Approval-B for Clara B. and Daryl

Larry Grabowski, April 13, 1999 ................................................................ *

b. REDACTED: New Account Approval-B for Clara B. and Daryl Larry

Grabowski, April 13, 1999 .......................................................................... 726

83. a. SEALED EXHIBIT: New Account Approval-B for Shao-Shin Liu, undated ............................................................................................................. *

b. REDACTED: New Account Approval-B for Shao-Shin Liu, undated ..... 727

84. Independent Contractor Agreement between Hahna Global Capital Management, Inc. and Huan Van Cao, May 1998 ................................................ 728

85. Letter from Susan H. Tregub, Attorney for Tae Goo Moon, to Eugene

Horwitz, Special Investigator for NASD Regulation, September 29, 1999 .. 729

86. Letter from Huan Van Cao, Senior Vice President of Hahna Global Capital Management, Inc. to Brenda Richardson, March 20, 1998 .................... 749

87. a. SEALED EXHIBIT: New Account Approval-B for Amy Le, undated ..... *

b. REDACTED: New Account Approval-B for Amy Le, undated ................ 750

88. Amy Le’s Loan Authorization to Lori Assunto, Margin Department,

Penson Financial Services, July 6, 1998 ......................................................... 751

Page

VIII

89. Huan Van Cao bankruptcy filing in the United States Bankruptcy Court,

October 22, 1999, Case number: 99–40177 ..................................................... 752

90. Letter from Henry D. Fahman, President of Providential Securities, Inc.,

to Wesley M. Phillips, Investigator for the Permanent Subcommittee on

Investigations, undated .................................................................................... 791

91. a. SEALED EXHIBIT: New Account Approval-B for Holly C. Clark, April

26, 1999 ........................................................................................................ *

b. REDACTED: New Account Approval-B for Holly C. Clark, April 26,

1999 .............................................................................................................. 792

92. Providential Securities, Inc.’s Customer Acknowledgment of Risk for

Holly C. Clark, April 13, 1999 ......................................................................... 793

93. Letter from Robert S. Bennett, Counsel, Momentum Securities, Inc., to

K. Lee Blalack, II, Chief Counsel and Staff Director for the Permanent

Subcommittee on Investigations, January 20, 2000 ...................................... 798

94. Momentum’s Current Organizational and Ownership Structure Chart,

undated .............................................................................................................. 801

95. Letter from James H. Lee, Principal for Momentum Securities, Inc., to

Robert Garza, NASD Regulation, Inc., District 6, June 21, 1999 ................. 802

96. Resume of Scott A. Webb, undated ................................................................. 805

97. Letter from Scott Webb to Alyce Wenzel, April 1998 .................................... 806

98. a. SEALED EXHIBIT: New Account Approval-B for Scott Allyn Webb,

July 28, 1998 ................................................................................................ *

b. REDACTED: New Account Approval-B for Scott Allyn Webb, July

28, 1998 ........................................................................................................ 807

99. a. SEALED EXHIBIT: New Account Approval-B for Spyderstorm Capital,

LLC, July 29, 1998 ...................................................................................... *

b. REDACTED: New Account Approval-B for Spyderstorm Capital, LLC,

July 29, 1998 ............................................................................................... 808

100. Account Guarantee Agreement between Scott Allyn Webb and

Spyderstorm Capital, LLC, July 29, 1998 .................................................... 809

101. Promissory Note between Gerald Simpson and Scott Webb, July 29,

1998 .................................................................................................................. 811

102. Syllabus for Professional Traders Group Training Seminar, January 4,

1999 to January 29, 1999 ............................................................................... 815

103. Momentum Securities, Inc. Branch Examination, Atlanta, Georgia, September 15–17, 1998 ........................................................................................ 822

104. Momentum Securities, Inc. Branch Examination Charts, Atlanta Georgia, March 5, 1999 .......................................................................................... 832

105. Letter from Saul S. Cohen, Counsel for Momentum Securities, Inc.,

to Glynna C. Parde, Esq., Chief Investigator and Senior Counsel for

the Permanent Subcommittee on Investigations, November 17, 1999 ....... 835

106. Momentum Journal Authorizations into the Claypool Account .................. *

107. Letter from Scott H. Maestri, NASD Regulation Examiner, to William

Cathriner, Vice President, Momentum Securities, Inc., August 10, 1999 . 840

108. Letter from William Cathriner, Chief Compliance Officer, Momentum

Securities, Inc., to Scott H. Maestri, NASD Regulation Compliance Examiner, August 23, 1999 ................................................................................ 845

109. Momentum Securities, Inc. ‘‘Brokerage Operations Manual,’’ July 1999 .. *

110. ‘‘Written Supervisory Procedures for Momentum Securities, Inc.,’’ March

31, 1998 ........................................................................................................... *

111. a. SEALED EXHIBIT: New Account Approval-B for Benchmark Trading

Fund, Ltd., April 14, 1998 ......................................................................... *

b. REDACTED: New Account Approval-B for Benchmark Trading Fund,

Ltd., April 14, 1998 ................................................................................... 850

112. a. SEALED EXHIBIT: New Account Approval-B for Henry M. Castro,

September 29, 1998 ................................................................................... *

b. REDACTED: New Account Approval-B for Henry M. Castro, September 29, 1998 ......................................................................................... 851

113. a. SEALED EXHIBIT: New Account Approval-B for Amit Berstein, September 29, 1998 ......................................................................................... *

Page

IX

b. REDACTED: New Account Approval-B for Amit Berstein, September

29, 1998 ...................................................................................................... 852

114. a. SEALED EXHIBIT: New Account Approval-B for Lunker Investments Corporation, December 2, 1998 ..................................................... *

b. REDACTED: New Account Approval-B for Lunker Investments Corporation, December 2, 1998 ...................................................................... 853

115. a. SEALED EXHIBIT: New Account Approval-B for Flora Siman, July

7, 1998 ........................................................................................................ *

b. REDACTED: New Account Approval-B for Flora Siman, July 7, 1998 854

116. Letter from Lily A. Camet, Counsel for Momentum Securities, Inc.,

to Brian C. Jones, Investigator for the Permanent Subcommittee on

Investigations, December 20, 1999 ................................................................ 855

117. a. SEALED EXHIBIT: New Account Approval-B for Hung C. Chan,

January 21, 1999 ....................................................................................... *

b. REDACTED: New Account Approval-B for Hung C. Chan, January

21, 1999 ...................................................................................................... 858

118. a. SEALED EXHIBIT: New Account Approval-B for Minder Singh, November 6, 1998 ........................................................................................... *

b. REDACTED: New Account Approval-B for Minder Singh, November

6, 1998 ........................................................................................................ 859

119. a. SEALED EXHIBIT: New Account Approval-B for Larry L. Hartman,

October 19, 1998 ........................................................................................ *

b. REDACTED: New Account Approval-B for Larry L. Hartman, October 19, 1998 ............................................................................................... 860

120. a. SEALED EXHIBIT: New Account Approval-B for Michael St. John

Dinsmore, March 13, 1997 ........................................................................ *

b. REDACTED: New Account Approval-B for Michael St. John

Dinsmore, March 13, 1997 ....................................................................... 861

121. a. SEALED EXHIBIT: Momentum Securities, Inc., New Account Paperwork Check List for Charles R. Lande, Jr., July 19, 1999 ..................... *

b. REDACTED: Momentum Securities, Inc., New Account Paperwork

Check List for Charles R. Lande, Jr., July 19, 1999 .............................. 862

122. a. SEALED EXHIBIT: Momentum Securities, Inc., New Account Paperwork Check List for Manfred Pojar, July 1, 1999 ................................... *

b. REDACTED: Momentum Securities, Inc., New Account Paperwork

Check List for Manfred Pojar, July 1, 1999 ............................................ 891

123. Momentum Securities, Inc., ‘‘Preliminary Results,’’ February 1999 [selected pages reprinted in hearing record—full exhibit retained in the

files of the Subcommittee] .............................................................................. 921

124. Declaration of James William Lauderback, Vice President of Momentum

Securities, Inc., January 12, 2000 ................................................................. 934

125. Momentum Securities, Inc., ‘‘SEC Commentary ‘Day Trading: Your Dollars at Risk,’ ’’ New Account Paperwork ....................................................... 935

126. Letter from James H. Lee, President, Electronic Traders Association

(ETA), to Jonathan Katz, Secretary, United States Securities and Exchange Commission (SEC), October 11, 1999 ............................................... 937

127. Notice of Filing of Amendment No. 1 to the Proposed Rule Change

by the National Association of Securities Dealers, Inc. Relating to Opening of Day-Trading Accounts,’’ File No. SR–NASD–99–41 .......................... 941

128. Notice of Filing of Proposed Rule Change To Amend NYSE Rule 431

(‘‘Margin Requirements’’), File No. SR–NYSE–99–47 ................................. 952

129. ‘‘Proposed Rule Change by National Association of Securities Dealers,

Inc.,’’ File No. SR–NASD–00–03, cover letter .............................................. 958

130. Letter from Joan C. Waller, Counsel for Cornerstone, to Joseph M.

Gonzales III, Investigator for the Texas State Securities Board, October

26, 1999 ........................................................................................................... *

131. Letter from Joan C. Waller, Counsel for Cornerstone Securities, Corp.,

to K. Lee Blalack, II, Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations, November 15, 1999 ........................ 989

Page

X

132. NASD Regulation, Inc. arbitration claims for Sandra Harlacher, Carmen

Margala, et al. (1999) ..................................................................................... 1005

133. SEALED EXHIBIT: All-Tech Branch Office Agreements ........................... *

134. Written Supervisory Procedures for Summit Trading, Inc., last amended

(March 19, 1999) ............................................................................................. *

135. Training Manual, ‘‘The Fundamentals of Successful Day Trading,’’ Cornerstone Securities Corporation, 1999 .......................................................... *

136. Momentum Securities, Inc., ‘‘House Systems and Trading Rules Acknowledgment,’’ July 27, 1998 ....................................................................... 1066

137. Letter from Robert S. Bennett, Counsel for Momentum Securities, Inc.,

to K. Lee Blalack, II, Chief Counsel and Staff Director for the Permanent Subcommittee on Investigations, February 18, 2000 .......................... 1067

138. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Huan Van Cao, December 28, 1999 ................................................... *

139. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Lisa Esposito, November 29, 1999 ..................................................... *

140. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Henry D. Fahman, December 15, 1999 ............................................. *

141. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Harvey Houtkin, December 7, 1999 .................................................. *

142. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of James H. Lee, December 22, 1999 .................................................... *

143. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Barry Scott Parish, November 30, 1999 ........................................... *

144. SEALED EXHIBIT: Permanent Subcommittee on Investigation Deposition of Fred A. Zayas, December 16, 1999 .................................................... *

145. Memoranda prepared by K. Lee Blalack, II, Chief Counsel and Staff

Director for the Permanent Subcommittee on Investigations, dated February 22, 2000, to Permanent Subcommittee on Investigations’ Membership Liaisons, regarding February 24 and 25, 2000 Day Trading Hearings ................................................................................................................... 1073

146. U.S. General Accounting Office Report, Securities Operations: Day Trading Requires Continued Oversight, GAO/GGD–00–61, February 2000 ...... 1100

147. Report of Examinations Of Day-Trading Broker-Dealers, Office of Compliance Inspections and Examinations, United States Securities and Exchange Commission, February 25, 2000 ....................................................... 1140

148. The Lazy DayTrader home page, www.lazytrader.com. .............................. 1186

149. Terra Nova New Account Form ..................................................................... 1187

150. ‘‘Case Study Witnesses,’’ chart prepared by the Permanent Subcommittee on Investigations .......................................................................... 1188

151. ‘‘The Importance of Risk Capital,’’ excerpt from Harvey I. Houtkin’s

book, Secrets of the SOES Bandit ................................................................. 1189

152. ‘‘Providential Day Trading Customer Account Forms That Fail to Include Required Financial Information on Income and/or Net Worth’’

chart prepared by the Permanent Subcommittee on Investigations .......... 1190

153. ‘‘Scott Webb Frequently Borrowed Funds From Momentum Customer

Gerald Simpson to Cover Margin Loans, chart prepared by the Permanent Subcommittee on Investigations ........................................................... 1191

154. Letter from Sandra H. Harlacher to the Permanent Subcommittee on

Investigations, March 1, 2000, regarding her February 24, 2000 Subcommittee testimony ...................................................................................... 1192

155. Letter from Lori A. Richards, Director, Office of Compliance Inspections

and Examinations, United States Securities and Exchange Commission

to Senators Collins and Levin, March 21, 2000, regarding margins loans

and letters of authorization ........................................................................... 1193

156. Letter from James H. Lee, Momentum Securities, Inc., to Senator Carl

Levin, March 6, 2000, regarding views on the profitability of Momentum

customers and reaction to the State of Washington profitability study .... 1195

(1)

DAY TRADING: EVERYONE GAMBLES BUT THE

HOUSE

THURSDAY, FEBRUARY 24, 2000

U.S. SENATE, PERMANENT SUBCOMMITTEE ON INVESTIGATIONS, OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, Washington, DC.

The Subcommittee met, pursuant to notice, at 9:30 a.m., in room

SD–342, Dirksen Senate Office Building, Hon. Susan Collins,

Chairman of the Subcommittee, presiding.

Present: Senators Collins, Levin, and Durbin.

Staff Present: K. Lee Blalack, II, Chief Counsel and Staff Director; Mary D. Robertson, Chief Clerk; Deborah Field, Counsel,

Detailee/SEC; Brian C. Jones, Investigator; Wesley Phillips,

Detailee/GAO; Eileen M. Fisher, Investigator; Elizabeth Hays, Executive Assistant; Linda J. Gustitus, Minority Chief Counsel and

Staff Director; Bob Roach, Counsel to the Minority; Felicia Knight

and Steve Abbott (Senator Collins); Anthony Pitago (Senator Specter); Anne Bradford (Senator Thompson); Nanci Langley and Glenn

Sauer (Senator Akaka); Marianne Upton, Darla Silva, and Jadie

O’Dell (Senator Durbin).

OPENING STATEMENT OF SENATOR COLLINS

Senator COLLINS. Good morning. The Subcommittee will come to

order.

Today, the Permanent Subcommittee on Investigations continues

its examination of day trading. Last fall, the Subcommittee began

its investigation with an overview hearing. After several months of

investigation, we will now draw back the curtain and provide an

in-depth look at the practices of three day-trading firms representative of the industry.

Day trading involves taking positions in stocks for very short periods of time, usually minutes or hours, but rarely longer than a

day. Day traders seek small increments of profits from moment-tomoment fluctuations in the price of a stock. The firms that cater

to day traders provide their customers with high-speed computer

access and real-time market quotes, both of which are necessary to

take advantage of small changes in stock prices.

Over the course of 8 months, the Subcommittee has investigated

15 day-trading firms which reported a total of about 12,700 day

trading accounts. While a day trader could open more than one account, the Subcommittee’s review indicates that the number of day

traders is significantly higher than most of the earlier estimates.

For example, at our hearing last fall, we heard testimony that

2

1See Exhibit No. 13 which appears in the Appendix on page 283.

there were about 5,000 day traders at approximately 60 firms. Our

analysis suggests that the number is at least double that.

Commission income, which is normally generated on a per trade

basis, is the primary source of revenue for most day-trading firms.

The day-trading firms we investigated charged an average commission of $16 per trade. In the aggregate, those firms estimated that

the average customer executes about 29 trades each day. Consequently, the average day trader must generate a minimum trading profit of over $450 each and every day simply to break even.

On an annualized basis, assuming 20 trading days per month, that

means the average day trader must generate a trading profit of

more than $111,000 to achieve profitability for the year.

As the testimony today will show, most day traders are not

breaking even. In fact, they are losing money, big money. The consumers who will testify before us today, for example, lost tens of

thousands of dollars.

The same cannot be said, however, for the day trading industry.

It seems to be doing quite well. The 15 firms that we examined reported aggregate gross revenues of over $491 million in 1999 and

aggregate profits of about $144 million. The Subcommittee found

that the industry is growing by leaps and bounds. Indeed, the revenues of day-trading firms that we analyzed grew by a whopping

276 percent from 1997 to 1999.

Everyone, even the industry, appears to agree that day trading

is highly speculative and extremely risky. Both the Chairman of

the SEC and the President of NASAA, that is the State Securities

Regulators Association, went so far as to call day trading gambling

during the Subcommittee’s hearing last fall. The Electronic Traders

Association, the trade organization for the industry, objects strongly to that analogy, contending that day trading requires skill, stateof-the-art technology, and hard work.

That may be true, but many day traders seem comfortable with

the comparison to gambling. The president of 1 day-trading firm

was quoted in the press as saying that day trading is like blackjack. Documents obtained by the Subcommittee also indicate that

some firms consider day trading to be essentially gambling.

I would draw everyone’s attention to the exhibit we have posted.1

This is a listing of trading tips from a day-trading firm called Insider Trading. You will note that Insider Trading cautions its customers not to get greedy. It states, ‘‘When you reach your goal, stop

and quit trading. Try not to be greedy and still trade. Remember

you are gambling and most likely will lose what you have made.’’

I believe that day trading can be fairly compared to certain types

of gambling. For inexperienced traders, it is little more than a

game of chance. I reached this conclusion based primarily on data

showing that only a small percentage of day traders ever make

money. Our investigation indicates that the small percentage of

day traders who are successful generally start with large amounts

of risk capital and substantial experience.

The best evidence that we have suggests that a significant majority of all day traders, more than 75 percent, lose money, and for

3

1See Exhibit No. 148 which appears in the Appendix on page 1186.

the novice under-capitalized trader, there is almost no chance of

success.

A document produced to the Subcommittee by the firm All-Tech

Direct sums up my concern about the profitability of day trading.

When the branch manager for All-Tech’s Seattle office was asked

to comment on the progress of his 51 customers, he wrote, ‘‘Overall,

good. We need to have a couple of people making money.’’ In fact,

when interviewed by the Subcommittee staff, the branch manager

estimated that only 10 percent of his Seattle customers were profitable. Even more striking, the branch manager of the Los Angeles

office of another day-trading firm, Providential Securities, stated

that none—none—of his office’s day-trading clients ever made

money. In fact, he estimated that the average customer lost approximately $50,000.

Because of the poor success rate of most day traders, one might

wonder how is it that the industry has grown? After all, why would

people give up good secure jobs or put their savings at risk to pursue a day-trading career when their chances of making money were

very small? The reason, of course, is that most people who lost

money, including the customers that we will hear from today, simply did not fully appreciate the risk.

While some day-trading firms give their consumers very good

risk disclaimers, on the whole, the industry has failed to disclose

adequately just how risky this speculative activity is. Many daytrading firms improved their written risk disclosures only after regulatory and Congressional scrutiny increased the last year, and as

today’s testimony will show, written risk disclosures are often contradicted by oral statements that minimize the risk through promises of big profits or cannot lose systems.

Even when the written risk disclosures are provided, they are

often undermined by deceptive advertising or other hype. As an example of this, I would refer to Exhibit No. 148.1 In this instance,

this is the Web site for Lazy Day Trader. It entices potential customers with an unbalanced and exaggerated testimonial which

says, ‘‘This is the only business I know of where there is absolutely

no limit ever as to how much I can earn. I am doubling my money

every 3 months buying and selling stocks. I have developed a simple method to determine what to buy and sell, how much, and

when to buy and sell, which everyone can follow. You can start

with as little as $2,500 and still make money.’’ It goes on to say,

‘‘You do not even have to understand economics, the stock market,

or international finance.’’

In other words, what this Web site is holding out is the promise

that with very little capital and no understanding of the markets,

the average person can get rich by following Lazy Day Traders’

cannot lose system. If only it were that easy.

What is most disturbing about these types of misleading claims

is that they often appeal to the very people who have limited investment experience. Press reports have noted that day trading attracts many young people because it is computer intensive, fast

paced, and offers the tantalizing prospect of quick riches.

4

The customers of Landmark Securities are a good example. The

Subcommittee staff conducted an analysis of Landmark Securities’

new account forms and found that 42 percent of the firm’s customers were 26 years old or younger and that their disclosed median income and net worth of these young traders was only

$30,000.

These data really highlight the most troubling finding of our investigation. Most day-trading firms have accepted customers whose

stated financial condition or investment objectives are inconsistent

with the firm’s own internal policies governing the opening of new

accounts. They are simply not suitable for day trading.

We will hear testimony today from several former day traders

whose disclosed financial conditions were well below the minimum

requirements of their respective firms. Ironically, however, these

firms must be commended for having any minimum requirements

at all. Twenty percent of the firms we examined maintained no

minimum financial requirements to open a day trading account. In

light of this evidence, it probably should not be surprising that so

many day traders eventually fail.

Let me conclude my opening statement by reaffirming that I

have no intention of proposing a ban on day trading. If an investor

who has adequate capital is fully informed of the risks of day trading and still elects to pursue this speculative strategy, then so be

it. But if day-trading firms fail to disclose the risk and entice unsophisticated investors with misleading ads or exaggerated claims of

profitability, regulators and the industry must put a stop to it.

Consumers who choose to day trade must be warned that they

could easily lose their entire investment.

It is now my pleasure to recognize my distinguished colleague

and the Ranking Minority Member of the Subcommittee, Senator

Carl Levin.

OPENING STATEMENT OF SENATOR LEVIN

Senator LEVIN. Thank you, Madam Chairman. First, let me commend you and your staff on the extraordinarily fine work that you

have done in preparing us for these hearings. You have been able

to sift through the hype that surrounds day trading and to get to

the real-life consequences of this latest ‘‘get rich quick’’ fad. For

many, as the work of you and your staff has revealed, the real

story of day trading is too often large losses and broken promises.

In our world of instant everything, from cellular communications

to microwave cooking to E-mail and hot mail, and under the influence of a rising stock market, it is not surprising that many people

are attracted to instant stock trading, as well. Buying into a company one minute, getting out of that the next. Day trading is clearly a phenomenon of our times.

Though considered a product of the investment world, day trading does not involve investing. Where a normal investor might execute 10 trades a year, a day trader typically might execute 100

trades a day. Day trading has absolutely no connection to the value

of the companies whose stock is being traded. As the SEC Chairman, Arthur Levitt, described it, day trading is more like gambling

than investing.

5

It is argued that day trading utilizes advances in computer technology to provide average Americans with access to securities markets that had previously been available only to professional traders, thereby bringing Wall Street, it is argued, closer to Main

Street. While that may have an element of truth, day trading also

has serious problems with unscrupulous hustlers who use day trading to promote ‘‘get rich quick’’ schemes to untrained consumers.

Given the size of the stakes at risk, tens of thousands of dollars,

losses can mount pretty quickly. The PSI staff, our Subcommittee

staff, has learned that when there are losses, the hustlers are there

to facilitate loans of more money at usurious rates to clients trying

to recover their stake. The longstanding rules that were developed

to protect investors simply fail to address some of the new practices

in the field of day trading.

The hearings that we are holding here will help us understand

what might be done to provide effective standards of consumer protection and to protect the integrity of our markets. Last year, I

asked the GAO to conduct a study of the day trading industry. Its

analysis included a review of the examinations of 67 day-trading

firms and their branches which had been conducted by the SEC

and the regulatory arm of the National Association of Securities

Dealers, NASD Regulation, Inc., and an in-depth exam of seven of

the largest day-trading firms. Those seven firms account for 80 percent of all day traders and 80 percent of all day trading volume.

Today, we are releasing the results of the GAO’s work and it affirms the work of the Subcommittee staff.

Because of the lack of data, GAO stated that it was unable to

verify the extent of profitability in the industry, nor was it able to

assess the impact of day trading on the volatility of the market.

GAO reported that day-trading firms admitted that most consumers will lose money initially, but the firms, they said, also contended that a majority of traders who traded more than 6 months

made money.

This claim directly contradicts the most extensive study on profitability, which was conducted by the Washington State Department of Financial Institutions. In that study, Washington State

looked at every account for the life of the account in five of the

seven day-trading firms in that State, and it reviewed a sample of

accounts in the other 2 day-trading firms. The Washington study

concluded that 77 percent of the traders were unprofitable, and

that for the 23 percent that were profitable, it concluded that the

profits were small compared to the size of the other losses.

The Subcommittee investigation has looked behind the claims of

day-trading companies and found how some day-trading firms skirt

the rules, use loopholes, and take advantage of their customers in

the pursuit of profits. We will hear how employees of some daytrading firms traded on behalf of clients, although not licensed to

do so, forged customers’ signatures and made unauthorized transfers of customer funds, opened accounts for customers when their

assets did not meet the firm’s own minimum requirements, and established fictitious accounts for customers so that they could continue to trade after their original accounts were closed due to insufficient assets.

6

1The prepared statement of Ms. Field appears in the Appendix on page 122.

We will hear how the top executives of some day-trading firms

employed exaggerated and deceptive ads touting the profitability

and suitability of day trading, hired unqualified individuals to run

branch offices and provided them with very little training, ran inadequate, and at times, virtually nonexistent compliance programs,

and are reducing minimum customer asset requirements to levels

lower than what they concede are necessary to have a reasonable

chance of success in day trading.

Again, I want to commend our Chairman for her determined

leadership in this area, and I commend the Subcommittee staff,

particularly the Majority staff that has done the heavy lifting in

this investigation, for their very professional, thorough, and revealing work.

The evidence and testimony presented over the next 2 days will

underscore the fact that day trading may work for some, but it is

a dangerous game for the average consumer. The stakes for the

consumer are high, again, tens of thousands of dollars. The promoters of day trading profit whether their clients win or lose, and

in some cases, they even stack the deck. Just like in Las Vegas,

in the world of day trading, the only guaranteed winner is the

house. Thank you.

Senator COLLINS. Thank you, Senator Levin.

I am pleased to welcome our first witness this morning, Deborah

M. Field. Ms. Field is a counsel to the Subcommittee and has been

on detail to the Subcommittee from the Securities and Exchange

Commission since September of last year. Ms. Field will provide an

overview of the Subcommittee’s 8-month investigation of the day

trading industry.

Pursuant to Rule 6, all witnesses who testify before the Subcommittee are required to be sworn, so I would ask that you stand

and raise your right hand. Do you swear the testimony you are

about to give will be the truth, the whole truth, and nothing but

the truth, so help you, God?

Ms. FIELD. I do.

Senator COLLINS. Thank you. Please proceed.

TESTIMONY OF DEBORAH M. FIELD,1 COUNSEL, PERMANENT

SUBCOMMITTEE ON INVESTIGATIONS, ON DETAIL FROM

THE SECURITIES AND EXCHANGE COMMISSION

Ms. FIELD. Thank you, Chairman Collins, Senator Levin, and

Members of the Subcommittee. My name is Deborah Field and I

am counsel to the Permanent Subcommittee on Investigations. I

am currently on detail to the Subcommittee from the Securities

and Exchange Commission. I have been a member of the SEC’s Division of Enforcement for about 2 years. Prior to joining the SEC,

I was an attorney with the law firm Wilmer, Cutler, and Pickering,

where I worked in the firm’s securities enforcement and litigation

practice. As counsel to the Subcommittee, I have been intimately

involved with the staff’s investigation of the day trading industry.

Today, I am presenting a brief overview of that investigation.

The Subcommittee staff conducted this investigation by casting a

wide net. We examined the largest day-trading firms and some

7

1See Exhibit No. 78 which appears in the Appendix on page 722.

2See Exhibit No. 83b. which appears in the Appendix on page 727.

that were very small. The Subcommittee sent detailed and comprehensive document requests to 19 day-trading firms. In response,

those firms produced approximately 50,000 pages of documents and

at least 10 videotapes containing advertisements.

In addition to reviewing all of these materials, Subcommittee

staff interviewed or deposed over 100 people. These witnesses included chief executive officers and other employees of day-trading

firms, former and current day traders, gambling experts, academics, and authors. We also spoke with State and Federal securities regulators and representatives of self-regulatory organizations.

Based on the evidence gathered by the Subcommittee, we narrowed our focus to three day-trading firms, All-Tech Direct, Providential Securities, and Momentum Securities. The staff conducted

a detailed examination of these three firms.

While some of our findings pertain to potentially illegal conduct,

such as forgery and unauthorized trading, perhaps the most disturbing evidence gathered by Subcommittee staff relates to business practices that are, under the current regulatory framework,

entirely legal. Perhaps the single most important finding of this investigation was that many firms allow and even encourage unsuitable customers to day trade. Contrary to their own internal policies, many firms have routinely failed to gather the information

about their prospective customers that is necessary to determine

whether those customers are suitable for day trading. Frequently,

customers end up losing tens of thousands of dollars, losses that

they cannot sustain.

I would like to direct your attention to Exhibit No. 78.1 This is

a page from the compliance manual of Providential Securities. As

you can see, Providential advises its employees that, ‘‘Living in

such a litigious society, brokers need to take special care in gathering complete and accurate financial information about their customers. You must take the time with your clients to assess their

situation on a regular basis and make recommendations based on

your fact-finding mission. Suitability is the key to client recommendation.’’

However, I would like to now direct your attention to this next

exhibit, Exhibit No. 83,2 which shows that Providential frequently

disregarded its own compliance manual. This new account form

contains virtually no information about the prospective day trader.

Providential did not document the customer’s employer, credit references, or tax status, and even though Providential supposedly requires its day traders to disclose a minimum income of $50,000 and

a minimum net worth of $200,000, it opened this new account

without documenting this customer’s net worth or income. And,

Providential had an initial deposit requirement, yet no initial deposit amount is written on this form. It is hard to imagine what

basis the firm had for determining that this customer was suitable

for day trading.

Even when day-trading firms have gathered the pertinent information, many have accepted customers whose disclosed financial

condition did not meet their own criteria for opening day trading

8

1See Exhibit No. 149 which appears in the Appendix on page 1187.

accounts. For example, firms have opened day trading accounts

based on new account forms indicating that customers’ investment

objectives were income or long-term growth, two objectives commonly understood to be at odds with a high-risk day-trading strategy. In fact, we reviewed over 300 All-Tech new account forms that

contained objectives that were inconsistent with day trading.

We have also uncovered evidence that some day-trading firms altered new account forms to make their customers appear more

suitable for day trading. I would like to now direct your attention

to Exhibit No. 149.1 This is a new account form produced to the

Subcommittee by Terra Nova Trading. As you can see from this

form, this customer initially indicated that his income and net

worth were $24,000 and $15,000, respectively. These figures were

then crossed out and someone wrote $30,000 in each category. As

you may have guessed, Terra Nova’s minimum financial requirement for day traders is $30,000 of income and $30,000 of net

worth.

The Subcommittee staff asked Terra Nova about the changes to

this account form as well as four others. Terra Nova informed the

Subcommittee that its employees made these changes, but contended that they were made ‘‘with the knowledge and consent of

the customer based on information received from the customer.’’

However, we found 50 Terra Nova new account forms that were

similarly altered. It is hard to believe that 50 customers first provided the firm with incorrect financial information and then later

informed the firm that their net worth and income were actually

$30,000 or more.

Some day-trading firms who formerly maintained sound minimum financial requirements for opening new accounts have lowered their standards. They have done so to compete with other daytrading firms who have weak minimum requirements or no standards at all. These firms are now accepting customers whom they

previously considered unsuitable for day trading. These firms readily admit that they are doing so because they do not wish to lose

the commission revenue generated by those customers.

Not only do firms accept new customers that they know have

very little chance of success, they also allow, and even encourage,

those customers to trade beyond their means. For instance, the

Subcommittee staff found that many day-trading firms systematically arrange for customers who cannot satisfy margin calls to obtain from other customers short-term loans at high interest rates.

The firms then manage all of the administrative and clerical functions attendant to servicing those loans. As an example, we found

that Momentum Securities used one customer’s account to lend almost $10 million to 52 customers in a single month. These margin

loans often exceeded $100,000.

We also found that day traders end up paying exorbitant commission fees throughout the course of the trading day. Although

the fees per trade are not necessarily high, day traders may make

up to 50 or even 100 trades per day, thereby generating significant

fees. That means that day traders may spend much of their time

9

1See Exhibit No. 150 which appears in the Appendix on page 1188.

and capital just trying to break even before accruing one cent of

profit.

Another troubling finding of our investigation related to the quality of the management and supervision of day-trading firms. Some

day-trading firms have hired unqualified personnel to manage their

branch offices. For example, some firms have hired branch managers who have little or no prior experience in the securities industry and some who were not even licensed. They have also failed to

adequately train and supervise branch personnel after they were

hired. And, despite their claims to teach customers everything necessary for day trading, many day-trading firms have provided their

customers with poor training, training that gives customers a false

sense of security about day trading and their likelihood of success.

For that training, customers paid thousands of dollars, and in fact,

most day traders end up losing money.

The testimony over the next 2 days will focus primarily on the

case study firms All-Tech, Providential, and Momentum. I would

like to now direct your attention to Exhibit No. 150.1 We have prepared this chart to help you understand the relationships between

the hearing witnesses and the case study firms.

Today, you will hear from former customers of these firms or

their representatives. They will be followed by former and current

branch managers of the firms, as well as one third-party trader.

The chief executive officers whose names appear on the second line

of the chart will each testify tomorrow morning. Harvey Houtkin

is the CEO of All-Tech, Henry Fahman is the CEO of Providential,

and James Lee is the President of Momentum.

In conclusion, the Subcommittee’s investigation uncovered many

disturbing, and in some cases illegal, practices by the day trading

industry. Chairman Collins, I would be pleased to answer any

questions that you and the Subcommittee Members might have.

Senator COLLINS. Thank you very much, Ms. Field. I want to

commend you for your excellent overview of the investigation and

also to thank you for the expertise that you have brought from your

position with the SEC’s Enforcement Division to the Subcommittee.

Your expertise in SEC and securities matters, and particularly on

the enforcement side, have greatly assisted the work of the Subcommittee.

I just want to ask you one question and it deals with an issue

that you touched on in your statement. You mentioned that while

day traders may not be paying that much per trade as a commission, that because they trade so frequently, they end up paying exorbitant commissions and that makes it very difficult for them to

turn an actual profit. It is one reason the losses are so great for

most day traders, is that a fair summary?

Ms. FIELD. Yes, Chairman Collins, that is a fair summary. They

make so many trades a day that when added up in the aggregate,

it often accounts for a tremendous portion of their losses.

Senator COLLINS. The Subcommittee’s estimate is that the day

traders, on average, at the firms that we surveyed would actually

have to make more than $111,000 a year just to pay commissions.

Have you discussed the issue of commissions with the regulators

10

and do you have some idea of whether the Subcommittee’s findings

are similar to the findings of the SEC and the State regulators?

Ms. FIELD. Yes, Chairman Collins, I have done that. I spoke with

the regulators and what I understand from my in-depth conversations with them is that our findings are actually quite conservative.

There is another study that is coming out that I think we will probably hear about later in this hearing which I think would show

that our estimates are quite conservative and that, in fact——

Senator COLLINS. You mean on the low side?

Ms. FIELD. Yes, exactly. When I say conservative, I mean being

on the low side, and that, in fact, it may be that the number could

be quite a bit higher, depending on an individual trader’s strategy.

Senator COLLINS. I bring up this issue because I believe that if

most day traders were told when they were opening an account

that they would have to clear more than $111,000 a year just to

pay the commissions before they earned a cent of profit for themselves, that many of those day traders, potential customers, would

decide not to engage in day trading. It would help them better understand how risky this business is and how high the commissions

are.

Ms. FIELD. I would certainly agree with that.

Senator COLLINS. Thank you, Ms. Field.

Ms. FIELD. Thank you.

Senator COLLINS. Thank you very much. Senator Levin.

Senator LEVIN. I just want to thank you for your work. It is extraordinarily helpful, professional, balanced, and thorough, and I

just am most appreciative and I know every Member of this Subcommittee has benefitted from it. Thank you.

Ms. FIELD. Thank you, Senator Levin.

Senator COLLINS. Senator Durbin, welcome. If you have any

opening statement you want to make at this time, feel free to do

so.

OPENING STATEMENT OF SENATOR DURBIN

Senator DURBIN. In the interest of getting to the witnesses, I

would like to just submit this for the record and thank you for your

work on this.

Senator COLLINS. Thank you, Senator.

[The prepared statement of Senator Durbin follows:]

PREPARED STATEMENT OF SENATOR DURBIN

I’d like to thank Senator Collins and Senator Levin for holding this hearing on

the rapidly growing practice of ‘‘day trading.’’ The electronic day-trading industry

has attracted thousands of individual investors who engage in the risky practice of

riding the stock market’s ups and downs, trying to squeeze out profits by rapidly

buying and selling shares.

The advent of the electronic communication networks and the Internet has dramatically changed the nature of the securities market and has made day trading

possible for people other than traditional brokers. Today’s market is more of a populist place—the masses on Main Street now have almost as much information as the

aristocrats who long ran Wall Street. Armed with instant information from the

Internet and CNBC, and enabled by rapid trading systems, people with very little

if no investment experience are becoming day traders.

The passion for trading by ordinary investors hasn’t just affected a few select

stocks, however. It has reshaped the entire market landscape. Since 1996, the size

of the average trade on the Nasdaq has dropped 50 percent, to just under 700

shares. What’s more, the old philosophy of buy and hold has gone out the window.

11

The average Nasdaq stock is now held for just 5 months down from 2 years a decade

ago. Meanwhile, trading volumes has surged—the month of January was the busiest

ever for both Nasdaq and the New York Stock Exchange. With an estimated 10 to

15 percent of Nasdaq trading volume attributable to day traders, their impact on

the markets will continue to grow.

Hand in hand with the frenetic pace of trading is increased volatility. While we

have all heard the countless stories about day traders who make it big, the other

side to that coin is others who lose everything. As Securities Exchange Commission

Chairman Arthur Levitt emphasized in his testimony before this Committee last

fall: Day trading is VERY RISKY.

Of the reported 287 day-trading firms nationwide, 29 are in my home State of Illinois. This figure does not include the number of firms that individuals may access

over the Internet. The Illinois Securities Department in the Secretary of State’s office is currently investigating several complaints filed against day-trading firms. A

chief concern of Illinois officials is that day traders receive very limited education

for what is a very sophisticated market, causing some traders to mortgage their

homes and sell other possessions to continue the practice.

I share the Committee’s concern in ensuring that people engaging in day trading

know what they are getting into. I welcome today’s opportunity to learn more about

the risks of day trading, its impact on the securities market and its effect on investor behavior.

Finally, I want to welcome Ms. Alyce Wenzel who is here today from Huntley, Illinois and will share the tragic story of her son, Scott Webb. Thank you.

Senator COLLINS. I would now like to welcome our second panel

of witnesses this morning. Each of these witnesses was formerly a

customer of either Momentum, Providential, or All-Tech day-trading firms, or they are here today on behalf of former customers of

the three day-trading firms that have been the focus of the Subcommittee’s investigation.

Our first witness is going to be Alyce Wenzel of Huntley, Illinois,

a constituent, I realized belatedly, of Senator Durbin. Ms. Wenzel’s

son, Scott Webb, was a day trader at Momentum’s office in Atlanta,

Georgia, for 1 year before he was tragically shot and killed last

summer. Ms. Wenzel will discuss how her son came to be a day

trader, his financial condition at the time, and his experiences day

trading at Momentum.

Our next witness will be Steve Buchwalter, who is an attorney

for Amy Le, a former customer of Providential in Los Angeles. Mr.

Buchwalter is testifying on behalf of Ms. Le, who unfortunately is

very ill and unable to come to Washington. Mr. Buchwalter will tell

us how Ms. Le was induced to open a day trading account by a

Providential day trader named Huan Van Cao and how Mr. Cao

fared when he day traded Ms. Le’s life savings.

Next, we will hear from Carmen Margala and Sandra Harlacher,

who are both former customers of All-Tech. They will discuss how

they were first attracted to day trading at All-Tech and their experiences trading at the San Diego branch office.

I want to thank you all for coming forward this morning and I

would ask that you all stand so that I can swear you in. Do you

swear that the testimony you are about to give to the Subcommittee will be the truth, the whole truth, and nothing but the

truth, so help you, God?

Ms. WENZEL. I do.

Mr. BUCHWALTER. I do.

Ms. MARGALA. I do.

Ms. HARLACHER. I do.

Senator COLLINS. Thank you. Before this panel begins, I just

want to thank you all again for testifying. I know that it is very

12

1The prepared statement of Ms. Wenzel appears in the Appendix on page 126.

difficult to come forward and publicly discuss your experiences day

trading. No one likes to admit that they have lost money. None of

us likes to admit that we have made mistakes or investment decisions that did not work out well, and I know that it is especially

hard to do this in a public setting. So I want to thank you very

much for being willing to come forward. Your testimony is so important to us and it is so important to other people who may be

considering day trading. I believe that by sharing your experiences,

you will save many other people the financial losses and the embarrassment and pain that you have experienced. So I want to just

personally express my appreciation to you and to commend you for

coming forward.

Ms. Wenzel, we are going to start with you. Again, I also want

to personally express to you my sorrow over the loss of your son,

and I know I speak for not only the Subcommittee Members but

everybody here in doing so. Would you please proceed.

TESTIMONY OF ALYCE WENZEL,1 MOTHER OF SCOTT WEBB,

FORMER DAY TRADER WHO WAS SHOT BY MARK BARTON IN

THE ATLANTA OFFICE OF MOMENTUM SECURITIES, HUNTLEY, ILLINOIS

Ms. WENZEL. Thank you, Senator Collins, Senator Levin, and

Members of the Subcommittee. My name is Alyce Wenzel and I appreciate the opportunity to share my story with all of you here

today. I do so on behalf of my son, Scott Webb.

As many of you know, Scott was a day trader at Momentum Securities in Atlanta, Georgia, who was senselessly murdered by

Mark Barton on July 29, 1999. The loss of my son continues to

haunt me today and it is still very difficult to talk about the incident and to reflect about him.

Particularly troubling, though, is what I have learned about the

world of day trading subsequent to his death. In fact, I wish I knew

as much back then about this practice as I do now because I would

have done everything within my power to keep Scott from getting

involved in day trading in the first place. My hope is that by communicating the story of my son today, others interested in day

trading might better understand the many risks and dangers associated with this industry.

To begin, my son was an extremely bright, enthusiastic, and a

very thoughtful person. He was also a very hard worker. Despite

this, he experienced a number of setbacks in the months leading

up to 1998. Among them, he lost the job that he loved at Enterprise Rent-a-Car, and then again, he was let go from Dean Witter

for not meeting required quotas as a broker. I recall being concerned about his confidence and spirit after these layoffs.

Shortly thereafter, though, he called me to say that he had found

a new way to make a living, day trading. I admit, at the time, I

knew little about day trading, but based on how optimistically

Scott described the practice, it sounded like a positive step for him.

My daughter corroborated his optimism about day trading when

she indicated that Scott told her, ‘‘I think I have finally found my

niche.’’

13

He informed us that he was going to relocate to Atlanta from St.

Louis with a friend and start day trading at a company called Momentum Securities. In preparation for this, he traveled to Tyler,

Texas, to be trained. While there, Momentum put Scott up in a lavish apartment, and as my daughter described, wined and dined

him. With that, he packed up and moved to Atlanta with expectation of being a successful day trader.

Not long after Scott arrived, Scott started having troubles. His

credit record was poor, a point illustrated by the fact that his father had to cosign for his car loan. He also had very little cash resources, so once again, he turned to his father, who loaned him

$30,000 for his day trading activities. In addition, Scott did not

have any other sources of income at the time, and this concerned

me. Despite all of these facts, Momentum allowed my son to open

a day trading account. After his death, I learned that Scott also

borrowed $30,000 from a Momentum customer from Tyler, Texas,

on the day he opened his account. Unbelievably, he did so at an

annual interest rate of 18 percent.

With the capital he was able to scrape together, Scott started

trading. Based on what he confided to me, my daughter, and his

girlfriend, my son lost money from the beginning. And in addition

to the obvious pressures that accompany financial strains, I noticed

a very real effect on Scott in general. His girlfriend described him

as depressed often about his financial situation. When I spoke with

him, he was not himself and he appeared to be under extreme pressure and stress. Right before his death, I called Scott to inquire if

he was going to attend his cousin’s wedding in California, and he

responded that his financial situation was such that he did not

know whether he had the money for a plane ticket for the event.

As I sit here today, I still cannot understand why my son was

allowed to trade at Momentum. He made decisions that never

should have been presented to him as an option for a person in his

financial situation. And I firmly believe that he was not adequately

prepared for the harsh realities of day trading. I also am surprised

that he was hired by Momentum to train other customers. Scott

had a gift for working with others, but given the fact that he had

not been successful as a day trader himself, it does not make sense

to me that Momentum would ask him to show people how to trade.

After his death, I was shocked to learn that Scott had tried day

trading before he moved to Atlanta and was not successful. All told,

he lost approximately $10,000 of borrowed money. Sadly enough,

Momentum officials knew this before he opened the account with

them, and yet they still allowed him to trade.

My son was not an appropriate person to be day trading based

on his financial situation and his background experience. For these

reasons, he should never have been at Momentum in the first

place. I hope my words provide comfort to all of those who lost family and friends on that awful July day. I also hope that by hearing

Scott’s story, people will take a closer look at day trading and realize the incredible risks inherent to this practice. By doing so, they

might avoid some of the insurmountable pressures my son experienced. Thank you very much for inviting me here.

Senator COLLINS. Ms. Wenzel, again, thank you so much for your

testimony.

14

1The prepared statement of Mr. Buchwalter appears in the Appendix on page 128.

Ms. WENZEL. You are welcome.

Senator COLLINS. I know this is extremely difficult for you, but

I think that you can take a lot of comfort that by coming forward,

you are sparing others the pain and the financial losses that your

son experienced. So I really appreciate your testimony.

Ms. WENZEL. Thank you, Chairman.

Senator COLLINS. Mr. Buchwalter.

TESTIMONY OF STEVE BUCHWALTER,1 ATTORNEY FOR AMY

LE, FORMER CUSTOMER OF PROVIDENTIAL SECURITIES,

ENCINO, CALIFORNIA

Mr. BUCHWALTER. My name is Steve Buchwalter. I am an attorney whose practice regularly entails representing investors against

brokerage firms and brokerage firms against investors. A client of

mine, Ms. Amy Le, was invited here today to tell you her stories

about her experiences with day trading. Unfortunately, Amy’s

health has prevented her from being here today and I have been

invited to tell you her story in her stead.

I recently read a Washington Post article entitled, ‘‘Day Trading’s

Showcase Victim,’’ and that article essentially asked, where were

the other victims? I have read the article, and I can tell you I have

spoken to many of the victims. I know other attorneys who have

spoken to many of the victims. And I believe Chairman Collins had

it right. Most people do not like people to know that they have lost

money. They feel stupid. They do not want to advertise that fact.

So it is a situation where most people simply do not come forward.

Day trading has been around for a while. In the older days, we

simply called it churning. It has become popular recently with most

of the investors making the decisions themselves, and it takes time

for these problems to work their way through the system, and I am

speaking of the legal system here. I can assure you, we are seeing

more and more problems coming to our office every month. I would

say, right now, approximately 10 percent of our cases contain at

least some element of day trading in them. Make no mistake about

it, a problem is out there and the problem does exist.

In general, the two biggest problems with day trading seem to

be the lack of disclosure of the risks of day trading to the customer

as well as the whole day-trading strategy and whether or not that

is suitable for the investor. Quite frankly, most investors do not

know the risks that they are going to be expected to put up with

when they open up an account. We have seen trading that is just

so unfathomable that we could not understand the risks, and we

have been doing this for years.

In Amy’s case, this was outright fraud. At the time she met her

broker, Huan Van Cao, she was working part-time for minimum

wage. She worked 1 day a week, made minimum wage, worked a

Sunday. She was also a full-time mother with very minimal experience when it comes to investing. This was her first brokerage account. Mr. Cao, who was a smooth-talking, well-dressed man,

walked into Amy’s store and after a brief conversation he gave her

his business card. The card identified him as senior vice president

of a brokerage firm. He told her he was also an attorney. Amy was

15

very impressed, a stockbroker and attorney. She asked him, why

would an attorney also want to be a stockbroker? His response was,

it is just so easy to make money day trading. Then he went ahead

and suggested that she open an account.

After several conversations going back and forth, she was invited

to the brokerage firm of Providential Securities, where Mr. Cao

worked. At first, she was very hesitant, and she even left very hesitant. After numerous phone calls from Mr. Cao, Amy did agree to

meet at the office. He had a big office, right next to the president’s.

After all, he was the executive vice president of the firm. He proceeded to get out his computer, a couple clicks, showing her how

much money there is to be made with just a click of the mouse.

Amy was very impressed, especially after he showed her some of

his other clients’ accounts. He went so far as to show her an account where he said there was a $1 million profit in it. She then

agreed to open up an account and she signed a document which allowed Mr. Cao to place trades in her account without her prior authorization.

Her initial deposit was only $10,000. When she wrote out her

check, her hands were trembling. Mr. Cao noticed that her hands

were trembling and told her not to worry. He went so far as to say

how fortunate she was to have someone like him trading for her.

She invested the remainder of her life savings, $26,000, after she

received glowing reports from Mr. Cao as to how much money she

was making. It was a lie. She was losing money.

At the time, Amy was driving around in an old beat-up car. Living in Southern California, she wanted to have a car with air conditioning. She was ecstatic when Mr. Cao asked her between a

Mercedes, BMW, and a Lexus, what kind of car do you like best?

She asked Mr. Cao, ‘‘Is my account doing that well?’’ He said yes.

He further told her that she should go out and start shopping now

because it takes a little bit of time to buy a car. Again, at that

time, she was really losing money.

Amy’s monthly statements appeared to show the account was losing money, as well. Mr. Cao told her that because of the turnover

in the account or the fact that because of day trading, by the time

you get your statements, most of the positions are probably closed

out anyway and that fact that the brokerage firm was miscalculating the value of her long positions, she was really making

money. And the fact that she was continuously making money was

consistently referred to her. All those statements were lies. The

truth was, over $36,000 invested, she had lost $22,000 in just 3

weeks. However, based on Mr. Cao’s assertions, she still thought

that she was making money.

While she was still believing that she was making money, she

made her last deposit. This last deposit was the life savings of

Amy’s mother. It was $12,000 and the money was earmarked to

renovate Amy’s grandparents’ or her mother’s parents’ burial plots

in Vietnam. Amy made this perfectly clear to Mr. Cao, and in fact,

he wrote a letter to her saying how he understands how important

this money is and reemphasizing how careful he is going to be.

That same letter also talked about his successes with other clients.

That was another lie.

16

Every time that Amy talked to Mr. Cao, she was falsely told that

she was making money. In her eyes, it was strange that these

statements that she was making money contradicted the monthly

statements that she was receiving every month. She became very

puzzled, very concerned, and she was doing whatever she thought

she could to try and find out whether or not Mr. Cao’s statements

were true. She would look through every document she ever got,

she would find names and she would call names. She would call

the names on the statement. She would call the names on the

faxes. She finally found someone that would talk to her. The person

that talked to her said, ‘‘You are losing money.’’

When she confronted Mr. Cao with this, she was told that the

person that she talked to was new. She had no idea what she was

talking about, but if Amy felt uncomfortable, he would go ahead

and buy out her account. She deposited $48,000. He offered to give

her $48,000. He even had a contract written out. It was signed by

both parties. Amy went to the offices of Providential in order to

turn over the contract and get her check. At that time, Mr. Cao

told her that he was not really going to go through with it. Amy

became very upset and she started crying. Apparently, Mr. Cao

took that as a personal affront. He saw that there was no more

money to be made from Ms. Le and threatened that if she did not

stop crying, he would lock down the building, call security to have

her escorted out, and ruin her credit.

Amy immediately left, went home, faxed Providential a letter

saying, liquidate my account and send me my money. They did do

that. When all was said and done, she lost in excess of $35,000,

which is almost completely her net worth or her life savings, in just

2 months. She also found out that Mr. Cao was not licensed as a

stockbroker, nor was he an attorney. He also told her that he had

the authority to investigate other firms on behalf of the NASD.

That was not true, either. It had all been a lie. Amy realized that

Mr. Cao was a predator and she was just his prey.

At that point, she contacted my office. We filed an arbitration

with the National Association of Securities Dealers Arbitration Department asking for her money back. Providential, strangely

enough, disavowed any knowledge of Cao’s activities. The NASD

awarded Amy all of her money back plus interest. The award was

split up between the various respondents, including Providential.

Amy did receive a partial payment of a little bit more than $13,000

when Mr. Cao filed for bankruptcy. She has not seen one penny of

the rest of her award.

Amy feels like she did everything right. She invested with a licensed stockbroker. She visited the brokerage firm. Her broker

guaranteed to make her whole when there were losses. When he

did not, we filed an arbitration. The arbitrators awarded her all of

her money back, plus interest. She still has not seen her money.

Amy, like other investors, had no idea what she was getting into,

no idea. Her $48,000 deposit bought almost $1 million in securities

in just 2 months. We have seen cases where an account with only

$100,000 in it bought over $200 million in securities in just 1

month—$200 million. That is a trade every 1.3 minutes. We have

seen investors’ losses so high where even the firm cannot make

good, the firm or the investor cannot make good on the losses. In

17

1The prepared statement of Ms. Margala appears in the Appendix on page 131.

that particular instance, the SEC stepped in and closed the firm

down. Somebody is paying for these people’s losses. Maybe it is the

brokerage firms. Maybe it is us as taxpayers. There is a problem

here and it will not go away without your assistance. Thank you.

Senator COLLINS. Thank you, Mr. Buchwalter. I hope you will

convey to Ms. Le our hope for her speedy recovery.

Mr. BUCHWALTER. Thank you.

Senator COLLINS. Thank you for your testimony. Ms. Margala.

TESTIMONY OF CARMEN MARGALA,1 FORMER CUSTOMER OF

ALL-TECH DIRECT, OCEANSIDE, CALIFORNIA.

Ms. MARGALA. Good morning. My name is Carmen Margala. I reside in Oceanside, just north of San Diego, California, and I am a

former client of All-Tech Investment Group. Prior to my experiences at All-Tech, I bought and sold some stocks, mostly on a longterm basis, but had never engaged in day trading of securities.

In approximately August 1998, I saw an All-Tech television commercial which made it appear quite easy to make money and

achieve financial independence as a day trader at All-Tech. The

commercial featured Barry Parish, the manager of All-Tech’s San

Diego office and the ad stated that I could start with as little as

$10,000.

At the time, I was not employed, I had no income, and I was

looking for a new profession, so I contacted Mr. Parish by telephone

and then met with him at the All-Tech office. Mr. Parish explained

that people make money by trading and scalping the difference between the bid and the ask price of a stock, and then demonstrated

this on a computer program. When I asked whether people were

making money doing this, he told me that they were.

Mr. Parish provided me with forms to open an account at AllTech, and when I returned with the forms, Mr. Parish told me that

I needed $20,000 to open the account. Neither Mr. Parish nor anyone else ever discussed risk or my tolerance for risk, my background, goals, or objectives, past experiences, my financial position,

or anything else other than how much money I could deposit in the

All-Tech account. Since I did not have much money or significant

net worth, I opened the account with $20,000. I paper traded my

account for 1 month and then began live trading so that I could

earn an income.

I experienced problems with the trading equipment that All-Tech

provided to us. For example, I repeatedly experienced inaccurate

quotes. At times, the quotes appeared to have been delayed as

much as 13 minutes. All-Tech set up a special computer line for

Mr. Parish which would at least provide him with accurate quotes,

but even these were sometimes behind the market. The inaccurate

quotes resulted in losses in my All-Tech account.

The trading software or system also allowed the purchase of any

amount of stock, regardless of what was in my account. Without

knowing it, I generated a number of margin calls, which Mr. Parish

then arranged for other clients to cover. Further, during much of

the time I was at All-Tech, the system could not even show me the

status or balances in my account. To encourage trading, the upVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
18

1The prepared statement of Ms. Harlacher appears in the Appendix on page 133.

graded computers were given to those persons that executed the

highest number of trades.

The atmosphere in the trading room at All-Tech was like a circus. Mr. Parish would sometimes play games, directing clients to

buy or sell. If there were losses, Mr. Parish would cover the losses.

If there were gains, they would end up as a credit for the benefit

of Mr. Parish.

Mr. Parish allowed one All-Tech client to trade other All-Tech clients’ accounts. A fellow All-Tech client told me that Mr. Parish personally provided him with clients’ accounts to trade. Neither of

these people had a broker’s license of any kind.

Mr. Parish would sometimes stand in front of his computer in

the All-Tech trading room and shout out to the room or to an individual client to load to buy. Other times, Mr. Parish would give instructions to get ready to sell stocks which he had picked.

All-Tech applied enormous pressure to trade our accounts. Mr.

Parish would sometimes stand next to me or other All-Tech clients

who were seated in the room and tell us what to trade and when

to trade. In addition to the pressure to constantly trade, Mr. Parish

made it very difficult to focus upon what we were doing.

Other forms of trading pressure at All-Tech were indirect. For

example, Mr. Parish oftentimes discussed other All-Tech clients

and made statements such as, ‘‘He just comes in to take up space.

I need people that trade.’’

All-Tech also pressured its clients to cover other clients’ margin

calls. At times, Mr. Parish simply shouted the margin call request

across the trading room. These requests were not limited to clients

within All-Tech’s San Diego office. The added pressure of trading

with margin money loaned by other clients was very stressful for

me.

Eventually, I realized that what All-Tech had told me about

making money and day trading was false and I left All-Tech. Unfortunately, before I left All-Tech, I sustained tens of thousands of

dollars in losses, due in part to the commissions which All-Tech realized from my account. Thank you.

Senator COLLINS. Thank you very much, Ms. Margala. We really

appreciate your sharing your experience so candidly with us today.

Ms. Harlacher, please proceed.

TESTIMONY OF SANDRA HARLACHER,1 FORMER CUSTOMER

OF ALL-TECH DIRECT, SOLANA BEACH, CALIFORNIA

Ms. HARLACHER. I reside in San Diego, California, and am a

former client of All-Tech Investment Group. Prior to trading at AllTech, I had minimal investment experience and I had never day

traded or short-term traded securities.

In early 1997, I saw a couple of different All-Tech advertisements

on television. The ads made day trading look easy and simple. The

ads stated that All-Tech could level the playing field with the professionals and show me everything I needed to know to make

money as a securities day trader. The ads portrayed day trading

as a new career which would give me the opportunity to earn as

much money as I wanted and become financially independent for

19

life. The impression given was that day trading was simple and

easy and anyone could do it.

After seeing the television ads, I visited All-Tech’s office in San

Diego, California, and then attended a seminar presented by Harvey Houtkin, the CEO of All-Tech, at a hotel in La Jolla, California. During the seminar, Mr. Houtkin extolled the virtues of the

All-Tech system and stressed that All-Tech’s training course and

All-Tech’s methods had created a level playing field which enabled

the average individual to trade with professional market makers on

equal terms and enabled the average individual to do well day

trading in the stock market. Mr. Houtkin promised that All-Tech

would teach everything one needed to know to be successful in the

stock market. Mr. Houtkin and All-Tech implied that if you had the

slightest bit of intelligence, you could make money day trading, and

this gave me the strong impression that it involved little or no risk

at all.

I paid $3,000 and took All-Tech’s training course. The course was

taught in All-Tech’s San Diego office on a Saturday and a Sunday.

The All-Tech course did not teach me how to be successful in the

stock market. Rather, All-Tech taught me how to use the software

and trained me to enter orders as frequently as possible to generate commissions for All-Tech. No one at All-Tech ever discussed

risk or my tolerance for risk, my background, goals, or objectives,

past experiences, my financial position, or anything else. At AllTech, none of this information seemed to matter. Furthermore, although some written documents contained disclosures, All-Tech led

me to believe that anyone with ordinary intelligence simply could

not fail at this.

I lost a tremendous amount of money trading at All-Tech and left

All-Tech after only a few months. I realized that I did not know

what I needed to know, and I had not been taught by All-Tech

what I needed to be successful day-trading stocks. Additionally, the

monies I lost were a sizeable portion of what I had been able to

accumulate over my lifetime and it will be extremely difficult at

this point in my life to try to earn those monies back.

After I left All-Tech, I decided to pursue a proper education and

took courses on technical analysis and read numerous books about

the stock market in general and analyzing and trading in the stock

market in particular. I also studied for, took, and easily passed the

Series 6, 7, and 63.

My education after leaving All-Tech made me realize how little

All-Tech had taught me. I was trading at All-Tech, but did not

know enough to realize that I really did not know what I was

doing. All-Tech had basically trained me to enter orders but had

not taught me why. The bottom line at All-Tech was that they

wanted you to trade and trade often. All-Tech set me and others

up for failure because they taught virtually nothing about how the

market works, the strategies of the market makers, order flow, or

the price action of stocks. Perhaps even more importantly, All-Tech

taught me nothing about money management or risk management.

Further, the staff at All-Tech constantly reiterated that anyone

could be successful day trading. The risks attendant to day trading

were either never discussed or extremely downplayed.

20

During the few months I was at All-Tech, I also found that the

environment was more conducive to failure than to success. Mr.

Parish was constantly harassing me and others, often making suggestions regarding which stocks to buy and sell, including when to

buy and sell. When I was hesitant to trade, he would egg me on,

telling me that I would never get experience or learn how to trade

or make up my losses unless I traded often.

After I had been at All-Tech for a while, I realized that most people were losing and not making money. When I suggested to Mr.

Parish that he was going to lose his clients if most of them continued losing money, he told me that he was not concerned because

there was always another body around the corner. I left soon after

that comment.

Senator COLLINS. Thank you very much, Ms. Harlacher. I am

very impressed that after your experience, you went to such great

lengths to become very educated and actually took your securities

exams, and I will be asking you in a moment what the benefit of

hindsight and that education has given you as you look back on

your experience.

Ms. Wenzel, one of the concerns that I have is that often times

first-time day traders have no idea of how risky day trading is. You

mentioned that your son, Scott, told you how excited he was about

embarking on this new career and how optimistic he was about his

chances of success. Do you think that he had any concept, any idea

when he decided he was going to day trade for a living just how

risky and speculative this activity was?

Ms. WENZEL. No, I do not, and the reason I say that is because

whenever he went to Atlanta, he thought he was going to be rich,

he was going to have this lavish lifestyle, and 2 weeks after he was

in Atlanta, when I talked to him, he was a different person.

Senator COLLINS. Because by then he had started losing money

already?

Ms. WENZEL. Then, I think the realities were beginning to set in. I had no idea that he had borrowed another $30,000 from Momentum. All his money was borrowed to begin with, but his father, we

could have dealt with that. But he was in so deep, he felt he probably could not get out. He had to keep going, and he was stressed.

The first time I saw him after he came home from Atlanta, I could

see in his eyes, Scott had lost some weight and he was very, very

stressed.

Senator COLLINS. And he had gone through a difficult period. He

had lost two jobs. He was not currently employed. As you said, all

of the money he used to open his account was borrowed. He had

very little cash. His credit record was not good. You subsequently

learned he had lost money at a previous firm. Is it your impression

that Momentum was aware of his poor financial condition and the

fact that it was borrowed money—they were obviously aware of

some of it, because they arranged for the money to be borrowed—

when they approved him as a client?

Ms. WENZEL. Well, if they were not aware, they should have been

aware, because they should have checked. If anyone has to come

in and before they even get started they have to borrow $30,000,

that has to tell you something. And I am sure the stress he was

under, because he kept that from his family. None of us knew that.

21

We thought he was—just the money his father had loaned him was

what he was going to get started with. In the meantime, with all

this other stress, not letting anyone know, and then losing it on top

of it and being down all the time, he was under a tremendous

amount of stress. He was covering from all sides. I do not think he

even knew where to turn.

Senator COLLINS. One of my concerns is that day-trading firms

are enticing perhaps naive individuals like your son who are investing money they cannot afford to lose. In this case, it was not

even his money, is that correct?

Ms. WENZEL. That is correct.

Senator COLLINS. Ms. Margala, when you went to inquire about

opening up your account and you found you were enticed by this

ad that again appeared to offer the prospect of each riches, did anyone sit you down at the firm and say, now, wait a minute. Your

financial situation really is not that strong and you could lose a lot

of money day trading. Did anyone warn you of the risks involved?

Ms. MARGALA. No, no one did. That was not even discussed. In

actuality, what occurred is I asked if anybody was making money

and several people were pointed out to me as making money.

Senator COLLINS. Mr. Buchwalter, when Amy Le opened her account, and we have a copy of her new account form which I think

you have been provided with a copy of—if not, I will ask the Subcommittee clerk to give you a copy, as well—this form indicates

that Ms. Le did not provide her information on her net worth. It

also shows that she checked income as her investment objective. Do

you know what Amy Le’s financial goal was for opening a day trading account with Providential and Mr. Cao?

Mr. BUCHWALTER. Her goal was to basically beat the 6.25 percent

interest rate that the CDs were charging. What she really wanted

to get out of this was an air conditioned car. She had no idea what

she was getting into, and the reason why income was checked is

because it was at the top of the list, and what she said was top

of the list would be less risky. It is the farthest away from shortterm growth. It is the farthest away from long-term growth. It is

the top of the list. It should be the least risky.

Senator COLLINS. So she felt that by switching to day trading,

that she was actually moving to an investment that would give her

a higher rate return but that was not particularly risky, is that

fair?

Mr. BUCHWALTER. As a matter of fact, what she was told is that

Providential had two different programs, one where they would

guarantee a return of 20 percent and one where they would do the

day trading for you. Mr. Cao recommended the day trading for you

because the returns are higher, the risk is lower. His particular

words were, ‘‘If a stock starts to drop, my computer tells me. I immediately click the sell button. How can you lose?’’ And ‘‘how can

you lose’’ seemed to be the theory throughout any risk disclosure.

How can you lose? This is not risky. How could you lose? Can I lose

money? How could you lose?

Senator COLLINS. And Ms. Le was working, you said, part-time

at minimum wage. This really was her life savings, is that correct?

Mr. BUCHWALTER. It was more than just her life savings. It was

also her mother’s life savings, yes.

22

Senator COLLINS. So this was not what we would commonly consider to be risk capital, money that she could afford to lose?

Mr. BUCHWALTER. Correct, and they went so far as to arrange

loans for Amy, also.

Senator COLLINS. Now, this new account form also indicates that

she initially funded her account at Providential with a $10,000 deposit. Did you know that at the time that Ms. Le opened her account, that Providential’s stated minimum deposit requirement was

$50,000 and not $10,000? Is that a fact you subsequently learned?

Mr. BUCHWALTER. That is a fact I subsequently learned, but the

important thing is, right now, we see a blank on the bottom right

where it says required signature. That was eventually—sometime

during the hearing, we got that back signed by a corporate officer

of Providential, which means by signing that, the officer says that

he has read everything, everything is proper, she is suitable for

this, and he also signed something saying that he knew Amy for

a year when they have never met.

Senator COLLINS. And this was signed by an official of Providential?

Mr. BUCHWALTER. A corporate officer, right.

Senator COLLINS. The corporate officer. I bring up that fact because, as you well know, Providential has tried to wash its hands

of this case and put the blame entirely on Mr. Cao. Could you tell

us the results of the arbitration, the National Association of Securities Dealers, and what the findings were of NASD on the issue of

who was responsible for the losses in Ms. Le’s account?

Mr. BUCHWALTER. Well, the first thing I would like to say is that

the broker of record for her account was a corporate officer of Providential. When I mentioned that she received $13,000 back, that

was paid for by Providential Securities and that was the part of the

award that they were responsible for. By being held responsible for

at least part of the award, I would say that the NASD panel felt

there was some liability. Maybe they felt that at a certain point,

Providential should have known what was going on and that is the

time that they should have stopped it. It is very hard to read into

the minds of arbitrators, but that is the way I took it.

Senator COLLINS. Did Mr. Cao have total discretion over Ms. Le’s

account at all times? Did he trade as he wished, or pursuant to her

direction?

Mr. BUCHWALTER. He had pretty much total discretion except he

was not allowed to take funds out of the account. Other than that,

he can pretty much do whatever he wanted.

Senator COLLINS. And in California, it is my understanding that

a person who trades for another has to be licensed as an investment advisor, is that correct?

Mr. BUCHWALTER. After a certain amount of clients——

Senator COLLINS. A certain number of customers?

Mr. BUCHWALTER [continuing]. Which Mr. Cao did exceed.

Senator COLLINS. And, to your knowledge, was Mr. Cao registered as an investment advisor in California?

Mr. BUCHWALTER. He was not.

Senator COLLINS. And to date, Mr. Cao has not paid Ms. Le the

money that the arbitrator ruled that he owed her, is that correct?

23

Mr. BUCHWALTER. I believe approximately 2 months after we received the award, Mr. Cao filed for bankruptcy.

Senator COLLINS. Thank you. Ms. Margala, did you know at the

time that you opened your account that All-Tech’s minimum standards required at least a $50,000 deposit?

Ms. MARGALA. No, I did not.

Senator COLLINS. So no one said to you when you went forward

to open your account originally with $10,000 that you, in fact, to

meet their requirements needed $50,000?

Ms. MARGALA. No. As a matter of fact, the commercial that sort

of lured me into this whole thing stated that the minimum requirement was $10,000. That was all you needed to trade, to open an

account, was $10,000, not the $50,000.

Senator COLLINS. And was the $20,000 that you ultimately used

to open your account, was it risk capital? Was it money that you

could afford to lose?

Ms. MARGALA. It was not money I could afford to lose. It was

savings. I was unemployed at the time and that was money that

we were using for our livelihood, for a nest egg. It was not money

I could afford to lose.

Senator COLLINS. Ms. Harlacher, I mentioned that I was impressed that you went on to learn a great deal about the securities

industry. Now, it is my understanding from your testimony that

you took All-Tech’s 2-day training course and you paid good money

for it. You paid $3,000 for that course. Based on what you know

now, how would you evaluate the quality of All-Tech’s training

course?

Ms. HARLACHER. I think it was totally inadequate. All it really

taught you to do was operate the software and to make as many

trades as possible and to rack up as many commissions as possible

for All-Tech, and All-Tech charged $25 a trade at that time, and

they also encouraged you to trade no less than 1,000 shares of any

particular stock at one time, but they taught you nothing about the

price action of stocks, how to read charts, technical analysis, fundamental analysis, nothing like that.

Senator COLLINS. So, really, the course taught you the mechanics

of how to trade quickly and often, is that fair?

Ms. HARLACHER. Right. In other words, what they taught you

was to scalp for eighths and quarters, or in other words, churn

your account. Basically, that is all they taught you. They were interested in you trading as often as possible and that is all that

seemed to matter.

Senator COLLINS. My time has expired. I am just going to ask

you one more question. I understand that when you first saw an

All-Tech advertisement, that you went in person to the San Diego

branch office and you attended the seminar. At any point along the

way, in the training course, when you were talking with All-Tech

officials at the San Diego office, did anyone explain to you how

much you might be racking up in commissions each day through

all these trades and how risky it was and that the probability was

that, at least initially, you were going to lose your money?

Ms. HARLACHER. Not at all.

Senator COLLINS. Thank you very much. Senator Levin.

24

Senator LEVIN. Thank you, Madam Chairman, and I want to

thank all of our witnesses for coming forward.

First, Ms. Margala, you said that you first paper traded your account before you did live trading, so that you went through a process of using a computer to see what you would gain or lose if you

actually bought or sold, but not actually buying or selling, as I understand it.

Ms. MARGALA. That is right.

Senator LEVIN. Did you lose money when you paper traded?

Ms. MARGALA. No, I did not.

Senator LEVIN. Did you make money?

Ms. MARGALA. Oftentimes, yes, money was made.

Senator LEVIN. How do you explain that you made money when

you paper traded, but later on you lost money?

Ms. MARGALA. That is a good question. That is a question I

asked Mr. Parish at one point, and how it was explained to me was

that paper trading is different in that there is actually a live person there who fills out a sheet and somehow walks it to—I am not

sure exactly how it works, but the general gist of it is that they

can—if you want several shares of a certain stock, they can give

it to you because it is like Monopoly. It does not mean anything.

So it is not an adequate representation of live trading.

Senator LEVIN. How long did you engage in paper trading before

you started the real thing?

Ms. MARGALA. From 3 weeks to a month.

Senator LEVIN. You were given, you said in your testimony, inaccurate stock quotes by the company. At times, their computers

were running behind, or for other reasons, they gave you inaccurate quotes, and you said that the inaccurate quotes resulted in

losses in your All-Tech account. If those quotes had been accurate,

do you know whether or not you would have made money? Can you

tell whether you would have made money in those cases where you

were given inaccurate quotes?

Ms. MARGALA. There is no way for me to determine that, but

what I can determine is, because as soon as you purchased that

stock, you are an instant loser if the stock was going down. For instance, if not myself, another client purchased a stock, $200 stock,

bought $1,000 shares of it, and as soon as he purchased it, it was

down 20 points, so he was an instant loser because of the timing

difference, and that had occurred to me and a lot of the losses I

sustained at All-Tech was because of the bad quotes.

Senator LEVIN. I want to ask you about margin calls, buying on

margin. Each of you, how were you notified about the margin call,

or were you notified about the margin call? Ms. Harlacher, let me

ask you first.

Ms. HARLACHER. I cannot actually recall ever having a margin

call. I tried to be very careful not to have one. I was—I had become

aware of what the ramifications of margin were and I did not want

to get into that situation.

Senator LEVIN. All right. Ms. Margala.

Ms. MARGALA. You were not always notified, to answer your

question. Sometimes, and often, Barry Parrish would come up and

tell me that I had a margin call, which I did not know about. I did

not even know how I had generated it or why I would have it. But

25

I think what is important to state here is that the computer allowed me to buy whatever I wanted, then there was no tabulation

in the system that showed me where my account was at. So, in essence, it is whatever was in my account at the time, I could purchase even $1 million worth of stock, and that, of course, would

generate a margin call.

Senator LEVIN. So you were not cut off automatically by the computer when that happened?

Ms. MARGALA. No.

Senator LEVIN. Now, when you did generate a margin call, did

you then have to borrow money from somebody to cover it?

Ms. MARGALA. What happened——

Senator LEVIN. Was there a short-term loan that was made to

you by somebody to cover that?

Ms. MARGALA. There was, yes.

Senator LEVIN. And how often did that happen?

Ms. MARGALA. Actually, that only happened to me, I believe, on

three separate occasions, and it is a major reason why I never went

back to All-Tech. For me, it was so much stress, that on top of

learning about my money, to be worried about paying other people

back, it was an insurmountable amount of pressure for me.

Senator LEVIN. Did they tell you how much interest you were

going to be paying for those short-term loans?

Ms. MARGALA. I believe there was no interest, not that I know

of. I do not know.

Senator LEVIN. They did not describe to you what the circumstances were?

Ms. MARGALA. No.

Senator LEVIN. OK. Mr. Buchwalter, can you tell us about margin calls for Ms. Le?

Mr. BUCHWALTER. Yes. Amy’s situation was a little bit different,

where she was not the actual person in the firm doing the trading.

She had Mr. Cao for that. Mr. Cao would receive any notices of

margin calls. They would not be forwarded to Ms. Le. At one specific time, Mr. Cao telephoned Ms. Le with great news that the

president of the company has approved a new program for small

businesses to help them out by funding them. She was asked to

sign some documents in blank, and those blank documents basically authorized a partner of one of the corporate officers of Providential to make loans to Amy Le. They would fill it out when they

wanted to fill it out. They would submit it. So there was margin

calls and margin calls were filled by loans that were generated by

one of the presidents of the brokerage firms through his partner.

The interest rate was $10.20 a day, which equated out to 18 percent, which according to California is considered loan sharking.

Senator LEVIN. I am sorry, $10 a day per what?

Mr. BUCHWALTER. Ten-dollars-and-twenty-cents a day, and I

think it was about a $21,000 loan.

Senator LEVIN. So for $10.20, you could borrow $20,000 for a day,

is that what it came down to?

Mr. BUCHWALTER. Correct.

Senator LEVIN. OK. Do you have anything, Ms. Wenzel, on that

subject that you know about?

26

Ms. WENZEL. I honestly do not know anything about the margin

call. I have learned things since Scott’s death that he had had numerous margin calls, but I honestly do not know.

Senator LEVIN. All right. And again, Mr. Buchwalter, the money

that was covering the margin, that came from the company or one

of its officers, is that correct?

Mr. BUCHWALTER. It came from—we have seen a prospectus and

the prospectus was for a new type of investment for Providential

investors, and what the prospectus asked you to do is put up

money, and when you put up money, you become a partner in this

investment. The prospectus basically guaranteed the investor, the

people that put up this money, that so many of Providential’s customers are going to need this margin money, are going to trade beyond their means, that they could guarantee the investors 10 percent return. And it happens to be a little bit easier when your

agents are doing the trading, which is in Amy’s case.

Senator LEVIN. So on the one hand, they are charging people to

train them to become day traders, making money off that, making

gobs of money off the trades, the thousands of trades, hundreds a

day, tens of thousands a month that each trader is doing. Each of

those trades puts money into the pocket of the company.

Mr. BUCHWALTER. Correct.

Senator LEVIN. And then you are saying that that same company

is telling other people, hey, we have got all these other customers

of ours that are going to get into trouble, have to borrow money

short-term, and if you will give us money, we will lend it to them

and guarantee you a 10 percent return on money which we then

lend to those other customers of ours?

Mr. BUCHWALTER. That is correct.

Senator LEVIN. That is a triple whammy.

Mr. BUCHWALTER. And it helps when you are in the position to

make it so, to control the amount of trading, where you are in a

position to control the amount of margin that needs to be borrowed,

and when you are in the position to put up the money.

Senator LEVIN. And then when you get above your margin call,

we will find other people who will lend you the money. We will pay

them 10 percent and then, presumably, keep 8 percent for ourselves. If it is an 18 percent interest rate, OK, on that assumption,

if they are paying people 10 percent for putting money into that

pot, lending it to the customer who is above the margin at 18 percent, then the company is making 8 percent on that money, as well,

under that hypothesis, is that right or not?

Mr. BUCHWALTER. I could not go that far. From what I have

seen, the interest went into the lender’s account. But this was before that investment program got set up. One of my clients was solicited with that program, and once we saw it, it gave us a bigger

picture of what was going on. Whether or not that program actually went through, I do not know, but I do know that it was the

partner of one of the officers of Providential that was arranging for

the loans.

Senator LEVIN. And presumably making some money on that?

Mr. BUCHWALTER. Absolutely.

27

Senator LEVIN. To each of you, when you indicate you were not

told about risk, did you ask about risk? Let us start with Ms.

Harlacher.

Ms. HARLACHER. Not really.

Senator LEVIN. And if you did ask about risk, what was the response?

Ms. HARLACHER. The risk was never really a factor. It was

stressed to such an extent how much money could be made in this

profession, as they called it, and they reiterated time and again

that they would teach us everything that we needed to know in

order to be successful. The risk never seemed to be a factor whatsoever.

Senator LEVIN. So you did not make any specific inquiry, what

is the risk here?

Ms. HARLACHER. I might have in passing, but it seemed so inconsequential, it just did not seem material.

Senator LEVIN. Thank you. Ms. Margala.

Ms. MARGALA. Senator Levin, I asked if people were making

money and I was told yes, so, therefore, I assumed that that was

the case. As far as me asking, what is the risk, I do not know that

I ever did that.

Senator LEVIN. OK, thank you. Ms. Buchwalter.

Mr. BUCHWALTER. Amy did. The response was, how could you

lose?

Senator LEVIN. How could you lose? Ms. Wenzel, do you want to

comment?

Ms. WENZEL. I cannot answer that because I do not know.

Senator LEVIN. Thank you.

Senator COLLINS. Thank you. Senator Durbin.

Senator DURBIN. Thank you, Madam Chairman. As I listen to

this testimony about day trading, I come to the conclusion that

Tony Soprano would be a better expert witness than Louis

Ruckheyser to describe what is going on here. This sounds an

awful lot like gambling and it appears that it is stacked against

those who are new to the business.

I would like to ask just a few questions about some of the experiences you have had. Ms. Wenzel, yours is the most tragic. To lose

money is one thing, but a son is just devastating.

Ms. WENZEL. We could have handled the money.

Senator DURBIN. Sure. Let me ask you about your son’s source

of money. You mentioned that your husband or his father had

loaned money to him as part of this undertaking?

Ms. WENZEL. Yes, he did. He loaned him $30,000 to get started

with.

Senator DURBIN. Do you know any other sources of funds for

your son’s trading?

Ms. WENZEL. Scott had no other sources. I remember when he

first told me that he was going to be doing this venture, he had

told me that his father had loaned him the money and that was

pretty much it. I mean, he never—I assumed that that was all he

was going to need to get started with whatever he was doing. None

of us, until after his death, even knew that the company had

loaned him this other money. We were shocked.

Senator DURBIN. How much was loaned to him by the company?

28

Ms. WENZEL. Thirty-thousand dollars at 18 percent.

Senator DURBIN. Over and above the father’s loan?

Ms. WENZEL. Yes, to open the—to get started.

Senator DURBIN. Were there any other sources of loans that you

were aware of for your son’s trading?

Ms. WENZEL. None that I am aware of.

Senator DURBIN. And his education and training prior to doing

this, did it involve any experience with this field?

Ms. WENZEL. To my knowledge, no. The only—if you want to call

it experience—he was at Dean Witter for a short period of time, I

think probably a year, and he did not meet his quota so, therefore

when the year was up, then he was let go because he had not met

his quota. And I had no idea that he had done any day trading

after he left Dean Witter. That was, again, a surprise.

Senator DURBIN. I might ask these other questions of the other

witnesses because you have no personal knowledge of what was in

your son’s mind at certain times, but thank you again for being

here.

Ms. WENZEL. Thank you.

Senator DURBIN. Ms. Margala and Ms. Harlacher, we are concerned about warning people about risk and whether adequate

warnings are being given. Would it have made any difference to

you? If we had told you you could lose it all in a matter of a day

or a week, would it have made any difference?

Ms. MARGALA. Absolutely. As I said, I was unemployed at the

time. If I knew that that money could have been lost just like that,

I would not have done it. Also, the advertisement that lured me in

touted day trading as a profession, and I was looking for a new profession at the time. I was in real estate before and my real estate

brokers license had just expired at the end of June and this I started doing in August. So I was made to believe that this was a profession, something new, that I was in on the ground floor of something, so to speak.

Senator DURBIN. Ms. Harlacher, was that your experience, as

well?

Ms. HARLACHER. That was my experience, as well, but what I

would like to reiterate is that they kept on stressing the fact that

anyone who had a modicum of intelligence simply could not fail at

this because they would give you all the tools you needed to be successful, and if you had an ounce of intelligence, there is no way you

would not make money. And I was also looking for a new profession at the time. They promised us this would be a new profession.

It would enable you to become financially independent. They might

have mentioned risk in passing, but all these other aspects were

so stressed and so magnified that the risk factors seemed to be

minimal or practically nonexistent.

If I had been made aware of the true state of affairs, if I had understood that the course was so inadequate and that it was all

slanted to their advantage—it set people up for failure, basically,

because it did not teach you anything that you really needed to

know in order to trade. If I had had any knowledge of any of these

factors, I never would have gotten involved.

Senator DURBIN. Well, it seems to me that there are built into

the system, or there should have been built into the system, some

29

firewalls to protect people from your experience. One of them was

a training course which virtually everyone has conceded was totally

inadequate to——

Ms. HARLACHER. Absolutely, but there are training courses and

training courses, as I have since discovered.

Senator DURBIN. Yes, you have. So you learned that hardware

that you were going to work with——

Ms. HARLACHER. Absolutely.

Senator DURBIN [continuing]. But you did not learn about the

volatility of the market and how you could profit from it?

Ms. HARLACHER. Nothing whatsoever about that.

Senator DURBIN. Is that your experience, Ms. Margala?

Ms. MARGALA. I never took the training course. It was discussed—it was offered to me. However, I did not have—I came in

with $20,000. Mr. Parish at that time knew I did not have the

money for it. He did not require that I take the course.

Senator DURBIN. At any point, did this sound too good to be true?

Ms. MARGALA. In hindsight, maybe, not then.

Senator DURBIN. Let me ask you about margin calls, because we

have built this into the whole system with the idea that people just

could not go crazy. At some point, you had to have real money. You

just could not speculate beyond your means.

Now, I believe in your testimony or one of the others on the

panel suggested that margin call requirements could not keep up

with the trading and volume on a day-to-day basis. Is that what

you said earlier? I do not want to put words in your mouth.

Ms. MARGALA. If you mean by that—what actually I found is that

I did not know that I had generated half the margin calls I did,

and these were like—some were on a daily basis. In other words,

there are different types of margin calls. One, I believe, is a Regulation——

Senator DURBIN. T.

Ms. MARGALA [continuing]. T, thank you. And one was sort of

like daily margin call, a maintenance call, like a maintenance margin call. So I had generated a lot of maintenance margin calls, but

I had to borrow money for numerous margin calls. I had to borrow

from my father. I had—$20,000 is not all that I put into the account. There are numerous margin calls, more money that I had

to put in afterwards to cover margin calls.

Senator DURBIN. So the margin call system was working in your

situation as you understand it? I mean, you kind of knew how you

were sinking. You could feel it on a day-to-day or week-to-week

basis?

Ms. MARGALA. No, it was not working. This was after the fact.

It is like you have got a margin call. Well, how did that happen?

You sort of did not know how it happened, or I did not, anyway.

Senator DURBIN. But what I am trying to get to is your experience took place over how many weeks or months?

Ms. MARGALA. I was there—I started trading sometime in early

September and left in 1988 and was gone by the beginning of January.

Senator DURBIN. Eighty-eight or 1998?

Ms. MARGALA. The beginning of——

Senator DURBIN. September——

30

Ms. MARGALA. December 1988 to January 1999.

Senator DURBIN. September 1998 to——

Ms. MARGALA. Ninety-eight, I am sorry.

Senator DURBIN. So this was a matter of, let us say, 4 or 5

months that you were involved in this, and what I am saying is

you came in with this $20,000 that you initially were involved in,

but did you know through your experience that you were getting

further and further behind because of the margin calls?

Ms. MARGALA. Yes, as I was getting the margin calls. But what

Barry Parrish would do—who was the manager—would borrow

money from other people, put it in my account, and then until I

built it up again to pay back, which, of course, encouraged more

trading and more commissions for All-Tech.

Senator DURBIN. Do you have any idea how much money you

gave to this firm in commissions over that 4- or 5-month period of

time?

Ms. MARGALA. I am in the process of calculating that, but I can

tell you it is in the thousands.

Senator DURBIN. Over $10,000?

Ms. MARGALA. I am not sure. I cannot——

Senator DURBIN. Ms. Harlacher, what was your situation with

the margin calls? Did they give you any warning that you were in

trouble?

Ms. HARLACHER. I used to call all the time and speak to Barry

Parish about the margin situation because I did not want to risk

having a margin call myself. But I was asked on two occasions to

lend a substantial amount of money to another trader to cover his

margin calls and I was not paid any interest for these loans, none

whatsoever. So the money was journaled out of my account overnight and then journaled back in the next day, and the way I was

able to keep up with whether or not what needed to be done had

been done was we were given a sheet of paper with our buying

power every day and I used to ask for accountability that I had got

the money back.

Senator DURBIN. So this Mr. Parish, with his svengalian qualities, would come in and say, we want to borrow money from you

and not pay you interest on it and we will give it back to you tomorrow?

Ms. HARLACHER. He did not put it quite that way. He just said,

somebody has had a margin call and you have money in your account, would you please assist, giving one the impression that you

were duty-bound to say yes. Otherwise, if you refused and you ever

got into trouble, then no one would help you.

Senator DURBIN. Amazing. It is said in here that if day traders

stick with it for 6 months, they tend to be profitable, at least one

of the studies that we have looked at, and also that it takes 3 to

5 months to come to some understanding of what is really happening here.

Ms. HARLACHER. I think it takes longer than that for a lot of people.

Senator DURBIN. That is true.

Ms. HARLACHER. A few people ‘‘get it’’ in that time but most people take much longer.

31

Senator DURBIN. I just wonder if, as we look at this and consider

legislation, if some of the requirements about the size of your account and the margin calls might have something to do with how

long you have been in the business and how frequently you trade

and what your sources of money might be. To think that the firm

that you are trading for, earning commissions for, is loaning you

money and moving money between accounts just seems to me to be

counter-productive. I cannot believe the securities industry is anxious to defend this practice at all.

Ms. HARLACHER. Well, from my point of view, what I believe is

really necessary in order to succeed in this business is a thorough

knowledge and understanding of the market through a lot of experience of having studied it. The things that I learned from the Series 7 which I found were terribly important were the knowledge

of options and margin. I think people need to understand those in

greater detail.

But what I really consider to be indispensable is the knowledge

of charting and technical analysis, and I believe people also need

to know some fundamental analysis so that they can assess whether or not what they are buying is a good investment before they

even get involved. And I think those are things that a lot of people

do not understand or have any knowledge of and I think those are

the things that need to be understood.

Senator DURBIN. Thank you very much. Thank you, Madam

Chair.

Senator COLLINS. Thank you, Senator Durbin.

I want to thank our witnesses on the panel today. You have been

extraordinarily helpful to the Subcommittee in letting us know

firsthand experiences of consumers. So we very much appreciate

your willingness to testify and we thank you.

I will now call forward our final panel of witnesses this morning.

All of the individuals are or were associated with Providential, AllTech, or Momentum Securities firms in dealings with the customers whom we just heard from.

Huan Van Cao was a day trader at Providential’s Los Angeles

branch office. He traded the account of Ms. Le and other Providential customers during the spring and summer of 1998. He is appearing today pursuant to a subpoena.

Fred Zayas was the former Branch Manager of All-Tech’s office

in Watertown, Massachusetts. Last year, he entered into a settlement agreement with State securities regulators in Massachusetts

and he, too, is testifying today pursuant to a subpoena.

Barry Parish was the branch manager of All-Tech’s office in San

Diego, California. Mr. Parish ran the San Diego office when Ms.

Margala and Ms. Harlacher first became day-trading customers of

All-Tech.

Justin Hoehn is currently the Branch Manager of Momentum’s

office in Atlanta, Georgia. Mr. Hoehn was a close friend of Scott

Webb and was instrumental in getting Mr. Webb involved with day

trading.

Pursuant to Rule 6, all witnesses are required to be sworn in. I

would ask that you all stand and raise your right hands. Do you

swear that the testimony you are about to give to the SubVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00043 Fmt 6633 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
32

1The prepared statement of Mr. Parish with attachments appears in the Appendix on page

135.

committee will be the truth, the whole truth, and nothing but the

truth, so help you, God?

Mr. HOEHN. I do.

Mr. ZAYAS. I do.

Mr. CAO. I do.

Mr. PARISH. I do.

Senator COLLINS. Thank you. I would like the attorneys who are

here this morning to briefly introduce yourselves and advise the

Subcommittee whom your client is. Mr. Berman.

Mr. BERMAN. Yes. Thank you, Chairman Collins. My name is

Norman Berman. My firm is Berman, Devolario, and Pease, and I

am here representing Mr. Zayas.

Senator COLLINS. Thank you. Mr. Ambrose.

Mr. AMBROSE. Thank you. I am John Ambrose representing

Barry Parish.

Senator COLLINS. Thank you very much.

Each of our witnesses on this panel has the opportunity to make

an oral statement this morning as well as to present any written

testimony that you wish for the hearing record. I am going to ask

if any of you has a statement you would like to present to the Subcommittee before we move to questions.

TESTIMONY OF JUSTIN HOEHN, BRANCH MANAGER,

MOMENTUM SECURITIES, ATLANTA, GEORGIA

Senator COLLINS. Mr. Hoehn, do you have a statement you would

like to make?

Mr. HOEHN. No, I do not.

TESTIMONY OF FRED ZAYAS, FORMER BRANCH MANAGER,

ALL-TECH DIRECT, WATERTOWN, MASSACHUSETTS

Senator COLLINS. Mr. Zayas, do you have a statement you would

like to make?

Mr. ZAYAS. No, I do not.

TESTIMONY OF BARRY PARISH,1 FORMER BRANCH MANAGER,

ALL-TECH DIRECT, SAN DIEGO, CALIFORNIA

Senator COLLINS. Mr. Parish, do you have a statement you would

like to make?

Mr. PARISH. Yes, I do.

Senator COLLINS. Please proceed, Mr. Parish.

Mr. PARISH. Thank you, Chairman Collins and Senators Levin

and Durbin. Before I read my comments, I would like to state that

the statements that we have heard so far today are completely at

odds with the record that I am happily here to cooperate with and

present to you.

I became interested in day trading when I learned from my previous job as a branch manager of a brokerage firm that major profits were being made by SOES traders. Back in those days, they

were called SOES bandits. I determined that SOES trading must

be a profitable enterprise, and so, therefore, I started exploring the

SOES business. I answered an ad by All-Tech and paid substantial

33

money to purchase equipment and be trained to head an All-Tech

office.

Very early in my management, I encountered a situation in

which a trader had made a computer mistake and had generated

a margin call. In the early days, there were no safeguards on the

equipment. All-Tech headquarters gave me forms, an example of

which is attached, to journal money from one account to another

to satisfy the margin call. The donor in the journal complained

about the risk, what would happen to his money in the event of the

death of the recipient of the money, and All-Tech headquarters’ solution was to prepare both the donor and the recipient journals simultaneously, fax them into headquarters, and have them approved, which was done.

So this was the first of hundreds of journals to satisfy margin

calls. My office did the administrative handling of these journals,

together with the headquarters, and we also helped in finding

other customers willing to journal funds. On two occasions, though,

I should have known better. I journaled money from my own personal account to assist customers with their margin calls. I also

overlooked the fact that although Adam Leeds acted in my office

as a trader, he in time became an employee of the firm and, therefore, his involvement subsequent to his employee relationship was

improper.

In approximately the late spring of 1999, headquarters began to

require notarized signatures on journals and the software was improved so that it was possible to prevent unwanted margin calls.

I used this opportunity to put an end to journaling in my office.

Journaling had been a product of the day-trading software and it

was made unnecessary by software improvements. As mentioned in

the 12 customer declarations attached to this exhibit, journaling

was an unwelcome headache to me and to my staff.

As is evidenced by the 12 customer declarations, risk disclosure

and warning was a constant theme in my communications with

customers. Attached hereto with the intention of being made a part

of the record are 12 declarations from customers with various degrees of exposure to the day trading milieu in the San Diego office.

Senator COLLINS. They will be made part of the record.

Mr. PARISH. Thank you. Although simplistic and obviously designed to support me, these declarations were obtained from a

hastily-called get-together in which 20 people were invited. No one

refused to help if given proper notice. The supplemental declarations are certainly not meant to be rude to the Subcommittee or

other investigative agencies, but to give a flavor of the temperament of many traders.

I stand ready to cooperate with the Subcommittee and other

agencies to learn the facts and make decisions designed to promulgate clear rules that fit new technology while minimizing adverse

effects on customers. Thank you.

TESTIMONY OF HUAN VAN CAO, DAY TRADER AT

PROVIDENTIAL SECURITIES, FOUNTAIN VALLEY, CALIFORNIA

Senator COLLINS. Mr. Cao, do you have a statement you would

like to make before the Subcommittee?

Mr. CAO. Yes, I do, Chairman.

34

Senator COLLINS. Mr. Cao, you may proceed.

Mr. CAO. I come here to—I heard the testimony and the statement that the attorney for Amy Le make this morning. I am very

sure that the statement he make were false. The information he

gave to you were false. Again, he have the reputation for having

an ambulance chaser run across the Vietnamese community. He is

behind all these chaos and lawsuits.

I saw Amy Le. Amy Le not sick as you make your statement. She

participate on every nightclub activity, shopping. In fact, 2 days

ago, I had been presented the award against me for $130,000. In

fact, it was in the two number by someone they said they know me

too well. I would appreciate opportunity to contradict his statement

and his information and provide you with direct knowledge of what

I know about Providential, about day trading, and anything that

you would like to ask me.

Senator COLLINS. You are welcome to take more time for your

statement if you want to put in the record any information that

you believe the Subcommittee should have.

Mr. CAO. Yes. In addition, Amy Le not a poor lady as he describe. She have in her saving account more than $200,000 cash.

Her brothers paid the house by cash and she worked at the weekend for her brother, and when I add up what she said, it do not

work. It does not work. I would like the panel aware about that.

Also, that her mother collect food stamp and welfare by false

statement and I want the panel aware about that fact.

Senator COLLINS. OK. Mr. Hoehn, I am going to start with you

today on the questioning that we are going to proceed with. Mr.

Hoehn, how old were you when you became the Branch Manager

of Momentum’s office in Atlanta?

Mr. HOEHN. Twenty-two years old.

Senator COLLINS. Could you describe for us your background and

your qualifications to be the Branch Manager?

Mr. HOEHN. My background, I had undergraduate studies, finance. I went on to leave college, take a position with A.G. Edwards which lasted close to 2 years. I went on to take a position

as a stockbroker trainee at Dean Witter, where I received my Series 7, 63, 65, and Series 3 licenses. While working at Dean Witter,

I had learned about the day trading industry through a magazine

article. I became interested and shortly thereafter joined on with

Insight Trading in St. Louis.

Senator COLLINS. So you had day traded yourself prior to taking

managerial control of the Atlanta office. Could you tell us what

your experience had been day trading?

Mr. HOEHN. My experience in day trading at Insight was brief,

in my opinion, 2 to 3 months. Insight had eventually closed the office. My trading was an introductory. I went through training with

some people at Insight and went on to Texas where they are affiliated with some day trading.

Senator COLLINS. Did you lose money trading at Insight?

Mr. HOEHN. I did sustain a loss while I was trading at Insight.

Senator COLLINS. And were you trading with money that you had

borrowed, or were you trading with money that you had saved?

Mr. HOEHN. They were borrowed funds.

35

Senator COLLINS. Can you give us an idea of how much money

you lost at Insight trading with borrowed funds?

Mr. HOEHN. Approximately $13,000.

Senator COLLINS. Was Momentum aware that you had lost

money previously day trading when you were hired to run the office?

Mr. HOEHN. Well, when I met David Dial in St. Louis, I am sure

that it was spoke about. I do not know if he knew particular what

the amount of the losses were.

Senator COLLINS. You were a friend of Scott Webb’s. Did you

know that he also had traded at Insight? Were you at Insight trading at the same time?

Mr. HOEHN. Yes, we were.

Senator COLLINS. And were you aware that he also had lost bor- rowed money trading at Insight of about $10,000?

Mr. HOEHN. At the end of the office, once they closed down, I realized that Scott had sustained losses, as well.

Senator COLLINS. Did you understand that Mr. Webb had had no

job for roughly 6 months before Dean Witter released him for failing to meet quotas and prior to his opening the account at Momentum?

Mr. HOEHN. I was aware that Scott had worked at Dean Witter.

I was not specific as far as how he was let go by the Dean Witter

office.

Senator COLLINS. When Mr. Webb opened his Momentum account, did you realize that the money he was using was money that

had been borrowed from his father?

Mr. HOEHN. I did realize that Scott had borrowed funds from his

father, yes.

Senator COLLINS. Did you realize that he was opening his account entirely with borrowed money?

Mr. HOEHN. Yes, I did.

Senator COLLINS. Were you involved at all in helping to arrange for an additional loan of about $30,000 for Mr. Webb?

Mr. HOEHN. Mr. Webb had approached both myself and David

Dial in regards to being introduced to someone who was prepared

to make a loan, such as a $30,000 loan.

Senator COLLINS. What is Momentum’s policy regarding opening

day trading accounts entirely with borrowed money?

Mr. HOEHN. Well, our requirements for opening the account, as

of today, are a $50,000 minimum deposit and a $100,000 net worth.

Senator COLLINS. And does it matter if that money is borrowed

for the initial deposit?

Mr. HOEHN. As far as being borrowed when you are talking

about from a family member or—if they are providing the funds,

it is a circumstantial situation.

Senator COLLINS. Mr. Webb had a poor credit record. He had to

borrow all of the money he was using to open his day trading account. He had no savings. He had very little cash. Why was his

account approved by Momentum? Did it meet the standards that

Momentum had in place at that time?

Mr. HOEHN. In all due respect, Chairman, to paint a picture of

Scott Webb’s specific situation, I think it would help to understand

that he was my roommate in Atlanta. We were friends before we

36

had moved, or before I had moved. He later came down. He was

a Series 7 licensed broker. He obtained all of these licenses that

I mentioned earlier from the Dean Witter office. He traded at Insight Securities. He was aware of the day trading practices, what

his objectives were as a trader.

He also, as far as his credit, Scott had told me on many occasions

of additional income through a trust fund, rental income, and he

also had worked at Enterprise and at Dean Witter, so he had made

a different picture as far as to his financial status when he had

opened the account.

Senator COLLINS. But you knew all the money that he was using

to open the account was borrowed money, and if you look at this

account application, it does not paint a picture of financial health

in any way. Are you saying that he did meet the standards that

Momentum had in place at that time?

Mr. HOEHN. At the time of Scott Webb’s initial account opening,

we did not have guidelines as we have today. So this was on the

circumstantial situation, and also from Scott, he had mentioned

how his dad was financially prepared to lend him the money, did

fully understand—his father, I am speaking of—knew what he was

using the money for.

Senator COLLINS. In September 1998, this is about 3 months

after Mr. Webb had opened his account and he is already losing

money, it is my understanding that an internal auditor for Momentum audited the Atlanta office, and it is Valynda Ewton, I believe,

is the name of the auditor?

Mr. HOEHN. Yes, it is.

Senator COLLINS. Are you familiar with that audit?

Mr. HOEHN. Yes, I am.

Senator COLLINS. As you will see from the exhibit that we have

put up, and there is a copy, as well, in the notebook before you,

the internal auditor characterized Mr. Webb’s account as only marginally suitable. She went on to say that in such instances, some

written memorandum may be needed to document why these persons were allowed to day trade. Perhaps limits on dollar amounts

of losses, additional credit checks, or written attestations from the

customer or special attention needs to be provided. I believe that

NASD will start taking a hard look at the knowledge and the suitability of the customers.

Given this audit, why did you allow Mr. Webb to continue to day

trade and to continue to lose money for another 10 months?

Mr. HOEHN. I wanted to point out, Chairman, that this was an

internal exam that was done from a consultant that we work with,

Valynda Ewton. We did review all of the points that she was making through this examination thoroughly. I did make a rebuttal towards the improvements that we were making, which did include

completing the necessary paperwork that was in question.

Spyderstorm and Scott Webb were part of that. Scott and I had a

discussion after this examination to the extent of financial suitability, and more importantly, just the status of his trading. It was,

once again, a situation where Scott wanted to continue to day trade

and was improving on his trading.

Senator COLLINS. Did Mr. Webb have two accounts, one of which

was called Spyderstorm and one was under his name?

37

Mr. HOEHN. Yes, he did.

Senator COLLINS. And both of these accounts were flagged by the

auditor as being problematic from the standpoint of suitability, is

that correct?

Mr. HOEHN. From Valynda Ewton’s examination, yes.

Senator COLLINS. Were any limits on dollar amounts of losses

put on the accounts that Mr. Webb had as a result of this audit?

Mr. HOEHN. As a result of this audit, no, but Scott and I would

frequently, on a daily basis, discuss his trading. So we were monitoring the trading closely.

Senator COLLINS. But Mr. Webb was losing money, was he not?

Mr. HOEHN. There were times where he was losing money, but

at the same time, he was making money, also.

Senator COLLINS. But on balance, he was losing money?

Mr. HOEHN. Yes.

Senator COLLINS. Despite the fact that Mr. Webb was losing

money, it is my understanding that early in 1999, Momentum and

the management company that Momentum has retained to run the

Atlanta office actually hired Mr. Webb to train new customers, is

that correct?

Mr. HOEHN. Yes, and Chairman Collins, as far as the examination, 6 months after that examination, the same company that

Valynda Ewton is associated with came back to do a review and

it states very clearly that there were major improvements made,

complimenting the fact that the necessary paperwork and some of

the administrative duties that were in question before looked much

better.

Senator COLLINS. There was a specific review of Scott Webb’s accounts?

Mr. HOEHN. There was a review——

Senator COLLINS. Or a review generally?

Mr. HOEHN [continuing]. Of the whole office.

Senator COLLINS. Let me just, in my remaining time for this

round, go through a chronology with you to make sure I have it

correct. So in July 1998, Momentum opened 2 day trading accounts

for Mr. Webb, is that correct?

Mr. HOEHN. I do not know if it was July, but yes, the summer

of 1998.

Senator COLLINS. And it was with borrowed money, including

$30,000 at an 18 percent interest rate that was arranged from another Momentum customer, is that correct?

Mr. HOEHN. Yes, it is.

Senator COLLINS. Then in September, 3 months later, Momentum’s own auditor flagged Mr. Webb’s account and characterized

them as only marginally suitable, is that correct?

Mr. HOEHN. Yes, it is.

Senator COLLINS. And yet in January, just a few months later,

Mr. Webb, despite the fact that he was losing money, was actually

hired to begin training new day trader customers, is that correct?

Mr. HOEHN. Scott had approached myself and David Dial on beginning a training class in the Atlanta office that he would take

a lead. That is correct.

Senator COLLINS. Was that because he was getting increasingly

desperate for money, as we have heard his mother testify?

38

Mr. HOEHN. I do not believe that Scott wanted to teach the

course just for the money, no.

Senator COLLINS. Do you know how much ultimately Mr. Webb

lost? At the time of his very tragic death, how much money had he

lost?

Mr. HOEHN. I do not know the exact amount of that.

Senator COLLINS. It is my understanding that he lost approximately $40,000. Do you have any indication that that is not correct?

Mr. HOEHN. Forty thousand in respect to the Momentum account, or within the Insight and Momentum——

Senator COLLINS. Not counting the Insight account. He lost about

$10,000 through that.

Mr. HOEHN. Excuse me?

Senator COLLINS. He lost approximately $10,000 while trading at

Insight.

Mr. HOEHN. How much are they——

Senator COLLINS. I am asking you how much he lost at Momentum. It is my understanding that it is $40,000 of the $60,000 that

he borrowed.

Mr. HOEHN. Well, first of all, I do not know the exact number,

but the number seems high, in my opinion. I do know that he made

a $12,000 deposit back in the account opening, plus the $30,000

that he had borrowed from a customer. I do realize that there was

approximately $20,000 left in the account.

Senator COLLINS. I was just going to say, the documents that the

Subcommittee has from your office show very clearly that there

was $19,000 left in his account.

Mr. HOEHN. OK. So, therefore, I would think that $40,000 would

be——

Senator COLLINS. Forty would be correct?

Mr. HOEHN. Yes. Losses of—no. I would say that with the numbers that we are speaking of, it would be closer to $25,000.

Senator COLLINS. That is not our understanding, but my time

has expired on this round, so I will yield to Senator Levin.

Senator LEVIN. Thank you, Madam Chairman.

Mr. Cao, let me ask you some questions. You heard Mr. Buchwalter this morning. I believe you heard his testimony.

Mr. CAO. Yes, I did.

Senator LEVIN. He testified that you told Ms. Le that you were

an attorney, is that correct?

Mr. CAO. Absolutely not.

Senator LEVIN. He said that you told her that you were a stockbroker, is that correct?

Mr. CAO. Absolutely not.

Senator LEVIN. You are not a stockbroker, are you?

Mr. CAO. I am not.

Senator LEVIN. Were you buying and selling stocks for her?

Mr. CAO. For Amy Le?

Senator LEVIN. Yes.

Mr. CAO. Yes, I did.

Senator LEVIN. Even though you are not a stockbroker?

Mr. CAO. That is right.

39

Senator LEVIN. Are you aware of that fact, that you are not allowed to do that?

Mr. CAO. Well, I understood differently. I understood——

Senator LEVIN. From whom?

Mr. CAO. From the NASDAQ that I call.

Senator LEVIN. Who did you talk to there that said you could buy

or sell stocks for somebody without being a stockbroker?

Mr. CAO. Well, as a day trader, I called to the NASDAQ office

in Los Angeles and they said there are no law right now not to

allow me to be a day trader and to buy and sell stock for the day

trader account.

Senator LEVIN. You were told by whom there?

Mr. CAO. I do not recall the names, but I called the office,

NASDAQ office in Los Angeles.

Senator LEVIN. Were the folks at Providential Securities aware

of the fact that you are not a stockbroker?

Mr. CAO. This is the first time that I heard about Providential

have something to do with me.

Senator LEVIN. I see. You have nothing to do with them?

Mr. CAO. I have nothing to do with them.

Senator LEVIN. Did you have your own office?

Mr. CAO. No, I do not.

Senator LEVIN. What office did you trade out of?

Mr. CAO. I trade out of the office in Los Angeles owned and operated by Mr. Tae Goo Moon.

Senator LEVIN. You never were at Providential Securities? You

never visited them? You never went in their offices? You were not

nearby?

Mr. CAO. That is totally correct.

Senator LEVIN. So you do not know anything about Providential?

Mr. CAO. I was not aware about that at that time.

Senator LEVIN. When was the first time you ever heard of Providential?

Mr. CAO. The first time I heard about Providential, when Mr.

Tae Goo Moon took me down to Providential to see Henry Fahman

with Tae Goo Moon, present me to Henry Fahman what kind of

lawyer that he needs to hire in order to defend for his lawsuit, and

throughout the conversation, I was not aware that they have some

relationship, but 2 days after that or 3 days after that, I came

down to Providential and talked to Henry Fahman again personto-person and he told me that they have some business relationship

with, at that time, Hahna Global Security.

Senator LEVIN. Give us the name of the person again that you

worked for.

Mr. CAO. I worked for myself.

Senator LEVIN. I see. And the office was under your own name?

Mr. CAO. No, I do not have an office. I am the day trader who

come in to trade every day.

Senator LEVIN. And what office do you go in?

Mr. CAO. I went in the trading room of Hahna Global Security.

Senator LEVIN. Hahna?

Mr. CAO. Global Security.

Senator LEVIN. And what building was that in?

Mr. CAO. It is in Los Angeles.

40

Senator LEVIN. Yes, I know, but what building is it in?

Mr. CAO. I could not recall.

Senator LEVIN. How close is it to Providential?

Mr. CAO. Oh, quite far away. It is about a 45-minute drive.

Senator LEVIN. All right. Are you aware that Providential does

business under the name of Hahna Global?

Mr. CAO. No, I was not aware about that.

Senator LEVIN. When did you become aware of that?

Mr. CAO. I became aware about that fact when Mr. Moon, the

manager or the operator or the owner of the Hahna Global, took

me down to Providential office in Fountain Valley.

Senator LEVIN. Is that before you met Ms. Le?

Mr. CAO. No, long after, long, long after.

Senator LEVIN. And after you were trading stocks for her?

Mr. CAO. Yes, when she filed the claim.

Senator LEVIN. Did Hahna Global know that you were not a

broker?

Mr. CAO. They knew.

Senator LEVIN. They know you are not a broker?

Mr. CAO. They know I am not a broker. They also know that I

am only a day trader.

Senator LEVIN. And you are listed on the stationery here as

being Senior Vice President for Hahna Global Capital Management, Inc., is that correct?

Mr. CAO. I am surprised about that document.

Senator LEVIN. You are shocked that the stationery here lists you

as a Senior Vice President of Hahna Global Capital?

Mr. CAO. Yes.

Senator LEVIN. When is the first time you saw that?

Mr. CAO. When I—it is about 4 months after I come in to trade

with——

Senator LEVIN. What month and what year would that be?

Mr. CAO. This would be about—it is about—I cannot be—it is

hard to recall.

Senator LEVIN. Well, approximately what time of year?

Mr. CAO. Approximately, I think after the lawsuit of Amy Le had

been filed.

Senator LEVIN. Is the first time you knew that you were listed

as a Senior Vice President of Hahna Global?

Mr. CAO. Probably not the first time, just the second time or

something.

Senator LEVIN. All right. How many times did you go to

Providential’s office?

Mr. CAO. Before or after——

Senator LEVIN. Ever.

Mr. CAO. Right now, I trade at the Providential office.

Senator LEVIN. So now you do trade there?

Mr. CAO. I do conduct my trading there.

Senator LEVIN. When did you start doing that?

Mr. CAO. I recall it is October 1999, or 19——

Senator LEVIN. That you started going to their office regularly?

Mr. CAO. Yes.

Senator LEVIN. All right. How much money did you make from

trading for Ms. Le?

41

Mr. CAO. For 2 weeks, I make about—no, for those weeks, I

make about $1,000 or $2,000 in profit.

Senator LEVIN. Pardon?

Mr. CAO. I make about $1,000 or $2,000 in profit.

Senator LEVIN. Over the entire length of time, all the trades that made for her, you made only $1,000 or $2,000?

Mr. CAO. Of those weeks.

Senator LEVIN. How many weeks?

Mr. CAO. For 1 week.

Senator LEVIN. One week. And how many weeks did you do the

trading?

Mr. CAO. And it——

Senator LEVIN. How many weeks?

Mr. CAO. Probably about 3 weeks, 4 weeks.

Senator LEVIN. So you may have made $8,000 in profit off her

altogether?

Mr. CAO. I did not.

Senator LEVIN. What is the total amount of money you made by

trading for her?

Mr. CAO. Well, I stopped trading at her account at very early

age, when she called in to stop trading.

Senator LEVIN. What is the total amount of money you made off

trading for her?

Mr. CAO. I could not recall.

Senator LEVIN. Could it be $5,000?

Mr. CAO. No, I do not think so.

Senator LEVIN. Now, Mr. Buchwalter said that you told Ms. Le that you would buy her account for $48,000. Is that true?

Mr. CAO. There was a conversation between me and Ms. Le when

she asked me to buy her account for that amount.

Senator LEVIN. Is it true that you offered to buy her out for $48,000?

Mr. CAO. She asked me for it.

Senator LEVIN. She what?

Mr. CAO. She asked me to buy her account for $48,000.

Senator LEVIN. And you agreed?

Mr. CAO. No, I negotiate with it. At one time, I asked her to go

to the attorney, her attorney, to draw up a paper, but she never

did that.

Senator LEVIN. And you told her to draw up a paper that you

would buy up her account at what amount?

Mr. CAO. Yes. I had draw——

Senator LEVIN. In what amount?

Mr. CAO. About $48,000.

Senator LEVIN. So you told her to draw up the paper?

Mr. CAO. No. I said—I told her that if I do the work, then I need

a written document to show what we did so you do not come back

and make a claim against me.

Senator LEVIN. But did you tell her to draw up a paper in which

you would buy her account at $48,000?

Mr. CAO. No, I did not say that.

Senator LEVIN. All right. How many clients like Ms. Le did you

have?

Mr. CAO. Only one.

42

Senator LEVIN. She was the only one?

Mr. CAO. She only one.

Senator LEVIN. Did this trading company have other clients like

you who had other clients like her?

Mr. CAO. No. I think that there is another trader, but I do not

know any client like Amy Le.

Senator LEVIN. And how did you happen to latch onto her?

Mr. CAO. Pardon?

Senator LEVIN. How did you happen to find her?

Mr. CAO. I do not find her. I was—first time I came down to

Fountain Valley to buy a music tape, to buy music for myself, she

work in the store that is selling music tape. I come in asking for

the tape and she does not have it and she introduce herself. I introduce myself and she asking me what do I do for a living. I said,

I am selling stock, and first she ask me where I come from. I said

I came from Texas.

Senator LEVIN. Was that true?

Mr. CAO. Is that very true.

Senator LEVIN. And whose idea was it that you would buy and

sell stocks for her? Was that your idea or her idea?

Mr. CAO. That is her idea.

Senator LEVIN. And was the CEO of Providential aware of the

fact that you were buying and selling stocks for her?

Mr. CAO. Yes. He—Mr. Moon aware about the trading.

Senator LEVIN. Even though you had absolutely nothing to do

with Providential, they were aware of the fact that you were trading for her?

Mr. CAO. They must be aware.

Senator LEVIN. Pardon?

Mr. CAO. Mr. Moon must be aware about that.

Senator LEVIN. Must be aware?

Mr. CAO. Must be.

Senator LEVIN. But you said that they did not even know of your

existence. You had nothing to do with them. How could they be

aware?

Mr. CAO. Well, first, the account have to open with them, with

Mr. Moon, and Mr. Moon will set up the computer for me to trade

and Mr. Moon’s back office must provide the buying power, provide

the number for me to trade.

Senator LEVIN. And for yourself or for Ms. Le?

Mr. CAO. No, for me to trade on her behalf.

Senator LEVIN. So you did set up an account there in order to

trade on her behalf?

Mr. CAO. No. She set up the account, not me.

Senator LEVIN. You dealt with Mr. Moon, did you not?

Mr. CAO. I do not deal with him. Ms. Amy Le come in to open

account——

Senator LEVIN. Were you with her?

Mr. CAO. Pardon?

Senator LEVIN. Were you with her?

Mr. CAO. I was in the office and I was—I was in the office.

Senator LEVIN. Were you with her?

Mr. CAO. No. Sometime I was, sometime I was not.

43

Senator LEVIN. When she opened up her account, were you with

her?

Mr. CAO. No, I was not.

Senator LEVIN. She just walked in on her own. You were somewhere else in the office——

Mr. CAO. I was somewhere else in the office.

Senator LEVIN. Not with her?

Mr. CAO. Not with her.

Senator LEVIN. But you told her to come in there and open an

account?

Mr. CAO. No, she came in and by her own idea and her own——

Senator LEVIN. Finally, though, Mr. Fahman, the CEO of Providential, was aware of the fact that you were going to be doing trading for Ms. Le?

Mr. CAO. I do not know that.

Senator LEVIN. You never told him that?

Mr. CAO. I do not know about that at all.

Senator LEVIN. Did you ever tell him you were going to be doing

trading for Ms. Le?

Mr. CAO. I have no opportunity to know Henry Fahman when

the account opened.

Senator LEVIN. So you never told him that you were trading for

Ms. Le?

Mr. CAO. Tell whom?

Senator LEVIN. Mr. Fahman.

Mr. CAO. I did not have the opportunity. I did not know him.

Senator LEVIN. I am asking you whether you ever told him you

were trading for Ms. Le.

Mr. CAO. I did not.

Senator LEVIN. Thank you.

Mr. CAO. Thank you.

Senator COLLINS. Thank you, Mr. Chairman. Mr. Chairman—I

cannot believe I am promoting you like that. [Laughter.]

We are in the final moments of a vote. Senator Durbin, do you

want to begin, or would you prefer to begin when we come back

from the vote? It is my understanding we have about 3 minutes

left.

Senator DURBIN. Vote.

Senator COLLINS. I think we had better go vote. We will stand

in recess for 15 minutes.

[Recess.]

Senator COLLINS. The Subcommittee will come to order. At this

time, I am pleased to call upon Senator Durbin for his questions.

Senator DURBIN. Thank you, Madam Chairman.

Mr. Cao, I would like to just ask you two or three questions. Are

you represented by counsel today?

Mr. CAO. No, sir.

Senator DURBIN. Do you understand that you are under oath?

Mr. CAO. Yes.

Senator DURBIN. And that the answers that you give must be

truthful?

Mr. CAO. Yes.

Senator DURBIN. Thank you very much.

44

Mr. Parish, I would like to ask you a couple questions. You did

some television advertising as part of the promotion of All-Tech?

Mr. PARISH. Yes.

Senator DURBIN. And you were the person on the ad?

Mr. PARISH. Some of them.

Senator DURBIN. OK. Was there money to be made by bringing

in more people to be day traders at All-Tech?

Mr. PARISH. More customers means more money, yes.

Senator DURBIN. And what did each one of your so-called customers, these day traders, pay in commission for each of the

trades?

Mr. PARISH. Twenty-five dollars.

Senator DURBIN. Twenty-five dollars? And what was the average

number of trades that your day traders would make each day?

Mr. PARISH. I would suggest to you that the—well, I would say

somewhere between 5 and 10 round-trips.

Senator DURBIN. I am not understanding round-trip.

Mr. PARISH. Think of buy-sell as a round-trip.

Senator DURBIN. So how much would they pay in commission,

then, using that 5, 10 round trips as a——

Mr. PARISH. Two-hundred-and-fifty dollars or $500.

Senator DURBIN. So between $250 and $500 a day, they are making profit for All-Tech, or at least they are bringing in commissions

for All-Tech, is that correct?

Mr. PARISH. Yes.

Senator DURBIN. So before they show their first penny of personal profits, they have to pay off the commissions, obviously.

Mr. PARISH. No, they have to make a winning trade.

Senator DURBIN. Well, of course, but they had better make more than $500 if they are paying you $500 in commissions, right?

Mr. PARISH. No. One trade is $50. They have to make more than $50.

Senator DURBIN. Well, you can do it trade by trade or day by day, but at the end of the day, if I am in the $500 category of paying commissions and look at my results of day trading and I may

have made money and lost on another, I had better net out $501

or I have had a losing day, right?

Mr. PARISH. Right.

Senator DURBIN. Thank you. So the more people you have day

trading, the more money for All-Tech, is that correct?

Mr. PARISH. Yes.

Senator DURBIN. And if these people win or lose at the stock

market, it really is not that important to you, is it?

Mr. PARISH. Oh, yes, it is.

Senator DURBIN. Why?

Mr. PARISH. If they keep losing, I will be out of business.

Senator DURBIN. Really?

Mr. PARISH. Eventually, yes.

Senator DURBIN. That is interesting, because you were quoted in

the course of your deposition saying something that I think is

worth repeating at this point. Let me see if I can find it here. Oh,

here it is.

Mr. Parish, in your deposition testimony, you indicated that,

‘‘Eighty to 90 percent of the people that trade lose their money

45

within 6 months, and given the chances of profitability,’’ your

words, ‘‘it is amazing how many people still want to try it.’’

Mr. PARISH. It is, that is true.

Senator DURBIN. Yes, it is amazing, is it not?

Mr. PARISH. Yes.

Senator DURBIN. It is a pretty big losing proposition, is it not?

Mr. PARISH. Yes, it is.

Senator DURBIN. Yes. So despite this losing proposition for the

people involved in it, the company did pretty well.

Mr. PARISH. I believe All-Tech does well.

Senator DURBIN. Yes. In fact, I think the Washington Post this

morning has a story which is based on some of the findings of this

Subcommittee. If I am not mistaken, it turns out that these daytrading firms, 15 of the largest firms in the field pulled in revenue

last year of $541.5 million, 276 percent more than in 1997. Profits

spiraled to more than $66 million. Last year, those firms alone

opened more than 12,000 new accounts. That is from the Washington Post story.

So let me just kind of go into the basics of this. I have seen your

TV ad. I am just swept away by how convincing you are and I call

and say, I want to get in on this deal. This is just too good to be

true. So how much money do I have to put up front to be a day

trader at All-Tech?

Mr. PARISH. Twenty-five-thousand when I left.

Senator DURBIN. And no exceptions to the rule, $25,000 cash or

else?

Mr. PARISH. There were special situations on occasion where

somebody would beg and plead and visit the office 10 times in a

row and be allowed to start with less.

Senator DURBIN. How little could they start with?

Mr. PARISH. I do not remember starting with anything much less

than—well, let me back up a second. There came a time at All-Tech

when we were trying to attract business somewhat as Charles

Schwab does, where a customer could come in with a $10,000 deposit and then they could stop by the office at any time during the

course of their regular day and adjust their own portfolio, sit down

at a computer, buy the stock that they want, sell the one that they

do not want. So there was a time it was as little as $10,000. It

started at $50,000. It went to $25,000. It came down to $10,000.

And then it went back to $25,000.

Senator DURBIN. And if I came in with $10,000 and I wanted to

buy stock, how much could I buy with a $10,000 account at AllTech?

Mr. PARISH. Twenty-thousand dollars’ worth of marginable securities.

Senator DURBIN. Twenty-thousand dollars. And was that accounted for on a daily basis, as to whether I was meeting my margin requirement?

Mr. PARISH. Absolutely.

Senator DURBIN. Every single day?

Mr. PARISH. Every trader received a trade blotter showing his

trades. Every morning when the trader came to the office, he received a trade blotter showing the previous day’s trades and he reVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
46

ceived a margin report showing his positions, his equity, his margin debit, his margin calls, everything.

Senator DURBIN. Why do we have margin rates, margins at all

in this business?

Mr. PARISH. To prevent people from over-borrowing.

Senator DURBIN. Going too far, is it not?

Mr. PARISH. Yes.

Senator DURBIN. And so, frankly, if I have had a very bad day,

I am supposed to, at least under the practices and regulations,

back off. But as I understand the testimony from you and some of

the things that you have submitted, if I had a very bad day, AllTech knew how to take care of me by transferring money from another account so I can keep right on rolling. Is that not true?

Mr. PARISH. It was not to help you out from having a bad day.

It was to help you keep your account open once you made a mistake.

Senator DURBIN. A mistake?

Mr. PARISH. Yes.

Senator DURBIN. What kind of mistake?

Mr. PARISH. Very simply——

Senator DURBIN. Bad trade?

Mr. PARISH. Not necessarily. You see, most people in the beginning, when they came into my office, they somehow thought they

were going to get in a Volkswagen and drive to Florida or something. But when they sat down in front of a trading machine, they

realized real soon that they were somewhat more realistically piloting a jet fighter plane here.

Senator DURBIN. Oh, so we had computer errors on top of bad

judgments on investments?

Mr. PARISH. Oh, many. It is very simple, Senator Durbin. You

buy 1,000 shares of stock and you own it, and then execute what

you believe to be the sell when, in reality, you just bought it again.

Senator DURBIN. So you had to have some pretty extensive training so people would not make these so-called mistakes, right?

Mr. PARISH. We did our best to teach them, but——

Senator DURBIN. What was your best? How long did you train

these——

Mr. PARISH. Training lasts 1 week.

Senator DURBIN. One week? Five days?

Mr. PARISH. Five consecutive—7 days.

Senator DURBIN. Seven days?

Mr. PARISH. Seven days with an instructor right there with the

class.

Senator DURBIN. I do not think anybody who testified earlier

talked about 7 days. They talked about 2 days. Did that happen?

Mr. PARISH. No, it never did happen.

Senator DURBIN. Never did happen?

Mr. PARISH. No.

Senator DURBIN. Someone only had 2 days of training? So they

get these 7 days of training, you sit them down in front of this jet

aircraft panel computer type thing and turn them loose and they’ve

got $10,000 in their account. They can buy $20,000 worth of stock

and they make a big mistake.

[Mr. Ambrose consults with Mr. Parish.]

47

Mr. PARISH. Well, it is not quite like that.

Senator DURBIN. Well, please explain. I thought I was following

you pretty closely.

Mr. PARISH. I will explain how I do it. I would be happy to. When

a customer answers my ad, he first has to come see my office and

see what we do. When he sits down with me at a trading terminal

and looks at that, 8 out of 10 of them leave and never come back.

Senator DURBIN. The smart ones?

Mr. PARISH. Yes, well, maybe they are smart, maybe they are

not. It remains to their experience afterwards. But of the two that

remain that go through the class, they get 7 days of training with

an instructor right there with them the entire time and then they

do not just sit down at a computer with their $10,000 and buy

$20,000 worth of stock. They are encouraged to simulated trade or

paper trade to get the software down.

Senator DURBIN. What kind of commission do you make on simulated trades?

Mr. PARISH. Zero commission.

Senator DURBIN. So at some point, for the good of your business,

you have got to get them beyond simulation and help them get

ready to take off in this new jet pilot——

Mr. PARISH. But I would never push anybody to start trading live

if they are not ready.

Senator DURBIN. But interesting, too, because the testimony was

that at your office, it was like a circus atmosphere and cheering,

to load up to buy and now it is time to sell, and it sounds like it

was a chorus section going, not so much people at the computer

making these discrete decisions. What was the atmosphere?

Mr. PARISH. On occasion, it was.

Senator DURBIN. Occasionally, it turned out to be a circus-like atmosphere?

Mr. PARISH. Well, occasionally, we would cheer when someone

made an exceptionally good trade and announced it to the whole

group. My office, I encouraged people to share information with

each other throughout the day to see what they saw.

Senator DURBIN. Journaling, let us talk about journaling. That is

moving money from my account to somebody else’s account on a

temporary basis, is that correct?

Mr. PARISH. Yes.

Senator DURBIN. OK. And what are the largest amounts that you

can recall journaling between accounts?

Mr. PARISH. I think $100,000 is a large amount for my office.

Mr. PARISH. So if I am sitting there trading and I have got

$100,000 in my account, what would you do? Would you ask me,

I have got this fellow right next to you who had a bad day, made

a few mistakes. Could you transfer $100,000 from your account to

his account? Could we journal that? Is that how that would go?

Mr. PARISH. Generally, I would tell you to ask him, but if you

would say, no, I do not want to ask him, could you ask him for me,

I would ask him for you.

Senator DURBIN. And so would people say at that point, well, is

he good for it? Have you done a credit check on him? What do you

know about this person? If I am going to give him $100,000, how

do I know he is even going to be here tomorrow?

48

Mr. PARISH. You do not.

Senator DURBIN. You really do not? Interesting business.

Mr. PARISH. That is why, as All-Tech explained, you fill out the

return journal at the same time, so regardless of whether he comes

back or what he does, the money comes back to you the next day.

Senator DURBIN. Oh, it does, automatically?

Mr. PARISH. Automatically.

Senator DURBIN. At All-Tech’s expense?

Mr. PARISH. It comes out of the customer’s account that received

it unless that customer loads up on a whole bunch of stocks.

Senator DURBIN. Did that ever happen?

Mr. PARISH. Yes, oh yes.

Senator DURBIN. And so somebody was left holding the bag when

they journaled some money?

Mr. PARISH. All of my customers always received their money

back. Nobody ever failed to receive their money.

Senator DURBIN. From journaling.

Mr. PARISH. From journaling.

Senator DURBIN. That is not counting the mistakes?

Mr. PARISH. Just from the journals. All journaled funds were returned 100 percent, not always the next day, however.

Senator DURBIN. Well, I see my time has expired, and I think

there is more that we will be asking you, but it just strikes me as

incredible as we read the Washington Post story that people fall for

this, and I guess this hearing will perhaps diminish your business

but maybe educate the American people about what a con game is

going on here. Thank you.

Senator COLLINS. Thank you, Senator Durbin.

Unfortunately, we are in the midst of two back-to-back votes, so

we will stand in recess for 20 minutes.

[Recess.]

Senator COLLINS. The Subcommittee will resume, come to order.

Mr. Cao, in response to a question from Senator Levin, you testified that you were not with Ms. Le when she opened her account.

I would like to direct you to look at your deposition and to look specifically at page 152. And while you are finding that, I will read

you what you told us under oath. You talk about going to see Ms.

Le at a park where her children are playing ball. You say, ‘‘And

then I came out to play ball with her children at the same time.

At the meantime, she filled out the application and completed the

paperwork. In between one of these times, she visited the office.’’

This is the question to you now. ‘‘In between one of the times she

visited the office, you talked to her by phone and she asked you to

come see her in a park next to the police station. You brought the

paperwork for her to open the new account form?’’

Your response was, ‘‘She said she had lost the last application.’’

Question: ‘‘Would you bring it?’’

Answer: ‘‘And she needed a new form.’’

Question: ‘‘She asked you to bring that new material?’’

Answer: ‘‘Uh-huh.’’

‘‘So you brought that material out and gave it to her in the car?’’

Your response, ‘‘Right.’’

Question: ‘‘And she sat in the car and filled out the paperwork

while you played with her kids in the park?’’

49

‘‘Yes.’’

So in view of that transcript, which was under oath, how could

you respond to Senator Levin’s question that you were not with her

when she opened the account?

Mr. CAO. Yes. I do not consider this at the time that she opened,

effectively opened the account. She filled out the information and

my only thing, and my understanding, when she opened an account

with a signature of that officer allow her to open the account, is

what I mean.

Senator COLLINS. Well, it seems to me if you brought her the application, were with her when she filled it out, and under oath she

has testified that she handed you a check to open the account, that

you clearly were with her when she opened the account.

Mr. CAO. Again, I understand differently. I understand that

when the account opened, when the manager, the branch manager,

put his signature on the account forms.

Senator COLLINS. I would like to now direct you to page 151 of

the transcript. It is the same page that you are on. Do you see the

numbers? You testified earlier that Ms. Le’s lawyer was not telling

the truth when he said that she was not wealthy. You said that

she had $200,000. Yet, under oath, you said, and I want to read

this part of the transcript, the question to you was, ‘‘How was it

that you came to meet her in her car?’’

Answer, your answer: ‘‘She called me. She said, ‘My car broke,’

and she already introduced to me that she was very poor. She

showed me the broken car.’’

Question: ‘‘She would always tell you that she was very poor?’’

Answer: ‘‘Yes. She would say she is very poor and I believe it,

and she says, ‘I want to open the account so that I can get money

to buy for myself a car, a new car.’ I believe it. I believe all she

said.’’

Mr. CAO. Yes, that was correct at that time.

Senator COLLINS. So you do not dispute at the time that she

opened the account that she was not wealthy and that she expected

to have money made through day trading?

Mr. CAO. Evidence later on proving that she was very wealthy

then, but she told me that she was not and I believe what she said

to me.

Senator COLLINS. Let me refer you to another part of your transcript. Again, in response to a question asked to you this morning

by Senator Levin, you testified that you only traded for one or two

clients at Providential’s Los Angeles branch office, which was operating under the name of Hahna Global. Now, I would like for you

to look at your deposition transcript on page 136.

You were asked the question, and I quote, ‘‘How many total do

you think you traded on their behalf?’’

Answer: ‘‘In and out?’’

Question: ‘‘Yes.’’

Answer: ‘‘Maybe 21 or 22.’’

Now, how do you reconcile that with your response to Senator

Levin today that you are only trading for one or two individuals?

Mr. CAO. Chairman, I recall that the Senator asked me how

many clients like Amy Le, and my response was, the only one.

Senator COLLINS. So what were the rest of these 21 people?

50

Mr. CAO. He did not ask me how many people total. He did

not——

Senator COLLINS. He asked you ‘‘how many people you were trading for.’’

Mr. CAO. No, I did not recall that. If you can backtrack the

record——

Senator COLLINS. Well, would you like to correct the record, since

you are under oath, about how many people did you trade the accounts for?

Mr. CAO. Well, if that is the question, then my answer is, in

total, I trade now for about 20-some for many years.

Senator COLLINS. Mr. Cao, Amy Le’s lawyer testified this morning that the NASD found you liable for thousands of dollars of

losses that resulted from your day trading Ms. Le’s account. Is that

accurate?

Mr. CAO. No, not at all. Not at all.

Senator COLLINS. It is not accurate that NASD——

Mr. CAO. Not accurate.

Senator COLLINS [continuing]. Entered a judgment against you

for thousands of dollars?

Mr. CAO. Again, Your Honor, it is not accurate at all.

Senator COLLINS. Well, we have the judgment of NASD here. Are

you disputing that the NASD found you liable for any amount of

money for——

Mr. CAO. Yes, Your Honor. I respect the law, but I do very much

disagree.

Senator COLLINS. That is not my question. I asked you, did you

agree with the testimony or disagree with the testimony of Amy

Le’s lawyer that the NASD found you liable for thousands of dollars of losses resulting from your trading of Ms. Le’s account. You

said that that was false, and yet I have in my hand the award provision from that decision which very clearly says, Respondent,

Huan Van Cao, is liable to and shall pay the Claimant, that is Amy

Le, an additional sum of $22,593.11 in compensatory damages plus

7 percent interest. So how can you say that it is not true that the

NASD entered a judgment against you?

Mr. CAO. OK. Basically, what I see it, the document speaks for

itself. Whatever there is correct, right.

Senator COLLINS. The document directly contradicts what you

just said under oath.

Mr. CAO. But I disagree with their finding.

Senator COLLINS. That is a different question.

Mr. CAO. Well——

Senator COLLINS. I did not ask you, do you agree with the decision. I asked you, did the NASD find you liable for thousands of

dollars to be paid to Amy Le to compensate her?

Mr. CAO. The answer is yes.

Senator COLLINS. That is the accurate answer.

Mr. CAO. That is right.

Senator COLLINS. Have you paid Ms. Le?

Mr. CAO. No, Your Honor.

Senator COLLINS. Why have you not paid that judgment?

Mr. CAO. I do not have money.

51

Senator COLLINS. It is my understanding that you filed for bankruptcy 2 months after the NASD judgment, is that correct?

Mr. CAO. That seems correct.

Senator COLLINS. In your bankruptcy filing, you claimed an ex- emption of $50,000 for your home, $44,000 for your personal property, which includes three cars, and a 401(k) account worth

$25,000. So you clearly have assets. Why have you not paid Ms. Le

the $22,000 for which you have been found liable?

Mr. CAO. I do not have money for it.

Senator COLLINS. So you are testifying under oath today that you

do not have sufficient funds to pay Ms. Le’s judgment?

Mr. CAO. That is correct.

Senator COLLINS. Mr. Parish, at the time that you were Branch

Manager at All-Tech’s San Diego office, did All-Tech have minimum deposit requirements to open a day trading account?

Mr. PARISH. That has always been the question. It is not a minimum deposit to open an account. It is a minimum deposit to get

a log-on to trade an account. You can open the account with no deposit.

Senator COLLINS. But to begin trading, was there a minimum deposit requirement?

Mr. PARISH. Yes.

Senator COLLINS. And what was that requirement?

Mr. PARISH. When I first became affiliated with All-Tech, it was

a $50,000 deposit, and then it——

Senator COLLINS. And when was that?

Mr. PARISH. That was in January 1997. My first training class

was February 1997.

Senator COLLINS. And it is my understanding that that deposit requirement of $50,000 was in effect until January of 1999, when

it was lowered to $25,000, is that correct?

Mr. PARISH. No. It was lowered before that.

Senator COLLINS. Do you know when it was lowered?

Mr. PARISH. I would suggest it was lowered about mid-way

through my 3 years with them, which I believe would put it somewhere in 1998, mid-1998, I expect.

Senator COLLINS. According to the responses we received from

All-Tech in response to our interrogatories, the standard was

$50,000 until January 1999. Is it possible that you are remembering incorrectly on that?

Mr. PARISH. I suppose it is possible.

Senator COLLINS. My time has expired, so I am going to go to

Senator Levin, but I do want to come back to that point.

Senator LEVIN. Go ahead.

Senator COLLINS. I would like to show you an advertisement.

Can you see the screen from where you are?

Mr. PARISH. Yes.

Senator COLLINS. I would like to show you an advertisement that

the previous witness, Ms. Margala, said was the advertisement

that enticed her to become a day trader, if we could roll the advertisement.

[A videotape was played.]

Senator COLLINS. This is obviously not the advertisement,

though perhaps it should have been. Since we are obviously not

52

able to get this up, Mr. Parish, I am sure you are familiar with the

ad. It is the ad that you are in. I think you produced it. It is a very

dynamic ad.

Mr. PARISH. Thank you.

Senator COLLINS. In the ad, you make a reference to a $10,000

amount. Why does your ad say that you only need $10,000 to open

a day trading account when at the time this ad was made, All-Tech

has informed us that $50,000 was required?

Mr. PARISH. All-Tech’s memory is incomplete. All-Tech’s minimums started at $50,000, subsequently went to $25,000, and for a

time they were actively—we were all at All-Tech, with All-Tech’s

blessing, actively engaged in seeking customers, like I explained to

Senator Durbin, to come in and open accounts for $10,000 that

were not actively day traded in the true sense of multiple turnover

of the assets. They were called retail accounts.

Senator COLLINS. But in this ad, which unfortunately I cannot

show you, this ad is for day trading accounts. So I want to go back.

You said that All-Tech’s information was incorrect that they provided us. Is that your testimony?

Mr. PARISH. Yes.

Senator COLLINS. So the information we received from All-Tech

on what the minimum standard was at that time is incorrect?

Mr. AMBROSE. May I have a moment?

[Mr. Ambrose consults with Mr. Parish.]

Mr. PARISH. This ad was specifically approved by All-Tech.

Senator COLLINS. Mr. Parish, at the end of the ad, there is a

white-haired gentleman who is grinning broadly. Are you familiar

with who that gentleman is?

Mr. PARISH. Yes.

Senator COLLINS. And is his name Fred Cook?

Mr. PARISH. Yes.

Senator COLLINS. Is it accurate that at the time that that ad was

made, that Mr. Cook had not yet begun day trading?

Mr. PARISH. Yes, that is correct.

Senator COLLINS. And ultimately, did not Mr. Cook lose approximately $175,000 day trading?

Mr. PARISH. I do not know what the exact number was, but he

lost substantial money, not by day trading.

Senator COLLINS. But not by day trading?

Mr. PARISH. He made bad investments.

Senator COLLINS. And is it accurate to say that he has sued both

you and All-Tech?

Mr. PARISH. Yes.

Senator COLLINS. OK. Mr. Zayas, did you ever change numbers

on new account forms to make customers appear more suitable for

day trading?

Mr. BERMAN. May I have a moment?

Senator COLLINS. Yes.

Mr. ZAYAS. No, I did not.

Senator COLLINS. Did anyone at All-Tech ever suggest to you

that you should change numbers on new account forms to make the

customers appear to be more suitable for day trading?

Mr. ZAYAS. Yes.

53

Senator COLLINS. And who at All-Tech—I am sorry, it is not AllTech. Who at your firm suggested that you alter the figures?

Mr. ZAYAS. It was All-Tech.

Senator COLLINS. It is All-Tech. I am sorry.

Mr. ZAYAS. Yes, it is All-Tech.

Senator COLLINS. Who did suggest that you alter the figures to

make the customers seem more suitable?

Mr. ZAYAS. The people in the margin department.

Senator COLLINS. But you are testifying today that you did not

alter numbers on new account forms to make customers appear

more suitable?

Mr. ZAYAS. That is correct.

Senator COLLINS. Senator Levin.

Senator LEVIN. Thank you, Madam Chairman.

Mr. Cao, earlier I held up a document here on Hahna Global

Capital Management, Inc., stationery which lists you as the Senior

Vice President of Hahna Global Capital, and we are getting you a

copy now so you will have that in front of you. You told me that

you were shocked when you discovered that, and I asked you when

was the first time that you saw that and you told me that it was

about 4 months after you went to trade at Hahna, and then you

said it was after Amy Le’s complaint had been filed. Her complaint

was filed in early 1999. That is her complaint with NASD.

Now, you testified under oath before the Subcommittee staff, and

according to your testimony, you said that you sent this very piece

of paper with the letterhead identifying you as a Senior Vice President on March 20, 1998, almost 1 year before Ms. Le’s complaint

had been filed. And if you will look at the date at the top of that,

the fax date, you will see where that date appears. By the way, is

this your signature on this sheet?

Mr. CAO. Yes, it was my signature.

Senator LEVIN. So, in fact, you knew nearly 1 year before Ms.

Le’s complaint was filed that you were listed on Hahna Global’s letterhead as their Senior Vice President, is that not true?

Mr. CAO. It seemed to me they list me as Senior Vice President

of Hahna Global Capital Management, yes.

Senator LEVIN. Did you send this fax that is in front of you——

Mr. CAO. No, I did not.

Senator LEVIN. Excuse me. Let me just finish my question. Did

you send this fax to a Ms. Richardson in March 1998?

Mr. CAO. No, I did not.

Senator LEVIN. I want to read to you now from your deposition.

Mr. CAO. OK.

Senator LEVIN. ‘‘Did you send this fax to Ms. Richardson in

March 1998 to let her know that you were in L.A. and that you had

gotten settled?’’ Answer, ‘‘Yes.’’ That is your sworn deposition. Now,

you are under oath here and you say that you did not send this

to her in March 1998.

Mr. CAO. May I provide the additional information?

Senator LEVIN. Yes, but either you were telling the truth in your

deposition or you are telling the truth today.

Mr. CAO. Well, in that firm, I am not allowed to use any fax machine at all. Whatever fax sent out need to be sent out by the back

office, not by me directly or physically.

54

Senator LEVIN. The question asked in your deposition was, ‘‘Did

you send this fax to Ms. Richardson in March 1998 to let her know

that you were in L.A. and that you had gotten settled?’’ Your answer was, ‘‘Yes, uh-huh.’’ Was that answer true?

Mr. CAO. I do not—that answer seems not to be—not to be clearly correct.

Senator LEVIN. Your answer was not accurate in the deposition?

Mr. CAO. My answer is, I do not recall.

Senator LEVIN. You do not recall making the answer?

Mr. CAO. I do not recall about sending this fax out.

Senator LEVIN. I see. When you testified at your deposition as

follows, ‘‘Did you send this fax to Ms. Richardson in March 1998,’’

your answer was, ‘‘Yes, uh-huh.’’ Was that statement true when

you made it at the deposition or did you not remember when you

said you did remember at the deposition?

Mr. CAO. I did not remember.

Senator LEVIN. So then your answer at the deposition, that yes,

you sent this fax to her in 1998, was not true?

Mr. CAO. I could not recall because here in that firm, I am not

allowed to use any fax machine at all.

Senator LEVIN. Whether you are allowed to use a fax is a different question from whether or not you remember the fax being

sent out to her in March 1998. Do you remember that in March

1998, this letter was faxed to her under your signature?

Mr. CAO. I will not be able to have any fax machine from that—

from inside of that firm to send out any fax.

Senator LEVIN. Is this your signature?

Mr. CAO. Yes, it is.

Senator LEVIN. And when did you send this to her?

Mr. CAO. I do not recall.

Senator LEVIN. Was it in 1998?

Mr. CAO. It does not seem right.

Senator LEVIN. You do not think you sent it to her in 1998?

Mr. CAO. I do not think so.

Senator LEVIN. When would you have sent it to her?

Mr. CAO. I do not recall.

Senator LEVIN. Are you currently day trading?

Mr. CAO. Yes, I am.

Senator LEVIN. Even though you are in bankruptcy?

Mr. CAO. Yes, I am.

Senator LEVIN. How are you suitable for day trading if you are

in bankruptcy?

Mr. CAO. Well, day trader look like any job. I come in to do the

job and even that I file for bankruptcy, I still much am living.

Senator LEVIN. You still what?

Mr. CAO. I still have to do something to make my living.

Senator LEVIN. So you are not using any of your own funds?

Mr. CAO. Not, not at all.

Senator LEVIN. And whose funds are you using?

Mr. CAO. I have three accounts at this time.

Senator LEVIN. And you have three customers?

Mr. CAO. Yes.

Senator LEVIN. And you only do day trading for them?

Mr. CAO. Yes.

55

Senator LEVIN. Would you file the names of those customers with

the Subcommittee? Will you give us the names of those customers?

Mr. CAO. Yes, I did.

Senator LEVIN. You have already?

Mr. CAO. Yes, I provided those names.

Senator LEVIN. Mr. Zayas, am I pronouncing your name correctly?

Mr. ZAYAS. Zayas.

Senator LEVIN. Zayas. In your deposition before the Subcommittee staff, you said that you first met the head of All-Tech,

Mr. Houtkin—am I pronouncing his name——

Mr. ZAYAS. Houtkin, yes.

Senator LEVIN [continuing]. Houtkin, that when you first met

him, ‘‘he kept stressing that it was—I was going to change my career. I was going to make millions and it was going to change my

life.’’ That is your quote.

Mr. ZAYAS. That is correct.

Senator LEVIN. And is that what he told you?

Mr. ZAYAS. Yes, it is.

Senator LEVIN. And how long had Mr. Houtkin known you when

he told you that this was going to make millions for you, change

your life? How long had he known you when he said that to you?

Mr. ZAYAS. Probably about 15 minutes.

Senator LEVIN. When he told you that, did he have any knowledge about your background, your educational background, whether you had any experience in securities trading?

Mr. ZAYAS. No. He had——

Senator LEVIN. Pardon?

Mr. ZAYAS. No.

Senator LEVIN. Now, did you make millions?

Mr. ZAYAS. No, I did not.

Senator LEVIN. Did you make anything?

Mr. ZAYAS. No, I did not.

Senator LEVIN. How much did you lose?

Mr. ZAYAS. Trading, approximately $60,000.

Senator LEVIN. During your initial trading, did All-Tech personnel say that if you generated a margin call, that they would

help you locate someone to help you meet that call?

Mr. ZAYAS. I did not trade at All-Tech.

Senator LEVIN. Pardon?

Mr. ZAYAS. I did not trade at All-Tech. After I took the class at

All-Tech, I had spoken with Harvey and I had taken the class,

there was no office in the Boston area. Harvey said that he would

find a trader for me to trade my account, since I obviously could

not commute between Boston and Montvale, New Jersey. So he

found a trader for me and that trader lost $60,000.

Senator LEVIN. OK. Now, my question is the following: During

the training class, were you told that if you generate a margin call,

that you will be able to find someone within the office to help you

meet the margin call?

Mr. ZAYAS. Yes.

Senator LEVIN. So you were informed of that during your training class?

Mr. ZAYAS. Yes, I was.

56

Senator LEVIN. Who was it who said that?

Mr. ZAYAS. It was probably somebody in the margin department

that——

Senator LEVIN. At your deposition, you said it was someone

named Kim-Lisa Esposito.

Mr. ZAYAS. Yes, that is in the margin department, Lisa Esposito,

yes.

Senator LEVIN. Lisa Esposito?

Mr. ZAYAS. Yes.

Senator LEVIN. Now, when they told you that during your training class, did they indicate that they would charge a fee for covering that margin account with such a loan?

Mr. ZAYAS. No.

Senator LEVIN. Now, I want to read your deposition to you. ‘‘At

that time’’—this is right after—let me just read the question. It is

on page 27. ‘‘At that time’’—this is during your training class—

‘‘was there any discussion of a fee that would be charged to a customer who borrowed money for such purposes?’’ Your answer was,

‘‘They did state that sometimes, depending on the situation, that

you might be charged a fee.’’ Is that true?

Mr. ZAYAS. I just—I do not recall. That was in 1995.

Senator LEVIN. Do you recall saying that at the deposition?

Mr. ZAYAS. Yes, I do.

Senator LEVIN. So you recall that being said at the deposition,

but you cannot recall——

Mr. ZAYAS. I am not 100 percent certain that it was at the class,

that it said that during the training class. I am not sure it was said

during the training class.

Senator LEVIN. But it was said at some other point?

Mr. ZAYAS. It must have—it was obviously said various times.

Senator LEVIN. To you?

Mr. ZAYAS. Yes, but not at the training class.

Senator LEVIN. All right. Now, there was a man or a woman

named Jody Krajak?

Mr. ZAYAS. Krajak.

Senator LEVIN. Is that a man or a woman?

Mr. ZAYAS. That is a man.

Senator LEVIN. A man named Jody Krajak——

Mr. ZAYAS. Yes.

Senator LEVIN [continuing]. Who you authorized, I believe, to

trade in your account, is that correct?

Mr. ZAYAS. Yes.

Senator LEVIN. And how did you happen to get into that situation? Was that at the suggestion of Mr. Houtkin?

Mr. ZAYAS. Yes, it was.

Senator LEVIN. Tell us how that happened.

Mr. ZAYAS. Well, I had finished taking the class and Harvey had

told me that there was no day-trading firms in Boston and that he

could find a trader for me to trade my account, that he had done

that in the past with numerous individuals. And he introduced me

to a number of people and——

Senator LEVIN. Did he introduce you to Mr. Krajak?

Mr. ZAYAS. Yes, he did.

57

Senator LEVIN. And to your knowledge, was Mr. Krajak a registered investment advisor or registered with the Securities and

Exchange Commission and the NASD to sell or trade in securities?

Mr. ZAYAS. To my knowledge, he was not.

Senator LEVIN. Now, you became a manager of the All-Tech

branch in Watertown, is that correct?

Mr. ZAYAS. Yes.

Senator LEVIN. And did Mr. Houtkin offer you that job?

Mr. ZAYAS. Yes, he did.

Senator LEVIN. I believe you told the Subcommittee staff that

you believe that he offered it to you as a consolation for the significant losses that you suffered through the trading and Mr. Krajak,

is that correct?

Mr. ZAYAS. He reduced the fee, also.

Senator LEVIN. The fee for what?

Mr. ZAYAS. To open up a trading office, a branch office.

Senator LEVIN. In other words, you are paying a fee to open up

this office?

Mr. ZAYAS. That is correct.

Senator LEVIN. And he reduced it from what to what?

Mr. ZAYAS. Well, the fee varied. It was from $75,000 to $100,000

and he reduced the initial fee down to $50,000.

Senator LEVIN. When you say initial fee, did he say you would pay the $25,000 extra later?

Mr. ZAYAS. No, but there was other charges.

Senator LEVIN. Now, did you receive any training from All-Tech

on how to be a branch office manager?

Mr. ZAYAS. No, I did not.

Senator LEVIN. Did you at any point forge documents to make account transfers for the purpose of meeting margin calls?

Mr. ZAYAS. I respectfully refuse to answer that question based on

my Fifth Amendment right.

Senator LEVIN. Did you at any time forge documents so that a

customer account could remain open and you could earn additional

commission income on trades that continued to be made through

the accounts?

Mr. ZAYAS. I respectfully refuse to answer that question based on

my Fifth Amendment right.

Senator LEVIN. I believe you had a total of about 50 customers

over the period of time that you managed the Watertown office between September 1997 and November 1998, is that correct?

Mr. ZAYAS. It was a little bit more.

Senator LEVIN. About how many?

Mr. ZAYAS. Probably—day traders was approximately 50.

Senator LEVIN. OK. Of those 50, how many were profitable?

Mr. ZAYAS. One.

Senator LEVIN. One out of 50?

Mr. ZAYAS. That is correct.

Senator LEVIN. Now, you told the staff that Mr. Houtkin was

aware whether people were making or losing money, is that correct?

Mr. ZAYAS. Yes.

Senator LEVIN. And is it correct that he once told you that people

were losing money, and most people do lose money?

58

Mr. ZAYAS. That is correct.

Senator LEVIN. Did All-Tech track which customers are making

money and which are losing money?

Mr. ZAYAS. Yes.

Senator LEVIN. You told the Subcommittee staff, I believe, that

there was a gathering in the All-Tech branch office in Kansas City

in the spring of 1998, and as you characterize it here, ‘‘Basically,

it was determined that everybody—a lot of—most people were losing money.’’ Do you mean that in most branches, a majority of people were losing money?

Mr. ZAYAS. In my discussions with the branch managers, yes.

Senator LEVIN. And do you believe that Mr. Houtkin was aware

that most traders at the All-Tech branches were losing money?

Mr. ZAYAS. Yes.

Senator LEVIN. Did you ever perform any suitability review of clients before they were accepted?

Mr. ZAYAS. That was not my function.

Senator LEVIN. Do you know if the function was performed?

Mr. ZAYAS. Everything was handled out of the Montvale main office.

Senator LEVIN. And so you do not know whether that function

was performed?

Mr. ZAYAS. I do not know.

Senator LEVIN. I believe you testified to staff that you were told

to change numbers on new accounts, the approval forms for new

accounts, before sending them to the Montvale office to make the

customer more suitable. Is that true?

Mr. ZAYAS. The way the wording was, probably there was a customer form sent to the Montvale office and I was told, do not send

us a form like this again.

Senator LEVIN. The question that was asked at the deposition of

you is the following. ‘‘So Lisa Esposito told you that you should

change numbers on new account approval forms before sending

them to the Montvale office to make the customer appear more

suitable to open a day trading account?’’ Answer, ‘‘Yes.’’ Was that

answer true?

Mr. BERMAN. May I have a moment, sir?

Senator COLLINS. Sure.

Mr. ZAYAS. That is what she told me.

Senator LEVIN. The answer——

Mr. ZAYAS. Yes.

Senator LEVIN. Yes. To your knowledge, was Mr. Houtkin aware

that numbers were changed or inserted on new account approval

forms to make customers appear more suitable to open day trading

accounts at All-Tech?

Mr. ZAYAS. I do not know.

Senator LEVIN. Were there situations where headquarters in

New Jersey would tell you to open new accounts for people under

another name after their old account had been closed or liquidated

because they could not meet the margin calls in those accounts?

Mr. ZAYAS. I did not open accounts. Basically, that was all handled through the New Jersey office.

Senator LEVIN. I have additional questions, but I have taken my

time. Do you want to go back and forth?

59

Senator COLLINS. I am just going to ask a couple of questions.

Mr. Zayas, just to follow up with Senator Levin’s question, were

there any customers whom you believed to not be suitable for day

trading for whom accounts were opened?

Mr. ZAYAS. I was not—I did not have the authority, nor was it

my position to determine whether somebody was suitable or not for

day trading.

Senator COLLINS. I understand that, and you have said those decisions were made in New Jersey, correct?

Mr. ZAYAS. That is correct.

Senator COLLINS. But my question is, were you aware of any

cases in which accounts were opened for customers whom you believed to be unsuitable?

Mr. ZAYAS. Yes.

Senator COLLINS. Yes?

Mr. ZAYAS. Yes.

Senator COLLINS. Mr. Parish, I just have one final question for

you.

Mr. AMBROSE. My client would like to correct what may be a misleading aspect of the answer to your last question.

Senator COLLINS. That will be fine, Mr. Parish.

Mr. PARISH. It was about the ad, when you were mentioning Ms.

Margala responding to the ad.

Senator COLLINS. Yes.

Mr. PARISH. Ms. Margala called my office in response to the ad

and came to visit me at my office, but it was not the ad that caused

her to day trade. It was what she found in the office and how the

office was and what she discovered during her paper trading.

Senator COLLINS. She has testified that but for the ad, she never

would have come to your office to talk about day trading.

Mr. PARISH. OK.

Senator COLLINS. Mr. Parish, what percentage of day traders in

the San Diego office lost money within the first 6 months of trading?

Mr. PARISH. At least 80 percent.

Senator COLLINS. Thank you. Senator Levin.

Senator LEVIN. Thank you. Mr. Zayas, I want to read you part

of your deposition and then ask you if it is true.

Question: ‘‘Did you assist people in opening new accounts when

you knew that other accounts, one or more, that they had been

closed or liquidated because they could not meet margin calls in

those accounts?’’

Answer: ‘‘Well, if an account would get closed up and the customer would say to me, what do I do, what do I do, I would talk

to the Montvale office and say, can this account get reopened, and

sometimes they would say yes and sometimes they would say no

and I do not know what determined that. But if the answer was

no, they would then tell me, ‘Just have them open up another account under a relative’s name or—’’

Question: ‘‘Who told you that?’’

Answer: ‘‘Lisa.’’

Question: ‘‘Esposito?’’

Answer: ‘‘Yes.’’

Question: ‘‘And did you do that for customers?’’

60

Answer: ‘‘Sure. Yes.’’

Was that a true answer?

Mr. ZAYAS. Yes, on their direction, yes.

Senator LEVIN. So you were told by the office that just have them

open up another account under a relative’s name. You were told by

Lisa Esposito that you could do that. Were you directed to do that

or were you told you could do that in order that they could continue

to do day trading?

Mr. ZAYAH. I was told that I could do that. I was not directed

to do that. That was——

Senator LEVIN. In your deposition, you indicated that All-Tech’s

philosophy regarding customer recruitment was, ‘‘take whoever

comes in.’’ Is that correct?

Mr. ZAYAH. That is correct.

Senator LEVIN. And in your deposition, you were told by somebody in the All-Tech corporation’s headquarters that you should inflate net worth numbers on new account forms to make customers

appear more suitable, is that correct?

Mr. ZAYAS. That is what they told me.

Senator LEVIN. You say that is what they told you.

Mr. ZAYAS. Yes.

Senator LEVIN. The answer is that it is correct——

Mr. ZAYAS. That is correct.

Senator LEVIN [continuing]. That you were told by someone in

the All-Tech corporation’s headquarters that you should inflate net

worth numbers on new account forms to make customers appear

more suitable?

Mr. ZAYAS. Yes, that is correct.

Senator LEVIN. Mr. Parish, Ms. Margala and Ms. Harlacher testified that you placed pressure on them to trade their account. Is

that correct? Did you?

Mr. PARISH. I placed pressure on them to stop holding losing positions. If you are not holding positions, then you can trade. Ms.

Margala and Ms. Harlacher continue to enter trades, and when it

went the wrong way, they would not exit the trade.

Senator LEVIN. And so you were urging them to exit trades?

Mr. PARISH. Yes. Get out of them. You are going to lose all your

money doing that.

Senator LEVIN. And were you compensated on the basis of how

many trades were conducted?

Mr. PARISH. Sure.

Senator LEVIN. So the more they traded, the more you made?

Mr. PARISH. Yes.

Senator LEVIN. So you had a direct interest in your advice to

them to trade because you were making more money when they

traded? You had a financial interest, did you not?

Mr. PARISH. Well, Senator, of course.

Senator LEVIN. OK.

Mr. PARISH. But if I could add something, nobody was ever encouraged or forced to make any trade that they did not want to.

The object is only to make a wining trade. That is why I became

a day trader in the first place and left the brokerage industry, is

so that that ambivalence that all brokers must have about whether

they are recommending this trade for the Subcommittee or are they

61

recommending this trade because it is a good trade? I left the retail

brokerage industry because of that ambivalence.

Senator LEVIN. Yes, but when you say urging people to make a

winning trade, you said a moment ago you were urging people to

get out of a position even if it was a losing trade. Is that correct?

Mr. PARISH. Yes, before it got worse.

Senator LEVIN. Right.

Mr. PARISH. That is what——

Senator LEVIN. Now, when you say a winning trade, you do not

mean that you were limiting your advice to people to make winning

trades. You meant that you were urging people to get out of a position, period, before the day was over, is that not accurate?

Mr. AMBROSE. May I have a moment?

Mr. PARISH. Could you repeat the question, please?

Senator LEVIN. You were urging people to get out of a position

by the end of the day, were you not, regardless of whether they

made money or not?

Mr. PARISH. Oh, no, not necessarily. If a person—could I take a

moment to explain how this works?

Senator LEVIN. No, it is OK, because I think we understand. You

were not urging people to get out of losing positions, only winning

positions?

Mr. PARISH. No, I was urging people, do not hold losing positions.

You want to carry a winner, go ahead.

Senator LEVIN. But let me be real clear. Even though someone

would lose by selling, you frequently urged them to sell, is that not

correct, very simply?

Mr. PARISH. Losing positions that you take home tend to get

worse, not better.

Senator LEVIN. My question, though, is even though somebody

would lose when they sold compared to what they paid for a stock,

you would urge them to get out of that position frequently, is that

not true?

Mr. PARISH. That is true.

Senator LEVIN. Now, in your statement, you say that on two occasions you journaled funds from your own account to assist a customer. As I understand it, that means you loaned or made money

available to a customer to meet a margin call, is that correct?

Mr. PARISH. Yes. I journaled money overnight from my account

to a customer and back the next day.

Senator LEVIN. All right. That was in order to help a customer

meet a margin call, is that correct?

Mr. PARISH. That is correct.

Senator LEVIN. Under the Exchange Act, is it not illegal to do

that unless you had set up a special margin account and obtained

separate collateral from the customer?

Mr. PARISH. I understood it to be—I did believe that it was improper and I ceased immediately, yes.

Senator LEVIN. How many times did you do that?

Mr. PARISH. Twice, small amounts.

Senator LEVIN. How long did the company continue to help people meet their margin accounts with these short-term loans from

other accounts? How long did that last?

62

Mr. PARISH. Are you asking me how long we journaled around

my office?

Senator LEVIN. I am asking you just as I asked you.

Mr. PARISH. What was the question again, please?

Senator LEVIN. How long did you help people cover their margin

accounts when they were over the margin?

Mr. PARISH. How long did I?

Senator LEVIN. How long did that procedure last? Does it last

until today, last month?

Mr. PARISH. I do not know if All-Tech is still journaling or not.

Senator LEVIN. They still may be doing that?

Mr. PARISH. They still could be, for all I know.

Senator LEVIN. Even though you have stopped?

Mr. PARISH. I stopped.

Senator LEVIN. Because you found out it was improper.

Mr. PARISH. Yes. I believe that it is—in the long run, it is detrimental to everybody and it is a nightmare.

Senator LEVIN. Did you facilitate loans to people to cover these

margin accounts from other customers?

Mr. PARISH. No loans. There are no loans. They were overnight

journals.

Senator LEVIN. Did you not have to put money into their account

in order to prevent the account from grinding to a halt? Is that not

what you were journaling? Did you not have to add money to their

account?

Mr. PARISH. Journaled money from Customer A to Customer B

back to Customer A, yes.

Senator LEVIN. And was interest ever charged for that?

Mr. PARISH. I do not know if you would call it interest. Customer

A had the money. If he wanted to charge a fee and Customer B

agreed to it, that happened frequently, yes.

Senator LEVIN. So fees were charged?

Mr. PARISH. Yes.

Senator LEVIN. What was the fee based on?

Mr. PARISH. The whim of the guy with the money.

Senator LEVIN. And you do not call that fee for a loan. You call

that fee for what? It is not a loan. What is it?

Mr. PARISH. It is an overnight journal to meet a margin call.

Senator LEVIN. An overnight journal?

Mr. PARISH. Yes.

Senator LEVIN. In effect, is that not a loan temporarily for a

short period of time in order to meet a margin call? Is it not the

same thing?

Mr. PARISH. I guess the answer is no. He cannot use the money

for anything else, can he?

Senator LEVIN. You mean I cannot loan you money to buy a

house, and you cannot use that money for anything but to buy a

house. It is still a loan, is it not?

Mr. PARISH. If you loaned me money, I would call it a loan, yes,

sir.

Senator LEVIN. To buy a house. Even though you cannot use it

for anything else other than what I lent it to you, it is still a loan,

is it not?

Mr. PARISH. OK, yes, sir.

63

Senator LEVIN. Now, is this not in effect a loan overnight? If it

is not a loan, what is it? You are pretty familiar with this stuff.

It is not a gift, is it?

Mr. PARISH. No.

Senator COLLINS. They are not giving him money.

Mr. PARISH. No.

Senator LEVIN. If they are not lending him money, what are they

doing?

Mr. PARISH. They are trying to help the guy out of a jam by

journaling some money out of his account and journaling back.

Senator LEVIN. All right. Did you hear Ms. Harlacher’s testimony

this morning?

Mr. PARISH. Yes.

Senator LEVIN. Did you hear her say that you asked her to use

her account to cover somebody else’s margin calls?

Mr. PARISH. Yes, I heard her say that.

Senator LEVIN. How many of your customers get paid fees for

doing that?

Mr. PARISH. Oh——

Senator LEVIN. What percentage?

Mr. PARISH. Only a few, because certain customers would have

the larger accounts and those are the ones that ended up doing the

majority of the journals because they had large amounts of money

that is available to get journaled around.

Senator LEVIN. And did you tell Ms. Harlacher she could charge

a fee or not in her discretion?

Mr. PARISH. Probably, yes.

Senator LEVIN. Did All-Tech ever prepare a brochure to people

saying that you could get a 10 percent return on your money if you

provided us funds to lend people overnight to cover these margin

calls? Did you ever have a program like that? I think you heard

testimony about that this morning.

Mr. PARISH. I never saw anything like that.

Senator LEVIN. So there is no such program that All-Tech ever

had?

Mr. PARISH. Not to my knowledge.

Senator LEVIN. And did All-Tech ever make money from these

fees that were charged to people to meet their margin calls?

Mr. PARISH. Not in my office.

Senator LEVIN. Do you know whether in any other office, AllTech ever got a part of that fee or made any money for covering

people’s margin calls?

Mr. PARISH. I have no way of knowing that.

Senator LEVIN. Do you know whether All-Tech had a policy to

allow this kind of lending, or was it just done ad hoc without a policy?

Mr. PARISH. Well, when I came to All-Tech, it seemed to be their

policy. They provided me with the documents to fill out and they

provided me with the instruction on how to fill them out. They explained to me how to make sure the money got returned to Customer A. So being new to their industry, I felt it was the way they

did business.

Senator LEVIN. In her testimony, Ms. Margala stated that you allowed one All-Tech client to trade other All-Tech clients’ accounts.

64

She further testified that another client told her that you had personally provided him with clients’ accounts to trade. Yet neither of

the two people had a broker’s license. Is that true?

Mr. PARISH. I did not provide anybody with any accounts to

trade. I introduce people to each other and they do whatever they

want.

Senator LEVIN. All right. So you never gave anybody accounts

and said, here, you can trade these accounts. That would be false

if she said that?

Mr. PARISH. I did not do that.

Senator LEVIN. It was always done person to person after your

introduction?

Mr. PARISH. Right.

Senator LEVIN. Are you aware of any instance in the All-Tech

San Diego office where an individual traded other people’s accounts?

Mr. PARISH. Yes.

Senator LEVIN. Were you aware of instances where people who

were trading those accounts were not brokers?

Mr. PARISH. Yes.

Senator LEVIN. And in those instances, do you know if the individual conducting the trades received any part of the commission

as compensation for their effort?

Mr. PARISH. No commission, now.

Senator LEVIN. Pardon?

Mr. PARISH. No, they did not receive a commission.

Senator LEVIN. Or a compensation?

Mr. PARISH. Oh, they received competition, sometimes.

Senator LEVIN. Sure, and what was that compensation based on?

Mr. PARISH. It was based on an agreement between the trader

trading the account and the person whose money it was and they

worked out arrangements between themselves.

Senator LEVIN. And then they set the fee or the——

Mr. PARISH. The split of the profit?

Senator LEVIN. Was there ever a fee charged for that?

Mr. PARISH. No.

Senator LEVIN. In All-Tech, did you ever make any money off

those trades?

Mr. PARISH. No.

Senator LEVIN. You never charged anything?

Mr. PARISH. Just the $25 per trade.

Senator LEVIN. Yes, that is what I mean. But you never split

that with the person who was doing the trading?

Mr. PARISH. No.

Senator LEVIN. And so if there was anything in addition above

the $25 that the person whose account it was was paying to the

person who was doing the trading, that would have been between

the two of them?

Mr. PARISH. The trader generally was paid if he was profitable,

and he was paid by the person whose money it was directly.

Senator LEVIN. If you knew that unlicensed individuals were

trading other people’s accounts, since you were branch manager,

why did you not stop it?

65

1See Exhibit No. 146 which appears in the Appendix on page 1100.

Mr. PARISH. When I came to All-Tech, they encouraged that sort

of thing. Mr. Houtkin was actively seeking investors to invest in

his own mutual fund, he called it, where he was going to have all

these investors put in money and he was going to find all the traders to trade the money.

Senator LEVIN. Even though those traders were not licensed?

Mr. PARISH. Yes.

Senator LEVIN. Thank you.

Senator COLLINS. Thank you, Senator Levin.

I am going to excuse this panel. The hearings will continue tomorrow, and at that time, we will hear testimony from the CEOs

of All-Tech, Providential, and Momentum. We are eager to hear the

firms’ reaction to the testimony of their former customers and employees. We will also hear from the regulators tomorrow about

ways to beef up the protections, the consumer protections and enforcement efforts in this area.

I would like to include in the record the report of the GAO entitled ‘‘Securities Operations: Day Trading Requires Continued Oversight.’’ 1

The Subcommittee will now stand in recess until tomorrow morning at 9:30 a.m., and I thank all the witnesses for their testimony.

[Whereupon, at 1:48 p.m., the Subcommittee was recessed, to reconvene at 9:30 a.m. on Friday, February 25, 2000.]

(67)

DAY TRADING: EVERYONE GAMBLES BUT THE

HOUSE

FRIDAY, FEBRUARY 25, 2000

U.S. SENATE,

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS,

OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS,

Washington, DC.

The Subcommittee met, pursuant to notice, at 9:31 a.m., in room

SD–342, Dirksen Senate Office Building, Hon. Susan Collins,

Chairman of the Subcommittee, presiding.

Present: Senators Collins and Levin.

Staff Present: K. Lee Blalack, II, Chief Counsel and Staff Director; Mary D. Robertson, Chief Clerk; Brian C. Jones, Investigator;

Wesley Phillips, Detailee/GAO; Eileen M. Fisher, Investigator; Elizabeth Hays, Executive Assistant; Stephen Wheeler, Intern; Linda

J. Gustitus, Minority Chief Counseland Staff Director; Bob Roach,

Counsel to the Minority; Michael Loesch (Senator Cochran); Anne

Bradford (Senator Thompson); Marianne Upton (Senator Durbin);

Nanci Langley and Glenn Sauer (Senator Akaka).

OPENING STATEMENT OF SENATOR COLLINS

Senator COLLINS. Good morning. The Subcommittee will please

come to order.

Good morning. Today, the Permanent Subcommittee on Investigation holds its third oversight hearing into day trading. After a

general hearing on the issue last fall, the Subcommittee began an

in-depth investigation into the business practices of 15 day-trading

firms, eventually narrowing our focus primarily on three companies, All-Tech Direct, Momentum Securities, and Providential Securities.

During the course of its 8-month investigation, the Subcommittee

uncovered some potentially illegal conduct, such as forgery and unauthorized trading. The most disturbing and pervasive evidence we

gathered, however, relates to business practices that are, for the

most part, entirely legal under the current regulatory framework.

Perhaps our most important finding is that many firms encourage

unsuitable customers with limited financial means and even less

knowledge of the markets to engage in day trading.

Yesterday, we heard testimony from and about such individuals

who were enticed to day trade with their meager life savings, or

worse yet, with borrowed funds, money that they could ill afford to

lose. Yet, lose they certainly did. Not understanding how risky day

trading is and believing the false promises of deceptive ads or slick

68

salesmen, these customers lost tens of thousands of dollars, not to

mention their pride.

We learned that some day-trading firms disregard their own requirements for minimum deposits, net worth, and income, and

opened accounts for individuals who clearly should not have been

accepted as clients. The desire for more and more customers and

more and more commission revenue has produced a race to the bottom, as firms have lowered or ignored their own standards.

While day trading is rarely profitable for the customer, it generates huge commissions for the firms. At the firms surveyed by

the Subcommittee, the average day trader would have to generate

a trading profit of more than $111,000 a year just to pay the commissions, and we will hear some testimony this morning that suggests that the amount of commission revenue may actually be

much higher. It is not surprising that the best evidence we have

indicates that more than 75 percent of all day traders lose money,

and in some day trading branch offices, not a single trader is profitable over the long run. Yet day-trading firms do everything possible to encourage a customer to keep on trading despite losses, including arranging for loans from other customers to cover margin

calls.

Today, we will hear from a panel of State and Federal regulators

as well as the regulatory arm of the National Association of Securities Dealers. The presidents and chief executive officers of All-Tech,

Providential, and Momentum will also testify. I look forward to

hearing from all of our witnesses this morning.

I am now pleased to call upon the distinguished Ranking Minority Member, Senator Levin, who has also been very active in this

area.

OPENING STATEMENT OF SENATOR LEVIN

Senator LEVIN. Thank you, Madam Chairman, and again, our

thanks to you and particularly the Majority staff, who have worked

so closely with you to provide hearings here which are illuminating

on this growing practice of day trading.

We heard testimony yesterday which was disturbing, indeed. We

heard from branch managers of All-Tech and one day trader at

Providential that unlicensed brokers trade for compensation on behalf of other individuals somewhat routinely. Mr. Cao of Providential Securities told us he is day trading right now on behalf of

three clients. He is not a licensed broker. Mr. Parish, former

branch manager for All-Tech, told us he knows of a number of day

traders at All-Tech who are not licensed brokers who trade on behalf of other clients for compensation. Mr. Zayas, also a former

branch manager for All-Tech, testified he was directed by Mr.

Houtkin, one of today’s witnesses, the CEO of All-Tech, to a day

trader who would trade on his behalf, and that trader was not licensed.

We heard testimony yesterday about the routine nature of loans

arranged by day-trading firms to help clients meet margin calls.

Mr. Parish admitted making two such loans, or journalings, as he

called them himself, out of his own account. A broker-dealer and

any person associated with a broker-dealer, as I understand it, is

not allowed to make loans to clients to meet margin requirements.

69

So we heard testimony about a number of very disturbing aspects, including the lack of analysis by day-trading firms as to

whether day trading is even an appropriate strategy for a new client. We learned that not only was such analysis a low priority, but

we learned that it is often ignored, or worse, that documents are

doctored to make a client appear to be appropriate for day trading

who otherwise would not even meet the firm’s own requirements.

These practices have exploited an ambiguous area in securities

law to the detriment of unwitting consumers. The securities laws

in general require that an individual who buys or sells stock on behalf of another individual for compensation must be licensed as a

broker-dealer, yet we have apparently some nuances and loopholes

in the law of which day-trading firms too often take advantage.

These practices are open and widespread, and today we will be asking our first panel why this is happening.

Day trading is an expensive gamble. People who try it without

adequate information and safeguards and forewarning are likely to

lose tens of thousands of dollars. The stories can be sad, sometimes

tragic. Victims get caught up in the hype of day-trading firms.

They fail to ask questions about the risk. They fail to be informed

about the risk.

Madam Chairman, I hope we can get some understanding today

of just what the people at the top of these day-trading firms know

or do not know about the lapses and irregularities that we heard

about yesterday, and from our first panel, what actions the regulatory bodies are going to take to bring day trading within both the

spirit and the letter of the requirements of securities laws and regulations.

Again, I commend you and thank you, Madam Chairman, for

your leadership and determination to probe this area.

Senator COLLINS. Thank you very much, Senator Levin.

We are now very pleased to have with us as our first panel of

witnesses this morning three members of the regulatory community. First, I would like to welcome Lori A. Richards, who is the

Director of the Office of Compliance Inspections and Examinations

for the Securities and Exchange Commission. Ms. Richards will

make public for the first time today a report prepared by the SEC

staff summarizing their findings from a comprehensive examination of 40 day-trading firms. Those of you who attended the Subcommittee hearing last fall may remember that the SEC Chairman, Arthur Levitt, told us that such an examination was underway and we are very pleased to hear the results of it today.

Next, we will hear from another witness who has appeared before us in the past, Barry Goldsmith, who is Executive Vice President, Enforcement of the National Association of Securities Dealers

Regulation. The NASD Regulation, Inc. is a self-regulatory body

that is charged with the initial duty of overseeing the day trading

industry, and again, we look forward to hearing Mr. Goldsmith’s

testimony regarding enforcement efforts on the part of the self-regulatory organization.

And finally, we are also very pleased to have with us today Deborah Bortner, who is the Director of the Washington State Securities

Division. In one of my previous jobs, I spent 5 years in Maine State

Government overseeing the Securities Division, so I have great adVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00081 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
70

1The prepared statement of Ms. Richards with an attachment appears in the Appendix on

page 174.

miration for securities administrators and I am delighted to welcome you here today. As the chief securities regulator for the State

of Washington, Ms. Bortner directed a comprehensive examination

of every day-trading firm doing business in her State. We are particularly interested in the profitability data which her office collected during this examination because it is the most comprehensive assessment of profitability that I believe has been conducted.

I should also mention that Ms. Bortner is the President-Elect of

the North American Securities Administrators Association, also

known as NASAA, which represents State securities regulators

from all 50 States and Canada.

So I am delighted to welcome our witnesses. I would ask you to

stand so that I can swear you in. Do you swear that the testimony

you are about to give to the Subcommittee will be the truth, the

whole truth, and nothing but the truth, so help you, God?

Ms. RICHARDS. I do.

Mr. GOLDSMITH. I do.

Ms. BORTNER. I do.

Senator COLLINS. I am going to ask that each of you limit your

oral testimony to no more than 10 minutes. We will be using a timing system this morning. The green light will come on at the beginning. One minute before the 10-minute period has expired or is

about to expire, the orange light will go on. And when you see the

red light, if you will conclude your testimony, that will be helpful

to us. We will, however, print your written testimony in its entirety

in the hearing record, as well as any other documents you may

wish to submit.

Ms. Richards, we will ask you to begin. Thank you.

TESTIMONY OF LORI A. RICHARDS,1 DIRECTOR, OFFICE OF

COMPLIANCE, INSPECTIONS AND EXAMINATIONS, SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, DC

Ms. RICHARDS. Chairman Collins, Ranking Member Levin, good

morning. I am pleased to appear before the Subcommittee this

morning on behalf of the Securities and Exchange Commission to

outline our recent actions with respect to day trading. I am Lori

Richards, Director of the Exam Program at the Commission.

The Commission has sought to address concerns about day trading by using a four-part strategy. First, by conducting an examination sweep of day-trading firms to evaluate their compliance with

the law and to gather information about this new industry. Second,

by fostering investor education about the risks of day trading.

Third, by considering regulatory changes. And finally, by bringing

enforcement actions, where appropriate.

I am pleased today to provide you with a report summarizing the

findings of the first part of that initiative. The report summarizes

our findings from our examination sweep of firms offering day trading to the public. From October 1998 through September 1999, in

coordination with the NASD, we examined 67 firms offering day

trading to the public. I would like to take a moment, if I could, to

briefly summarize what we found in those examinations.

71

While the examinations did not reveal widespread fraud, they

did reveal a number of serious violations warranting referral to our

Division of Enforcement. These violations included net capital,

short sale, and margin violations. The examinations also revealed

deficiencies in advertising, in supervision, and in registration rules.

As a result of these examinations, we have concluded that many

day-trading firms need to enhance their compliance with securities

regulations. The inability of some firms to monitor their compliance

with capital, margin, and the short-sale rule, or to maintain adequate books and records, raises serious concerns. All of the firms

at which deficiencies were found have been cited in deficiency letters, or in the most serious cases, referred to our Division of Enforcement.

In September, Chairman Levitt told this Subcommittee that he

was concerned about the potential for individuals to be seduced by

promises of easy profits from day trading without fully understanding the risks. During our examinations, we reviewed the information that firms were providing to customers concerning the

risks of day trading. We found that as of the time of the examinations, most firms provided little or no information to their customers concerning the risks of day trading. A recent review indicates, however, that many firms have vastly improved their risk

disclosure. Clearly, the industry is responding to regulators’ concerns, and certainly the work of this Subcommittee and the media

have highlighted the risks associated with day trading.

I would like to also address another area of concern, margin

lending. During examinations, we focused on a number of lending

practices by the firms, direct lending by the firm, lending through

associated persons of the firm, and the arranging of loans by the

firm between customers and between third parties and customers.

By using leverage, day traders hope to increase their potential profit from small movements in the price of stocks. Unfortunately, that

leverage can also substantially increase losses, often beyond what

day traders can afford to lose. We are concerned that many day

traders do not fully appreciate that by borrowing to buy securities,

they can actually lose more than their initial investment.

This is why our collective efforts to educate investors are so important. Today, we are continuing to do that by posting another notice on the Commission’s investor education Web site. Along with

our investor alert concerning the risks of day trading, we have

today posted investor tips concerning the risks of buying stock on

margin.

We are also focusing on securities rules and how we can address

concerns about day trading by tightening up regulations. The

NASD, the New York Stock Exchange, and other SROs have taken

a number of steps and have proposed rules that would restrict margin for day traders, require day-trading firms to disclose the risks

of day trading to potential customers, and to determine whether

day trading is appropriate for their customers.

Finally, our Division of Enforcement is continuing to investigate

several referrals that stemmed from our examination sweep, and

recently, the Commission brought two cases against day-trading

firms for lending violations.

72

1The prepared statement of Mr. Goldsmith appears in the Appendix on page 179.

The SEC will continue to focus resources on day trading. We will

be conducting additional targeted examinations, continuing to

evaluate whether regulatory changes are appropriate in light of industry practices, continuing to work to educate investors about the

risks of day trading, and we will bring additional enforcement actions, where appropriate.

As Chairman Levitt told this Subcommittee last September, we

are committed to doing everything we can to ensure that day-trading firms are operating within the boundaries of the law and we

hope that individuals considering this type of trading strategy do

their homework on the risks of day trading before risking their

money.

Thank you. I am happy to respond to any questions you may

have.

Senator COLLINS. Thank you very much, Ms. Richards. Mr. Goldsmith.

TESTIMONY OF BARRY R. GOLDSMITH,1 EXECUTIVE VICE

PRESIDENT, ENFORCEMENT, NASD REGULATION, INC.,

WASHINGTON, DC

Mr. GOLDSMITH. Thank you. Good morning. Thank you for the

opportunity to testify today on behalf of NASD Regulation, Inc.

These hearings provide the industry, the regulators, and most importantly, the investing public with new and useful information

about day trading. My testimony this morning will deal with NASD

Regulation’s enforcement actions and investigations relating to day

trading, as well as the NASD’s recent rule proposals in this area.

NASDR recognizes that day trading is a legitimate trading strategy and, if it is conducted by individuals who both understand and

knowingly assume its risks, we do not intend to encourage or discourage such activities. That being said, NASDR continues to view

day trading as a highly risky form of trading that requires new

regulatory initiatives and, where appropriate, the filing of formal

enforcement actions. The eight day trading enforcement cases we

filed this week are examples of our strong commitment to compliance by NASD member firms and their personnel in this area.

In 1999, the staffs of NASDR and the SEC launched a coordinated, focused examination program of day-trading firms. As part

of that effort, we examined 22 day-trading firms that varied significantly in size and makeup. Fifty-five NASDR examiners received

special training in the intricacies of day trading. During these examinations, we found several potential problem areas, including

misleading and exaggerated advertising, improper margin lending

practices, improprieties in customer-to-customer loans arranged by

day-trading firms, registration violations, supervisory failures, and

violations of the NASD short-sale rules.

As a direct result of our examination efforts begun last year,

NASDR announced yesterday that it had filed eight new day trading enforcement actions. While other day trading investigations

continue, the actions that we filed this week represent an important step in our efforts to address problems in this area and our

goal overall of improving member firm compliance.

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These eight cases allege allegations and findings against firms

and individuals that reflect many of the concerns we originally reported to the Subcommittee last September. They include misuse

of customer funds and securities, improper lending and margin

practices, exaggerated and misleading advertising, improperly registered persons, violations of the NASD short-sale rule, improper

use of the small order execution system, and supervisory inadequacies.

Two of the cases involve allegations of misuse of funds, including

one in which we allege that the owner of a day-trading firm solicited more than $150,000 from outside investors, falsely representing that these monies would be used for risk-free loans to

day-trading customers of the firm. In that case, the investors were

promised returns of at least 15 percent per year, or 20 percent of

the profits earned by the day traders to whom the money was lent.

Instead, the funds were loaned to customers with no controls or restrictions and were improperly used for branch operating expenses

and virtually all of the money was eventually lost.

In two other cases, NASDR found violations of the NASD rules

in connection with margin calls, including one in which a firm’s

principal allowed a customer to effect 120 transactions while the

customer’s account was coded ‘‘no more business’’ by the clearing

firm for failing to meet a margin call.

In another case, a firm employee established a separate entity

which then loaned funds to firm customers to meet margin calls to

enable them to continue to trade.

Four of the day trading actions announced yesterday include allegations or findings of violations of our advertising rules, including

instances in which firms placed exaggerated and potentially misleading advertising on the Internet, as well as in local print and

media advertisements. These firms typically exaggerated the ability of customers to access markets immediately without disclosing

the risks inherent in day-trading strategies, including market volatility. One advertisement told prospective day traders that they

could, ‘‘Control their own destiny through electronic day trading’’

without any corresponding disclosure of the risks.

NASDR alleged and made findings that firms failed to ensure

that individuals actively engaged in their day trading operations

were properly registered, including one case in which the individual running the firm’s day trading business was not even registered as a principal. In other cases, employees of the firm were

acting as equity traders without having completed the NASD’s Series 55 registration requirements. In one case, the firm allowed individuals to input trades for customers for periods of several weeks

without registering them in any capacity with the firm.

Finally, certain of the actions taken this week involve serious supervisory deficiencies, including one case in which a firm engaged

in day trading activities without having any written supervisory

procedures in place to address that area of the firm’s business.

In addition to the enforcement actions we filed, we also have instituted new heightened procedures in our review of day-trading

firms’ Web sites. Since we instituted this program, NASDR staff

have looked at over 120 Web sites, reviewing each of those sites at

least four times since the program’s inception through the end of

74

1999. To date, more than 30 sites have needed revisions to achieve

compliance with our rules. The subject firms have been notified of

the deficiencies identified in their sites. In the more serious situations, NASDR staff contacted the firms immediately and recommended that materials or representations on the sites be removed. In each of these cases, the problematic portions of the sites

were taken down.

One such site involved a day-trading firm’s claims about the profitability that customers could expect from day trading. Under a

banner headline, ‘‘Do the Math,’’ the firm suggested that a typical

day-trading customer could easily make almost a quarter-million

dollars per year. What was the basis for this prediction? A simple

syllogistic formula. ‘‘One point on 1,000 shares equals $1,000. One

point average per day, 240 trading days, equals $240,000 annually.’’ One can only imagine what the portrayed profits would have

been on the site if the firm had taken into account extended trading hours.

To address the risk presented by day-trading firms both to individuals and to firms, NASDR also has engaged in rulemaking

initiatives in three areas: Risk disclosure, appropriateness determinations, and margin requirements. These newly proposed rules require that firms that promote day trading to individuals fully disclose the risks involved, as well as assess whether such a strategy

is appropriate for the individual. These rules were filed with the

SEC last August, and after receiving comments, amended rules

were filed with the SEC last week.

We believe that the proposed rules, as amended, serve to maintain the standards necessary for the protection of investors without

imposing overly burdensome regulatory requirements on firms that

promote day trading. We are also working closely with the New

York Stock Exchange to amend margin requirements applicable to

day traders.

Earlier this year, NASDR filed with the SEC a rule proposal that

would amend the margin requirements that apply to pattern day

traders. The amendments would do a number of things. First, they

would change the definition of day trader to cover only true day

traders, not incidental or occasional day traders. The rule would require minimum equity of $25,000 in a day trader’s account on any

day in which the customer trades. The rule would permit day trading buying power of up to four times a day trader’s maintenance

margin excess. However, unlike the present rules that allow funds

to meet a day trading margin call to be deposited after the day

trading risk has already been incurred, the proposed rule amendment requires that the funds be in the account prior to any trading. The rule would also prohibit cross-guaranteeing of accounts.

Finally, NASDR is continuing to look at whether to impose any

restrictions on day-trading firms’ activities when they facilitate or

participate in arranging loans among customers. We believe that

there may be an inherent conflict of interest when member firms

facilitate or participate in lending activities with or between their

customers. It is these lending activities that often allow customers

to continue to trade when they would not otherwise be in a financial position to do so, thereby generating more commissions for the

firm. While these same conflicts arise when principals, registered

75

1The prepared statement of Ms. Bortner appears in the Appendix on page 206.

2See Exhibit No. 23 which appears in the Appendix on page 365.

representatives, and significant shareholders of members lend

funds to customers, those are already addressed in the rules and

we are looking to see whether we need to do more.

We will continue our regulatory initiatives with respect to day

trading. To the extent that our ongoing investigations find violations of the securities laws or NASD rules, we will bring additional

enforcement actions. We have received a broad array of very constructive comments on our new rule proposals and we will work

hard with the SEC and all interested parties to finalize them and

get them on the books as soon as possible. At this time, we remain

of the view that no new legislation on this subject is necessary.

On behalf of NASDR, I would like to thank the Chair, Senator

Levin, and the rest of this Subcommittee for the opportunity to appear here today and provide testimony on these important issues.

I would be happy to answer any questions you may have. Thank

you.

Senator COLLINS. Thank you, Mr. Goldsmith. Ms. Bortner.

TESTIMONY OF DEBORAH R. BORTNER,1 DIRECTOR, SECURITIES DIVISION, WASHINGTON STATE DEPARTMENT OF FINANCIAL INSTITUTIONS, OLYMPIA, WASHINGTON

Ms. BORTNER. Good morning, Chairman Collins, and Senator

Levin. My name is Deborah Bortner. I am the Director of Securities

in the State of Washington. I am also President-Elect of the North

American Securities Administrators Association, NASAA, for short.

I want to thank you for the invitation to testify today as you continue to look into issues surrounding day trading.

Chairman Collins, as you know, day trading has been a concern

of State securities regulators for several years now. We appreciate

your leadership in bringing this issue to the attention of Congress

and to the American public. This AP article that was published

yesterday reached hundreds of thousands of people. Try as we

might, it is very hard for us to reach that many people with our

educational efforts to let people know that day trading is risky.

In December 1998, NASAA formed a task force to research the

day trading industry. That group spent 7 months gathering information, analyzing issues, and studying trading records from daytrading firms. It released its report last August. Last September,

NASAA’s then-President of NASAA testified before this Congress

on that report and its findings and recommendations. The report

did not suggest major restrictions on the day trading industry. Instead, it called on firms to do a better job of screening out unsuitable customers and disclosing the risks for those remaining customers who still wanted to day trade.

I am not here today to go over NASAA’s report or to comment

on day trading in general. NASAA’s findings and views are already

part of the Subcommittee’s record. I am here to discuss the results

of a series of examinations my office conducted last fall. We audited

all the known day-trading firms with branches in the State of

Washington. I have submitted a copy of our report to be included

in the record.2

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A team of my examiners, each of whom have more than 15 years’

experience, inspected the branch offices of our seven day-trading

firms. They are all located in or near Seattle. The team looked at

advertising, loans, third-party trading, and account opening requirements, all issues identified by other State securities regulators as potential problems. The most striking finding had to do

with profitability, or should I say, lack of profitability of day trading.

My team analyzed 124 trading accounts. That sample represented 100 percent of the accounts in five of the firms and a representative sample in two of the larger firms. More than threefourths, 77 percent, of the accounts examined had net losses, with

an average loss of $36,000. Nine accounts had losses of more than

$100,000, the biggest of which was a loss of $641,000. Twenty-three

percent of the accounts were profitable, with an average profit of

around $22,000. Only two had gains of more than $100,000. The

biggest gain was $160,000.

Now, some proponents of day trading, and I think I heard this

yesterday in the testimony, suggested that day traders who can

survive the learning curve, which purportedly takes about 6

months, are much more likely to be successful. As you can see from

our report at Tab E, we analyzed accounts that were open from 1

to 25 months. We found no correlation between the length of time

an account was open and its profitability.

In addition to profitability, our examiners reviewed other issues.

At several firms, we found questionable loan arrangements between customers. These loan arrangements, we believe, serve to

circumvent margin loan requirements, and in some cases, these

loans may have resulted in even greater losses by customers.

We also found instances at several firms where day traders were

trading on behalf of others. This may prove to be a violation of the

registration provisions of our investment advisor laws. We are continuing to investigate these accounts.

After listening to yesterday’s testimony about Amy Le, I would

like to recommend that before anyone invest with someone in a situation like that, they should call either their State securities regulator or the NASD to make sure that person is registered. If he or

she is registered, they can also ask about disciplinary history.

As Deborah Field highlighted in her testimony yesterday, we are

also concerned that many firms are encouraging and allowing unsuitable people to day trade. For example, each of the firms we examined claimed to require a minimum balance to open and maintain an account. For most firms, that was around $20,000. But in

some cases, we found the branch manager or compliance officer approved new accounts with opening balances far below the minimum, even as low as $6,000. Some firms also allowed customers

to continue to trade after they had fallen below their minimum.

A word about day trading advertising, which has been a major

concern of State securities regulators. Our examiners only reviewed

advertising done by the branch office in Washington, not ads produced and placed by the corporate headquarters of the firms. As it

turns out, the branches we examined did either no or little advertising, and we found no serious problems.

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Recently, however, one of the firms did post something problematic in our view on the Web site. On its home page, it made claims

about the trading success of its principal with no disclaimer. The

required disclaimer is actually a mouse click away from the home

page. Our Enforcement Section is reviewing this matter to determine whether that violates the advertising rules.

To conclude, our findings on the profitability of day trading are

consistent with those of the NASDR report, which found that about

70 percent of day traders lose money. Exams and enforcement actions by State regulators have highlighted problems with day-trading firms. Federal regulators, the NASDR, and industry representatives are now involved in working to address the regulatory issues

from a national perspective. NASAA supports the NASDR’s rules

to increase risk disclosure and require the firms to determine the

appropriateness of the potential customer. We expect to be commenting in support of their new proposed rule to impose higher

margin requirements for day-trading customers.

As we said before, day trading is a very risky strategy. We will

continue to monitor it and bring enforcement actions when appropriate. We are working closely with the SEC and the NASD to address issues in this area.

Again, I appreciate this opportunity to testify and I look forward

to answering any questions you might have.

Senator COLLINS. Thank you very much, Ms. Bortner.

As you were speaking, I was thinking that probably only the people in this room, when they hear the term NASAA, think of securities regulations rather than space exploration. We are probably unusual in that regard.

Ms. Richards, your report points out that day traders incur significant costs day trading because of the commissions. As I thought

more about this issue, I am reminded of a traditional problem that

the securities regulators have dealt with of churning, of brokers

needlessly selling stocks in order to generate commissions. With

day trading, we have moved to a whole different level, where it is

the individual customer that is doing the trades, but the result is

the same. You have, arguably, excessive commissions being generated.

Could you describe to us what your findings were with regard to

commissions? In particular, it is my understanding that our estimates, based on our survey, are actually lower than what you

found would be generated annually. So could you talk about what

your findings were in that area?

Ms. RICHARDS. Yes. We found that day trading is extremely expensive. The average commission cost per trade at the firms that

we reviewed ranged from $15 to $25 per trade. There are additional costs that many day traders incur for services like data

feeds, news, research. Those services can range anywhere between

$50 and $675 a month at the firms that we visited.

So collectively, putting those costs together, we did an analysis

to evaluate how profitable day traders would have to be simply in

order to break even. On page 9 of our report, we analyzed three

fee structures of typical day-trading firms. We concluded that in a

typical day-trading firm with what we determined was a medium

fee structure, where commissions were $16.70 per trade and the

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day trader paid $150 per month for additional services, that that

day trader, if he or she made 50 trades per day, would need to generate $16,850 each month in trading profits simply to be able to recoup the cost from the commissions and from the extra costs that

he or she would pay to the firm.

Clearly, we believe that day trading is expensive and we want

to make sure that investors realize that they are going to incur significant costs before they even reach a point where they can break

even.

Last fall, we put on our Web site tips for investors which would

remind them that they have high expenses, that they need to pay

their firm sometimes large amounts in commissions for training,

for computers, and for other services, and I know that as part of

the NASD’s rule proposal, one of the items that day-trading firms

would be required to disclose is the fact that total daily commissions that day traders may pay may add to customers’ losses or significantly reduce their earnings.

Senator COLLINS. So what you found, if my quick math here is

correct, is that for the median fee structure, the day trader would

actually have to generate more than $200,000 a year just to pay

the commissions, before incurring one cent of profit, is that correct?

Ms. RICHARDS. You did the math more quickly than I did, but it is $16,850 each month. The total cost would exceed $200,000 a year

that an investor would have to generate in order to make a profit.

Senator COLLINS. Has any consideration been given, and I would

ask all three of you who are working on comments on the rules

that the SEC has, to using that as an example in the risk disclosures that are going to be required from these firms? It seems to

me if you told most people who are interested in opening a day

trading account that they would have to generate in excess of

$200,000 just to pay commissions and other fees, that that would

discourage a lot of people from opening an account because it would

make them understand very clearly the fiscal realities and how difficult it was going to be for them to make a profit for themselves,

much less make a living day trading, which is what these people

are doing.

Has any thought been given to actually putting that concrete example—I mean, it is one thing to warn people that it is expensive

to trade, that commissions are high. That example really says it

all.

Ms. RICHARDS. What we have reminded investors in the educational tips on our Web sites is that they should ask the firm how

many clients the firm has who have lost money and how many clients the firm has who have made money, and as we have told investors, if the firm says that it does not know or will not tell you,

that that investor should think twice about doing business with the

firm.

In our report, we also recommend that the day-trading firms provide this information to customers, that it is information that they

need to provide to allow the customer to make an informed judgment about whether or not he or she should day trade.

Senator COLLINS. But the rule that the SEC is looking at simply

says, as part of the disclosure, day trading may result in your paying large commissions. The total daily commissions that you pay in

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your trades may add significantly to your losses or reduce your

earnings. That is just not nearly as powerful as putting in an example. It is just something I think should be considered.

Ms. Bortner, I am particularly interested in your study because

it really is the most comprehensive analysis we have on profitability, and it is interesting, because when we had our hearing last

September, the industry representative was extremely critical of

the profitability study conducted by the Massachusetts State Securities Bureau, and indeed, the industry pointed out that it was just

one branch office, that it was not comprehensive. But your review

actually reached very similar conclusions, but it was a much more

comprehensive study, is that correct? I mean, you looked at every

day-trading firm that you were aware of in the State?

Ms. BORTNER. Yes. In order to make—I heard those criticisms,

too. We wanted to know about all the firms in our State, but from

a statistical point of view, I believe that the fact that we did all

the firms and looked at all the accounts, except in the two larger

firms, and in that situation, we went through and hit every 10th

account. I believe that, statistically, that is probably significant. So

we believe that this represents a true number.

Senator COLLINS. And very important, because another repeated

claim we hear from the industry is the novice trader loses money,

but over time, if you can stick with it and you have got sufficient

capital, day traders tend to be profitable. You did not find that to

be true, that even those traders who had been trading for more

than 6 months had significant losses, is that correct?

Ms. BORTNER. Yes. As I said in my testimony, we sorted all the

accounts by profit and loss, well, actually, by the months, and you

can see if you look in our report that there is no correlation. Winners and losers, winners and losers, winners and losers, mostly losers, occurred throughout the time period all the way from 1 to 25

months.

Senator COLLINS. In our hearing yesterday, we heard very disturbing testimony about an unregistered investor who was day

trading, Huan Van Cao, who was not registered as an investment

advisor and yet was trading for 20 to 21 other customers and, indeed, is still trading today, albeit for a smaller number.

In your analysis in Washington State, did you look at unregistered activity or did you concentrate just on the profitability issue,

and did you find it to be a problem?

Ms. BORTNER. We did find several instances where day traders

were trading on behalf of others. I mean, it is very difficult to find

in the firms because most do not keep records. The day trader

makes agreements, side agreements, with friends and family and

larger groups of people out in the community and there is no record

of that. But we did find some records in one of the firms and we

are following up with our enforcement staff.

Senator COLLINS. Mr. Goldsmith, in that case that I mentioned

with Huan Van Cao, there was arbitration done by NASDR which

led to a judgment against him. When you do a regulatory action

like that, is it reported to the State regulators? What I am curious

about is here there was a judgment entered against Mr. Cao, a

judgment he has not paid, and yet he is still trading and he is still

unlicensed. I am wondering why an enforcement action taken by

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the self-regulatory organization did not trigger an investigation by

the California State Securities Administrator. Maybe it did and it

is ongoing.

Mr. GOLDSMITH. I really cannot comment. I do not know whether

there is an investigation in California or not. But what I understand you are saying is that there was an arbitration, which is not

an enforcement action. It is a private dispute among parties. To the

extent there is an arbitration involving somebody who is registered

with the NASD, that would go on CRD and would be available to

the States.

Senator COLLINS. The CRD being the central repository that you

can check license and disciplinary action, right?

Mr. GOLDSMITH. That is correct.

Senator COLLINS. I just have a little time remaining in this

round, but I want to touch on the issue of deceptive claims or advertising and I want to show you a Web site that I used yesterday

called the Lazy Day Trader. In this Web site, it says, ‘‘The ideal

profession, day trading. It is the only business I know where there

is absolutely no limit as to how much I can earn. I am doubling

my money every 3 months buying and selling stocks. I have developed a simple method. You can start with as little as $2,500. You

do not have to understand charts, technical analysis, or fundamental analysis. You do not have to understand markets, etc. You

do not have to worry about the stock collapsing because you will

only be in the market for brief periods, etc.’’

I would like to ask each of you whether this, as a result of the

reviews and the examinations you have done, is this the kind of deceptive advertising that you have found? Ms. Richards.

Ms. RICHARDS. This is a particularly egregious example. Clearly,

there are misrepresentations and omissions in that ad. We also

found examples of deceptive advertising in our reviews, and I can

give you a couple of examples if you like of some of the advertising

that we found to be exaggerated.

Much of the advertising, I would say, looks like puffing. It was

simply bloated and exaggerated. One firm’s Web site that we found

displayed a newspaper article that quoted a day-trading firm employee as saying that the number of trades at the firm’s branch office doubled on two particular days with the result that one trader

netted more than $50,000 on both of those days, on days when the

Dow Jones Industrial Average plummeted several hundred points.

We found that that employee’s statements were exaggerated and,

in fact, not true.

Another firm’s advertising represented that the firm had a day

trading program, including statements by one of the trading school

graduates who was actually an employee of the broker-dealer. The

pamphlet also represented that the trading school was the top trading school in the Nation, which appeared to us to be without any

factual basis.

Several firms we found also falsely represented in their advertising that they provided formal training programs for new day

traders. In fact, the firms had no training programs whatsoever

and day traders simply arrived on site and were asked to begin

trading.

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Another firm’s advertisements we found targeted inexperienced

day traders and emphasized the firm’s ability to provide training

to enable the customer to become an experienced proprietary day

trader. In fact, we found that that firm only accepted experienced

day traders and referred the new, inexperienced day traders to an

affiliated firm, which looked to us like a kind of bait-and-switch

tactic.

In all the examples of exaggerated or misleading advertising that

we found, we sent the firms deficiency letters and required that

they correct and withdraw the misleading advertising.

Senator COLLINS. Thank you. Mr. Goldsmith.

Mr. GOLDSMITH. I would agree with Ms. Richards; that is a more

egregious example than we usually see. We have noticed recently

is that there are day-trading schools or day-trading recruitment

firms that are not licensed with the NASD, that are not brokerdealers, and are out there promoting day trading in ways similar

to this and then possibly referring customers or have arrangements

with member firms.

Senator COLLINS. So how do you get at those people, because you

do not have any regulatory jurisdiction over that, do you?

Mr. GOLDSMITH. Not over the unregistered entities or individuals, but certainly over the member firms and, in some cases, we

are examining the relationships between the two.

We have seen many ads that disparage long-term buy-and-hold

strategies. In fact, one site that we had taken down said a day

trader can realize significant profits while minimizing the downside

exposure that comes with holding a stock for extended periods of

time. Those are the kinds of risk statements that we have found

to be problematic.

We do have our project where we are continuously reviewing

day-trading firms’ Web sites based on their history of problems in

the past. The more frequent the problems, the more frequently they

are being reviewed. But a site like this, and this may not be a registered NASD member——

Senator COLLINS. It is not.

Mr. GOLDSMITH [continuing]. We are seeing more and more of

that, day-trading schools. In fact, one ad in the Wall Street Journal

I saw last Friday, and this happened to be from a member firm,

said that our day traders use a system that makes them two to

three times as profitable as the national average. I am not sure

whether they were using Ms. Bortner’s statistics as the national

average, but statements like that, where there are really, I doubt,

a sound basis, are quite troublesome.

Senator COLLINS. Ms. Bortner.

Ms. BORTNER. We did, in our examinations, we go out and look

at the advertising that is done by the branches, and many times,

at least what we found was that the branches themselves were not

advertising. When we discover national advertising, we actually

usually pass that along to the NASD because they are in the main

branches of the firms, and as State regulators, we sort of focus on

the local branches.

Senator COLLINS. Thank you. Senator Levin.

Senator LEVIN. Thank you, Madam Chairman.

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First, Mr. Goldsmith, I want to get a clearer picture of the requirements for firms and individuals in the day trading business

to be licensed to buy and sell securities. First, must day-trading

firms be licensed as broker-dealers to buy and sell securities?

Mr. GOLDSMITH. Yes.

Senator LEVIN. By you?

Mr. GOLDSMITH. Yes.

Senator LEVIN. And would that be true not only for the main office of a day-trading company, but also for the branch offices?

Mr. GOLDSMITH. Well, the firm has to be licensed. A firm can

have branch offices, so they have to be licensed branch offices, yes.

Senator LEVIN. But if the firm is licensed, then all of their

branch offices automatically are covered by that license?

Mr. GOLDSMITH. Firms need to make certain filings with us to

advise us of where they have branch offices and their size and operations.

Senator LEVIN. But subject to you being informed that those

branch offices exist, that one license for the main firm covers all

the branches?

Mr. GOLDSMITH. There is a licensing procedure for branch offices

where we need to know how many branches, and how many individuals. A firm cannot have a branch office that we do not know

about.

Senator LEVIN. All right. Now, what about the individuals who

are employed by those offices to oversee the clients’ day trading, to

teach day trading, to accept people in the firm as day traders, to

conduct day trading on behalf of customers of the firm? What are

the registration requirements in each of those situations, and I can

repeat them one by one.

Mr. GOLDSMITH. Why don’t you do that, please.

Senator LEVIN. OK. First, are there any requirements, any registration requirements or licensing requirements for people who

oversee clients day trading?

Mr. GOLDSMITH. Employees of the firm?

Senator LEVIN. Yes.

Mr. GOLDSMITH. Yes. They would be associated persons and they

would have to be registered, depending on the nature of what their

job is at the firm. There are one or more various licenses that they

would have to have.

Senator LEVIN. Do they have to get their own license or do they

simply have to be referred to in the firm’s registration?

Mr. GOLDSMITH. No, they need to be licensed.

Senator LEVIN. They are licensed by you?

Mr. GOLDSMITH. Yes.

Senator LEVIN. What about people who teach day trading?

Mr. GOLDSMITH. Again, if somebody is an associated person

working for the firm, that person would have to be licensed. If we

are talking about a day-trading school that is not part of a firm,

that would be a different question.

Senator LEVIN. All right. What about people who accept people

into the firm as day traders, the same thing?

Mr. GOLDSMITH. People who——

Senator LEVIN. Those who make the judgment as to whether

someone is——

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Mr. GOLDSMITH. Employees of the firm?

Senator LEVIN. Yes.

Mr. GOLDSMITH. Yes.

Senator LEVIN. What about people who conduct day trading on

behalf of customers in the firm, actually conduct the day trading

on behalf of a firm’s customers?

Mr. GOLDSMITH. Are they employees of the firm or are these

other day traders?

Senator LEVIN. Yes. These are employees of the firm.

Mr. GOLDSMITH. If there is somebody employed by the firm,

being compensated by the firm, who is trading for others, they

would have to be licensed.

Senator LEVIN. So if you are compensated by a firm, if you are

trading for that firm’s customers, then you must be separately, individually licensed?

Mr. GOLDSMITH. If you are an employee of the firm trading for

public customers, yes.

Senator LEVIN. Yesterday, I had this exchange with Mr. Parish,

who worked for All-Tech. ‘‘If you knew that unlicensed individuals

were trading other people’s accounts, since you were Branch Manager, why did you not stop it?’’ Mr. Parish, ‘‘When I came to AllTech, they encouraged that sort of thing. Mr. Houtkin was actively

seeking investors to invest in his own mutual fund, he called it,

where he was going to have all these investors put in money and

he was going to find all the traders to trade the money.’’ And I

asked, ‘‘Even though those traders were not licensed?’’ And his answer was, ‘‘Yes.’’ Now, my question to you is, is that proper?

Mr. GOLDSMITH. Well, I think you need to distinguish between

customers of the firm who are not employees of the firm, that is,

day-trading customers who may be trading for others’ accounts,

versus employees of the firm who are trading customer money. I

think the question, if I understand it, and it is a little ambiguous

from the piece of testimony that you read, is you have a day-trading customer of the firm who happens to be trading others’ accounts, that is a different question and one that really goes to facts

and circumstances, whether that person needs to be registered.

Senator LEVIN. But my question was this. Parish said the following. ‘‘When I came to All-Tech, they encouraged that sort of

thing,’’ unlicensed people trading other people’s accounts, so it is

being encouraged by the firm. Then he said the following. ‘‘They

encouraged that sort of thing. Mr. Houtkin was actively seeking investors to invest in his own mutual fund, he called it, where he was

going to have all these investors put in money and he was going

to find all the traders to trade the money.’’ He was looking for the

traders who would trade money that he was urging people to invest

in his so-called mutual fund, and he did not seek licensed traders

to do that. And he said that is correct. ‘‘Yes,’’ his answer was. Now,

my question to you is, is that covered?

Mr. GOLDSMITH. I do not think it is a clear case. I am not sure

whether the individuals who would be doing the trading were sharing commissions with the firm or compensating the firm or anything like that. I think it is a legitimate question that those individuals may have to be registered. But again, there are people who

trade other customers’ money: A child trading for a parent, someVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00095 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
84

body who is incompetent or disabled, or a friend trading his brother-in-law’s money. The real key is whether these individuals are

engaged in the business of trading for others, whether it is a business, and you need to look at a number of factors to determine

that.

Senator LEVIN. It is not enough that the owner of the firm is actually soliciting investors to put in money and then putting them

together with people who will be doing the trading for them? That,

under current regulation, may be unclear?

Mr. GOLDSMITH. I think in terms of whether those people doing

the trading would have to be registered is unclear. I certainly do

not believe it is a best practice to be doing something like that and

it certainly could involve other violations of our rules. I think you

would have to know more about the situation.

Senator LEVIN. If it is unclear, should it be unclear? In other

words, should that not be covered, where a firm is soliciting investments into its funds, into its mutual funds, from which the firm

makes commissions when the day trading occurs, and when the

firm is putting that investor together with the day trader, should

that day trader not be a licensed person?

Mr. GOLDSMITH. Well——

Senator LEVIN. Whether it is clear or not now, should it not be

clarified that in that situation, that there should be a license required?

Mr. GOLDSMITH. I think under the existing rule, which is obviously a facts and circumstances rule, I think it is certainly broad

enough to reach that kind of conduct. You may also have a situation where a brokerage firm is aiding and abetting someone’s violation of the registration requirements of the securities laws. So I am

not sure whether a new rule specifically directed at this, but this

is certainly something——

Senator LEVIN. Is necessary?

Mr. GOLDSMITH. Is necessary.

Senator LEVIN. Because it may already be covered?

Mr. GOLDSMITH. It may be covered.

Senator LEVIN. Would you take a look at yesterday’s testimony

and determine whether, if that allegation is correct, whether or not

it constitutes a violation? Would you make that assessment for us?

Mr. GOLDSMITH. Yes.

Senator LEVIN. If a company employs a person who day trades

for others, does the company charge the client for the service of day

trading generally beyond the commission that is charged for each

trade?

Mr. GOLDSMITH. I really do not know what the general practice

would be. My understanding is that most customers are charged

commissions and that would be it. I think, going back to your previous question, if there were a sharing of profits with the firm in

these accounts, that would be one factor that one would look to in

terms of whether that individual should be registered.

Senator LEVIN. But in terms of whether or not that person is receiving any compensation from the investor who is giving them the

money to do the day trading or whether or not the firm is relying

solely on commissions, you do not know, as to what the general

practice is?

85

Mr. GOLDSMITH. As a general matter, my understanding is that

most day-trading firms, in addition to training and making money

that way, make the money from the commissions.

Senator LEVIN. OK, just from the commissions.

Now, on the study that you made, Ms. Richards, for the SEC, you

indicated that the staff looked at year-end 1998 trading data. You

reviewed a total of 123 trading accounts. The average of the profitable accounts, you said, was $177,000, and I assume that that is

profit, is that correct, Ms. Richards?

Ms. RICHARDS. Yes.

Senator LEVIN. While the average of the unprofitable accounts was $73,000. Of the 123 trading accounts that your staff looked at,

how many of those accounts were profitable? Was that a majority

or minority of the accounts? We know what the average profit and

loss was. That is given to us by your testimony. But what you did

not tell us was whether or not the majority of the accounts were

profitable or not.

Ms. RICHARDS. We evaluated, for each of the firms we looked at,

we selected the 10 most profitable accounts and the 10 most unprofitable accounts, so there would be an even divide in that 123—

62 profitable, 62 unprofitable.

Senator LEVIN. Did you look at the total number of accounts of

that firm to see how many were profitable and how many were

not?

Ms. RICHARDS. We did not. We did not attempt to do a profitability analysis in our examination.

Senator LEVIN. Would that not have been fairly easy to look at

all the accounts and determine how many were profitable and how

many were not profitable since you were taking 10 of each to see

what the average was?

Ms. RICHARDS. It is not that easy, and our goal in these examinations was to determine whether or not firms were in compliance

with the law. We had the benefit of profitability analyses that had

been prepared by the States, so we did not attempt to do a separate profitability study.

Senator LEVIN. The Electronic Traders Association did a study of

profitability last year, according to their representative at our last

hearing. They took a snapshot of each month to determine how

many customers were profitable and non-profitable in each of the

5 months. You did it over the period of a full year, did you, or the

length of the account?

Ms. RICHARDS. Yes.

Senator LEVIN. The length of the account, more accurately, is

that correct?

Ms. RICHARDS. Actually, ours was just a snapshot as of the time

of the examination, whether the accounts were unprofitable at that

time or profitable at that time. We did not look at profitability over

the period, over a longer period.

Senator LEVIN. Ms. Bortner, finally, just to wind this up, as my

time is up, you looked at the length of the account, then, is that

correct, the life of the account in your study?

Ms. BORTNER. We actually took a snapshot in time, too. I mean,

we could not figure out any way to look at the—you could take a

snapshot every single day of the—and that would be a much more

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difficult kind of study. We did a simple analysis, went in. If you

went in a different day, the numbers would be different. I just believe that they would be similar.

Senator LEVIN. So you took a snapshot as of a date looking at

the beginning of the account to that point to determine whether or

not it was profitable or not?

Ms. BORTNER. We looked at minimum balances and we looked at

the profit incurred in the account up until the time we got—you

know, at the exam.

Senator LEVIN. From the beginning of the time the account was

opened——

Ms. BORTNER. Right.

Senator LEVIN [continuing]. To the day of the snapshot?

Ms. BORTNER. Exactly.

Senator LEVIN. You found 77 percent of all those accounts were

unprofitable, is that correct?

Ms. BORTNER. Exactly.

Senator LEVIN. And if you had done it month by month, do you

know whether, in a different way, if you had done it the way the

Electronic Traders Association claims they did it, do you know

whether your result would have been any different?

Ms. BORTNER. I do not know the answer to that.

Senator LEVIN. Thank you.

Senator COLLINS. We are now going to do a 5-minute round of

questions, which will be the last round for this panel.

Ms. Richards, one of the debates is whether or not the current

suitability requirements apply to day-trading firms, and the daytrading firms have argued that because they are not recommending

specific stocks, that they do not have to abide by the suitability requirements already in current law. Is that generally a fair description of their position?

Ms. RICHARDS. Yes. The day-trading firms that we examined all

stated that because they were not making recommendations about

particular securities to customers, that they had no suitability obligations.

Senator COLLINS. Now, yesterday, we heard sworn testimony

from two clients of All-Tech who claimed that the branch manager

routinely pressured them to buy and sell specific securities at specific times at specific prices. Assuming their testimony is accurate,

would that not implicate the current suitability requirements?

Ms. RICHARDS. Yes, it would. If individuals associated with the

firm are making specific recommendations about specific securities

to customers, they have an obligation under existing law to determine whether or not those recommendations are suitable for that

particular customer.

Senator COLLINS. Ms. Richards, would you please describe the

activities that the SEC documented that led the SEC to file a case

this week against All-Tech and several of its employees? The reason I ask is we heard testimony yesterday that was very disturbing

from one of the branch managers who claimed that the head of

margins at All-Tech had directed him or instructed him or at least

suggested to him that he alter figures on clients’ applications to

make them appear appropriate for day trading. We heard testimony from this branch manager that he personally had—he took

87

the Fifth, I should say. He took the Fifth when asked whether he

had forged documents.

We heard a lot of very disturbing testimony yesterday about AllTech. Could you describe for us what led the SEC to bring an enforcement action against the company?

Ms. RICHARDS. Yes. Earlier this week, the Commission actually

brought two enforcement actions against registered broker-dealers.

One was All-Tech and one was a firm called Investment Street Corporation. Both of those enforcement cases alleged illegal lending in

violation of margin rules. In both cases, the Commission charged

that the firm indirectly loaned funds to customers through the

firm’s associated persons.

In the All-Tech case, the Commission is alleging that All-Tech in- directly made over 100 loans totaling $3.6 million through the accounts of three employees. The Commission has also alleged that

seven other employees of All-Tech either directly violated or aided

in abetting margin violations. Similar allegations were made in the

Investment Street matter.

In both of those cases, the Commission is alleging that the firm

itself indirectly loaned money to customers in order to allow them

to meet their margin calls.

Senator COLLINS. And to keep them trading, essentially? Is that

the effect of that?

Ms. RICHARDS. That is the effect, and the Commission specifically

alleged in its order instituting proceedings against All-Tech that

All-Tech had an incentive to make improper loans, to receive further revenue from day-trading customers who would have otherwise been cut off from further day trading.

Senator COLLINS. Thank you. Mr. Goldsmith, could you explain

to us what responsibility a firm has for its branch managers with

regard to appropriate supervision?

Mr. GOLDSMITH. The firm’s supervision of its branch managers?

Senator COLLINS. Yes.

Mr. GOLDSMITH. Full responsibility. The branch manager is very

oftentimes, I do not want to use the cop on the beat, but the supervisor on the beat responsible for the operations of an office and

when a firm has branch offices around the country, those are very

significant responsibilities from a supervision standpoint.

Senator COLLINS. Ms. Richards, I want to come back to you with

one final question. It is my understanding, and please correct me

if I am wrong on this, that the New York Stock Exchange and

NASD have recently proposed to the SEC a rule that would actually increase the intra-day buying power or margin of day traders

from 2-to-1 to 4-to-1. Now, if I am understanding this correctly,

that means a day trader like Scott Webb could control $100,000 of

stock with only $25,000 of actual equity without generating a margin call.

Given your statement earlier that excessive leverage creates

problems and produces losses, why would we want to go in this direction? Why would we want to increase the ratio of borrowed

funds to equity?

Ms. RICHARDS. First, I should say that the margin rules are designed to protect the firm itself from incurring excessive risk. I

think the New York Stock Exchange and the NASD felt that it was

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1See Exhibit No. 155 which appears in the Appendix on page 1193.

appropriate to raise the total buying power for day traders along

with the requirement that day traders be required to have in their

accounts $25,000 minimum equity at all times, which is a significant increase over the existing rule, which is only $2,000.

So I think, in tandem, the Exchange and the NASD felt that that

was appropriate, along with the other restrictions that are included

in the proposed rules. I will say that the Commission is considering

the proposed rules now and the comment period is still open and

extends through March 10, so we are actively considering other

comments on the proposals.

Senator COLLINS. And you will be hearing from me on that.

Thank you very much. Senator Levin.

Senator LEVIN. Thank you, Madam Chairman.

On the margin issue, it is already against regulations, as I understand it, for a broker to use his or her own money to help a customer make a margin call, is that correct?

Ms. RICHARDS. Yes. In the cases that we brought this week, for

example, we alleged that both firms, in effect, indirectly themselves

loaned funds to customers in excess of the margin requirements.

Senator LEVIN. And whose money was it they were lending?

Ms. RICHARDS. I cannot answer that. I can get back to you and

let you know. I cannot answer that, but I believe they were funds

of the firm’s employees.1

Senator LEVIN. Say they were funds of a firm’s other customers.

Ms. RICHARDS. It is legal under existing Federal Reserve Board

regulations for broker-dealers to arrange loans between outside entities, for example, the customer-to-customer loans that are so

prevalent in the day trading industry.

Senator LEVIN. Yes, but the customer-to-customer loans that are

prevalent are totally different in the day trading world than they

are in the more normal world, is that not true?

Ms. RICHARDS. Yes, that is exactly right. We have seen the day

trading industry use these customer-to-customer loans in ways that

we have never seen before.

Senator LEVIN. Does the customer making the loan usually get

a fee or interest paid for that 24-hour loan?

Ms. RICHARDS. Yes. In the cases that we have seen, the customer

making the loan gets a fee.

Senator LEVIN. Does the broker share in that fee at times?

Ms. RICHARDS. We have not seen that.

Senator LEVIN. But it is against current regulation for a broker

to facilitate a loan from one customer to another, is that correct or

not?

Ms. RICHARDS. It is allowed under current rules for broker-dealers to arrange——

Senator LEVIN. Forgive me. I misspoke. Are you making any

change in that, where the broker is doing the arranging under day

trading?

Ms. RICHARDS. There is one part of the rule proposals that have

been submitted by the NASD and the New York Stock Exchange

which may impact this, and that is the requirement that the funds

remain in the account, in the day trader’s account, for two full

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1See Exhibit Nos. 154 and 155 which appear in the Appendix on pages 1192 and 1193.

business days, thus be subject to the new risk that that day trader

is incurring. We think that it is very possible that customers may

be more reluctant to lend their funds to other day traders if they

know that those funds are going to be subject to the new risk of

day trading.

Senator LEVIN. Is it against current regulations for a broker to

transfer, the word that was used yesterday is to——

Ms. RICHARDS. Journaling.

Senator LEVIN [continuing]. To journal?

Ms. RICHARDS. No, it is not, and it is very common now. The

funds are not actually transferred from one customer to another

customer. They are just on paper journaled over.

Senator LEVIN. Who is the owner of those funds at the moment

that they are journaled over?

Ms. RICHARDS. The day trader who has incurred the margin call

gets the benefit——

Senator LEVIN. The borrower is the owner?

Ms. RICHARDS. The borrower, correct.

Senator LEVIN. Is the owner?

Ms. RICHARDS. Correct.

Senator LEVIN. Even though it is just a journal entry?

Ms. RICHARDS. Correct.

Senator LEVIN. Yesterday, there was some resistance to our witnesses using the word ‘‘lend,’’ but it is a loan, is it not?

Ms. RICHARDS. It is a loan and it allows the day trader to meet

his or her margin call and to continue to trade. I think one of the

things that causes us trouble about those loans is that they are so

easy that they are routine, and day traders, I think, do not fully

realize that they are borrowing additional funds.

Senator LEVIN. And we heard yesterday from Ms. Harlicher that

she did not even realize her funds were being used that way. Is it

against current regulation for a broker to journal somebody’s funds

to somebody else to cover the second person’s margin requirement? 1

Ms. RICHARDS. Well, both parties to the loan must know that

they are involved in a loan. So yes, if a broker-dealer was, for example, forging the lender’s signature or otherwise not notifying the

customer their funds were being used in that way, yes, that would

be violative.

Senator LEVIN. Against current law?

Ms. RICHARDS. Yes.

Senator LEVIN. And so the current journaling requires a signature from the lender, is that correct?

Ms. RICHARDS. Yes.

Senator LEVIN. Do you know whether or not, in fact, when they

do this ‘‘journaling,’’ this lending, whether, in fact, in practice, the

lender is signing these notes for 24 hours?

Ms. RICHARDS. In our examinations, we did not find any indications that the customers were not signing the letters of authorization.

Senator LEVIN. Did you find to the contrary, that they were?

Were you looking for that?

90

1See Exhibit Nos. 154 and 155 which appear in the Appendix on pages 1192 and 1193.

Ms. RICHARDS. We were looking for indications that they were

not and we did not see that in our examination.

Senator LEVIN. OK, that is fine. So Ms. Harlicher’s experience

may be unusual.

Ms. RICHARDS. Yes.

Senator LEVIN. Will you check out that allegation of Ms.

Harlicher that her funds were lent to cover someone else’s margin

without her knowledge? Would you check that out for us? It was

testimony under oath yesterday.

Ms. RICHARDS. Yes, we will.1

Senator LEVIN. Now, is there not a conflict of interest on the part

of the day-trading firm or the day trader trading on behalf of another person, since the more trades that occur, the more commission and money that the firm and the trader make? Now, in a normal investment, so-called, there are rules against churning so that

there is a brake, there is some kind of a counter-check. There is

a check on a trader during the churning, because it is unethical to

churn.

Well, in the day trading world, it is completely reversed. The

more trades you make, the more money the firm is going to make,

but that is encouraged when you take a look at the criteria, make

more trades. That is what is taught to these folks. So we have the

opposite, in a sense. Churning is the rule. The more trades, the

better. Take a look at their lesson plan. And we do not have a

brake on that, right, in the day trading world? We do not have any

brake on that ethically, so is there not a conflict of interest in that

it does not have the natural brake on it.

I would ask, maybe, Ms. Bortner, we will go back just kind of

quickly on that. My time is up.

Ms. BORTNER. Well, certainly, I believe that that does create conflicts as there are in the normal relationship between broker and

client, and this is just another conflict, but I do not think there is

any law against having a conflict like that. People should be aware

of it and when someone is trading on behalf of others, under our

State statutes, that is a violation of the law. In fact, it is a felony

if you commit that kind of trading on behalf of others without

being licensed and defrauding them in that way.

Senator LEVIN. Your answer to my question about trading on behalf of others without being licensed in your State would have been

that is against the current law?

Ms. BORTNER. That is against current law.

Senator LEVIN. Quickly, on the churning.

Mr. GOLDSMITH. I think you are absolutely right. I think there

is an inherent conflict.

Senator LEVIN. There is no check.

Mr. GOLDSMITH. Firms make money by doing trades.

Senator LEVIN. But with no check in the day trading world.

Mr. GOLDSMITH. Right.

Senator LEVIN. Whereas you have a churning——

Mr. GOLDSMITH. We have a specific rule. I will say on the arranging of loans among customers and the procedures, we have found

situations where the interest rates that are being charged are a litVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00102 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
91

1See Exhibit No. 23 which appears in the Appendix on page 365.

tle, shall we say, on the high side, procedures, principal sign-offs,

xeroxed copies of signatures, customers not knowing that they are

actually lending, and no disclosures. So under present law, there

are ways of reaching that, but the mere lending by customers or

firms facilitating the lending is not necessarily a violation of our

rules now.

Senator LEVIN. Thank you.

Senator COLLINS. Thank you very much. I appreciate your testimony.

We will be putting into the hearing record the Washington State

Securities Division’s report 1 and any other documents that you

wish to submit. Thank you.

I would now like to call forward our next panel of witnesses, who

are the representatives of the three day-trading firms on which the

Subcommittee’s inquiry has focused. They include Harvey Houtkin,

who is the Chief Executive Officer of All-Tech. All-Tech is

headquartered in Montvale, New Jersey, and is one of the largest

day-trading firms in the country.

Another of the witnesses will be Henry Fahman, who is the

President and Chief Executive Officer of Providential. Providential

is headquartered in Fountain Valley, California, and provides daytrading services to its clients at several California branch offices,

as well as an office in Oregon.

The third witness we will hear from is James H. Lee, who is

President of Momentum Securities, which is based in Houston,

Texas. Mr. Lee also serves as the President of the Electronic Traders Association, which is the trade group representing the day trader industry.

I would ask the three individuals to please come forward. Gentlemen, if you would please stand so that I can swear you in. Do you

swear that the testimony you are about to give to the Subcommittee is the truth, the whole truth, and nothing but the truth,

so help you, God?

Mr. HOUTKIN. I do.

Mr. FAHMAN. I do.

Mr. LEE. I do.

Senator COLLINS. Thank you. I will ask that you each limit your

oral testimony to no more than 10 minutes this morning. You are

welcome, however, to submit a longer statement or any other material that you deem pertinent to the hearing record and it will be

published in its entirety.

Mr. Houtkin, we will start with you.

TESTIMONY OF HARVEY I. HOUTKIN, CHIEF EXECUTIVE

OFFICER, ALL-TECH DIRECT, MONTVALE, NEW JERSEY

Mr. HOUTKIN. Thank you. Good morning, Ms. Collins, and Mr.

Levin. First, I would like to start with a little biography of who I

am because I think it is important, because you had a lot of your

experts up here and I would like a little background.

My name is Harvey Houtkin. I am 51 years old. I am Chairman

and Chief Executive Officer of All-Tech Direct. I have an MBA from

the Bernard M. Baruch College of the City University of New York.

92

I have been in the industry approximately 32 years, a former member of the New York Stock Exchange, American Stock Exchange,

and my master’s thesis was on the impact of NASDAQ on the overthe-counter market. I have been a major proponent for market reform for the last 12 years and I have been instrumental in bringing

many of the changes that have come for transparency, access, investor education, etc.

Just yesterday, I was considering basically boycotting this hearing because I feel this is not a hearing, this is not an impartial tribunal trying to find something out and clarify, ‘‘day trading.’’ What

it is is a search and destroy mission, a crucifixion, an ambush. I

am hearing about day trading when the term ‘‘day trading’’ has not

even been defined here. What is a day trader? What are we talking

about? What rights do people have in this country to access the

market equally and fairly without broker intervention? That is the

issue.

The reality is, most day traders, and I can mostly speak for my

firm because I do not really have access to other firms’ information,

many day traders do not, in fact, day trade at all. I mean, they day

trade to some extent, but they take home positions, and our experience, for example, when you are talking about loss, is that it comes

from the investment or overnight or longer-term holding of a security, not the day trading of a security.

But day trading has a negative connotation. The press, the regulators, the industry has been very interested in giving it a negative

connotation. I have been in contact with literally thousands of day

traders. There was a major forum just this past weekend in New

York, a major day trading expo where thousands of people, very sophisticated, enlightened people who desire the right to interact in

the market on a fair and equitable basis attended that show and

were very interested in the new and modern technology that has

narrowed spreads, that has made the markets more competitive,

that has given rise to the opportunity for the average guy who has

the credentials to compete in the market to the best of their ability.

This is wonderful, and the report that I received just a couple of

days ago from the Senate here gave a whole three sentences of

credit to the changes that have taken place in this industry,

changes that were mandated by the Congress in 1975. Under the

Market Reform Act of 1975, you mandated transparency, access, a

level playing field for the world. And what happened over the next

25 years? Virtually nothing. The Senate, the Congress, the SEC

stood by idly while the industry just stood there.

We still have the specialist system. We still have payment for

order flow, not to mention we are all here today facing a day trading hearing, a hearing where I have not even heard of very many

complaints. The regulators, the State regulators, did they list how

many complaints there were, how prolific this, ‘‘problem’’ is? No,

because when I spoke to the State of Massachusetts and when I

spoke to the news officials, when I spoke to Dan Rather from ‘‘60

Minutes,’’ they had a hell of a tough time trying to find anyone to

come forward to complain about the ‘‘horrors of day trading.’’ But

that is what we are here for.

Now, of course, the price-fixing scandal that went on that resulted in a billion-dollar civil settlement to the major brokerage

93

community, we did not have a PSI investigation of price fixing,

even though the SEC charged 24 firms with violations. When the

NASD failed to enforce all the regulations, backing away, trading

through, I did not hear of a PSI investigation, and this only involved perhaps billions of dollars to the public. This was never

talked about. Even the presence of organized crime in the brokerage community, that has not warranted a PSI investigation.

But if people want to trade voluntarily with their eyes open, that

is a real major problem to the Senate, and this is what disturbs

me. There are issues here that are so much greater, yet we are

here having these studies because several thousand people, some of

the most sophisticated investors, some of the most enlightened

traders in the country, want free and open access to the market

through technology. This is the problem we are here to discuss

today.

Now, have we had a balance? I heard one person testify, and a

former rogue branch officer, perhaps two branch officers and two

people that are in litigation with us. Yes, those people, they had

a complaint. Where are the people who are doing well? Where is

the testimony—I got calls yesterday from people all over the country who wanted to know how they could come here today and testify to refute some of the nonsense that has been spewed from this

hearing. So I was very seriously considering not even showing up,

and I said so on CNBC yesterday. But I felt that would just allow

the same nonsensical rhetoric to continue without a voice of opposition.

Like I say, so little attention has been paid to what is direct access—and that is what we are really talking about here. Not day

trading; direct access. The ability of the public customer to directly

access the market, to receive transparency and information

uncompromised, and to be able to do a transaction for a whopping

$16 to $25.

Now is it not—it also very amazing here today, I have not heard

the name E-Trade, Waterhouse, AmeriTrade, DLJ Direct. These

are the firms that are performing the bulk of what you would call

day trading. These people have millions of clients, and these are

the people where thousands of complaints were filed. How come

they are not part of this hearing? How come the SEC has not seen

fit to bring these people in?

These are the people who are telling me, if I open up an account

at E-Trade I can have money coming out the wazoo. Or I can have

an island. Or maybe make a $4 billion acquisition while tending

bar. Do any of these commercials sound familiar? They are not part

of this hearing. Yet, they do far more transactions than a firm like

All-Tech. But yet it seems very politically expedient to slow down

the growth of direct access.

Now I do not want to be on the attack here, but if I am going

to be attacked, I will attack. You are very interested in disclosure.

You are very interested in suitability. Well, I have not seen anywhere anything mentioned about campaign contributions, and

where both senators here receive a decent amount of money from

the securities and investments industry. Now of course, that would

never slant anyone, and all this is being done in good faith.

94

Look, I have a 12-year history. I have fought at every level of

this. I have had to be at the Federal Appeals Court. I have had to

be in front of the SEC, and I am under tremendous pressure because I am bringing direct access to the public, for better or for

worse. I have never heard anywhere where we are now evaluating

the profitability of accounts.

When was the last time Merrill Lynch did a survey on how much

money their customers made, or Dean Witter, or Paine Webber, or

Morgan Stanley? No. But the day-trading community, which in my

instance I have the highest suitability standards in the industry.

I have the best disclosure in the industry. We are under the gun.

We are under the watchful eye of an industry.

Look, if you want to start looking at things, let us look at things

fairly. How come there has been no balance here? How come, with

the exception of myself now and my two colleagues to the left, no

one has spoken favorably? If you are looking to slow down direct

access, if you want to violate the public’s right to trade, if you want

to invade the public’s privacy . . .

I believe that what a person does with their own money in the

investment markets, in a country that prides itself on free trade

and free markets, and you are going to come here and tell me that

we are going to have to evaluate, analyze, and allow people to

trade, and have all these tough criteria? That is as private to them

as what goes on in the marital bedroom. You are really starting to

get involved in things I do not think you want to get involved in.

Now the fact is that no one has spoken out, maybe that is why

I have gained some national notoriety. Because most people are

shaking when they walk into these chambers because you are all

looking for the negative of what is going on. I am proud of what

I have done. I stand on what I have said. And yes, are there some

problems? Do we have some problems with what is going on in the

industry? Is there an occasional rogue broker? Does someone fail

to fill out a form properly? Absolutely.

But then again, if you are looking to regulate and close down this

type of activity, let me tell you, there will not be a business left

in this country. So let us get real. Let us get serious. And if we

do need some changes and if we do need some regulatory improvements, let us do it. But let us stop pointing these fingers at a few

small day-trading firms that have been on the leading edge of

change and improvement for the market.

Thank you.

Senator COLLINS. Mr. Fahman.

STATEMENT OF HENRY D. FAHMAN, PRESIDENT AND CHIEF

EXECUTIVE OFFICER, PROVIDENTIAL SECURITIES, FOUNTAIN VALLEY, CALIFORNIA

Mr. FAHMAN. Good morning, Chairman Collins. Good morning,

Senator Levin.

Senator LEVIN. Good morning.

Mr. FAHMAN. Good morning, Members of the Subcommittee. My

name is Henry Fahman. It is an honor and privilege for me to appear at this hearing today to address some of your concerns as far

as the day trading industry is concerned. Like my colleague, I

would like to go over a little bit of my background and also share

95

with you some of my thoughts about the day trading business, and

also where our firm stands on these issues.

I was born and raised in Vietnam in a small town, and during

the war as a teenager I was involved with the U.S. military as an

interpreter, and also as an interpreter for the American Red Cross.

And because of my involvement with the U.S. Government and my

involvement with the South Vietnamese government as a former

officer, I was imprisoned by the communist government for 31⁄2

years. After my release from prison I tried to escape from the country, and many times I was captured and put into prison. And many

times I was at gunpoint because I was trying to leave the country

to come to the United States of America for freedom; the freedom

of choice.

I come here in 1982. I attended law school in Vietnam but was

not able to complete and had to join the army during the most ferocious time in the history of the war in Vietnam. I came here and

went to UC-Berkeley and earned my degree in business and economic and financial analysis at Berkeley. And also worked for a

number of firms including A.G. Edwards & Sons, and the Investment Center, a firm based in New Jersey, as their branch manager

in southern California before founding Providential Securities in

1992, first mainly to address the needs of investment in the Asian

community in southern California.

Before going into other parts that you may be interested I would

like to give an overall picture of our view of what we see as far as

the day trading industry is concerned. I think a number of issues

have arisen during this testimony and also during the investigation

across the country. I think No. 1, is suitability. No. 2, is risk disclosure. No. 3, lending practices. No. 4, maybe operational problems

that have occurred at some firms.

As far as our firm is concerned, some of the allegations and some

of the operations and complaints that were brought up like Amy

Le, Linda Richardson, for example, those were the legacy of the Go

Trading Company. It was not ours. We happened to inherit those

complaints in those cases because Tae Goo Moon, who happened to

be our branch manager at the Los Angeles office moved those accounts over to us. And when they were not happy, they filed a complaint and went into arbitration, we were named in those cases.

But Providential Securities, we did not start with those clients. We

did not have those clients to begin with.

As far as the recommendations by NASAA and other regulatory

agencies are concerned, I believe it is important to allow and educate and let the public know the risks that are involved in day

trading. Of course, there is a great relation between risk and reward, as every one of us is aware. That is why Providential Securities, we have come out with a warning, warning, warning. Please

read carefully before you sign. And all the risks are disclosed in

this document every time a client opens an account.

Some people choose to do that. Some people choose to day trade

because that is what they want to do. There is a utility function

that can be derived from any activity in life, and I was disturbed

by some of the filing or the allegations that day trading is an addiction, is like an addictive habit. People choose to do certain things

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1The prepared statement of Mr. Lee appears in the Appendix on page 212.

in life because they are willing to, because they are able to, because

they are ready to, because they know what they are doing.

For that reason, of course, day trading is not for everyone. It fits,

it suits a certain group of people, to a certain segment of the market who knows what they are doing. Of course, we want to cater,

we want to service those people, and we want not to include those

people who should not belong in the day trading business because

it is not suitable for them.

But as far as choices are concerned, like myself, I was in prison

many times. Every time I tried to leave the country I was arrested.

I was captured. I was put in prison. I was at gunpoint. But I was

determined to leave Vietnam for America. Why? Because I knew

beyond the other side of the Pacific Ocean there is a free country.

There is a country where there is freedom of choice. That is why

I make the decision.

I was arrested. I could have been killed many times. And if you

know the story of the boat people, many of them have been raped.

Many of them die in the open sea. But they were willing to take

that risk. Why? Because the risk/reward ratio. They knew, if they

made it, they would have gained freedom that is unparalleled anywhere in this world.

So I think we need to look at day trading and other matters in

life with a broader context, not just a small segment. And sometimes I am disturbed at the empirical, the statistical evidence.

Sometimes because of the lack of the sample data, because the universe is not broad enough, maybe the time frame is not broad

enough. So the conclusion that has been drawn based on losses,

profitability, suitability, a number of other reasons, sometime may

be skewed to one side or another.

Those are my comments. But I think this is a segment of the

market that is here to stay because of the burgeoning of new technology that gives easy access to the market for everyone. And here

is the land of America. Land of the brave. Land of the free. And

we are free to choose. Of course, we want to educate people so they

know what they are choosing. But that does not mean that we

should limit to them to our own parameters, to our own interests,

and to our own agenda.

I would like to open up for any questions or any other points of

concern that I would be willing to address.

Senator COLLINS. Thank you, Mr. Fahman. Mr. Lee.

STATEMENT OF JAMES H. LEE,1 PRESIDENT, MOMENTUM

SECURITIES, HOUSTON, TEXAS

Mr. LEE. Good morning, Madam Chairman, Senator Levin.

Senator LEVIN. Good morning.

Mr. LEE. I appreciate the opportunity to appear here today and

discuss day trading and to address your concerns. I commend this

Subcommittee’s effort to review the industry and help suggest improvements in the system.

I am president of Momentum Securities. My company is a registered broker/dealer with the NASD and SEC. I am also president

of the Electronic Traders Association. I co-founded Momentum in

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1995. Since them, Momentum has grown to be one of the largest

electronic brokerages in the United States serving some 1,300 fulltime day traders and employing over 150 people in various States.

This past January we executed approximately 800 million shares

across 3 million transactions. I believe this makes us one of the

largest day trading organizations in the country and second only to

Charles Schwab in the overall electronic brokerage space.

Today, Momentum, as the primary broker/dealer of TRADESCAPE.com is part of an integrated enterprise focused on trading

and technology development. TRADESCAPE earlier this month

agreed to purchase MarketXT, a recently authorized ECN in a

vertical acquisition valued at about $100 million. The MarketXT

acquisition will expand our liquidity pool, accelerate the offering of

execution services and technology to institutions, and will benefit

our retail customers who participate via our web browser interface.

Our organization is backed by investment partners who are leaders in technology and financial services, including SOFTBANK,

Morgan Stanley, Salomon Smith Barney, Mattof Securities, Warburg Pincus, among others. Indeed, SOFTBANK is currently lead

managing a $100 million additional round of financing for our company.

Technology developments in recent years have had a fundamental and profound impact on our securities markets. Participants today are benefiting from the new technology and systems

that provide quick access to multiple points of liquidity. This new

technology allows investors the ability to manage, monitor, and

trade their own portfolios without the need for intermediaries to

place investments.

Both changes in technology, principally in the communications

area, and recent SEC rule changes now make it possible for day

traders to have virtually the same access to market information,

executions, and order exposure as traders on the floor of our national exchanges. Recognizing our technology, many mainstream

brokerages are now seeking to broaden the services of their customers by merging their resources with firms like mine.

Not only have major participants invested in TRADESCAPE, but

earlier this month Charles Schwab, America’s leading discount and

online brokerage, acquired CyberCorp, a day trading boutique

whose revenues are about one-third of ours. The transaction was

valued at nearly $500 million.

Day trading is but one of many ways to earn a return on capital.

Placing capital in the securities markets always involves some degree of risk. On one end of the continuum there are forms of investments with low risk and low return, like CDs and savings bonds.

On the other end, with higher risk, is day trading. The higher the

risk, it generally follows, the greater potential for higher yield.

Our day traders generally understand these risks and choose day

trading for the benefits it has to offer. They are not seeking slow,

steady investments with little risk. They recognize, and indeed acknowledge, that they are accountable for their own trading decisions. Those decisions are theirs and theirs alone. With adequate

and appropriate disclosure, and truthful advertisements, both of

which you will find at Momentum, day trading can be a viable approach to the market.

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With that background I would like to outline some of the policies

Momentum has voluntarily and proactively implemented to enhance customer protections and to share some of my views on day

trading.

No. 1, to me risk disclosure is the most important area from the

standpoint of customer protection. The securities markets always

involve some degree of risk and day trading certainly involves more

risk than many other approaches to the market. The critical issue

is whether the investor has been apprised of the level of risks being

assumed.

SEC Chairman Levitt told this Subcommittee in September, ‘‘if

day traders are adequately apprised of the risk of their day-trading

strategies, the Commission believes that the individual day traders

bear responsibility to make sure that they do not trade with funds

they cannot afford to lose.’’ I agree.

Our present form of risk disclosure exceeds those proposed by the

NASD and are far beyond those found at online or full-service

firms. We voluntarily designed this risk disclosure statement and

require our customers to read and acknowledge it before day trading. The disclosures were developed with guidance from NASAA

and were later used by the NASD in developing its own risk disclosure proposal. I noticed Mr. Fahman has a copy of it now and appears to be using it. Indeed, we require our customers to read and

sign four separate documents that deal with these issues before

they open an account.

Furthermore, as an ETA member firm, we also fully subscribe to

the ETA statement of ethical principles, a copy of which you will

find with my testimony.

No. 2, to me, day-trading firms must be accountable for the manner in which they advertise to the public. I believe we must be

truthful in all of our communications with customers. And while

we do very little advertisement, Momentum does not make misleading or exaggerated claims about our services or the overall benefits of day trading. We believe we have an excellent relationship

with our customers and we receive very few complaints given our

size and reach.

No. 3, I believe internal compliance is also important to developing best industry practices. At Momentum, we are fully committed to the highest standards. That having been said, have we

made mistakes? Can we do better? Absolutely. Momentum has only

been in existence for 4 years, and in many ways we are still in our

infancy. We strive to refine and improve our system. Our operation

is far better today than it was when we first opened.

We have implemented greater internal controls. Among these are

a formalized compliance department; commitment of additional resources for compliance personnel; development of new policies on

risk disclosure and account opening guidelines; and we have instituted regulator self-imposed compliance visits to our branch offices.

No. 4, I recognize that there is a learning curve involved in successful day trading. While we are not required to do so today, we

have developed voluntarily a threshold guideline of available risk

capital. At Momentum we developed such a guideline because I believe it is the right thing to do. We now ask for a minimum initial

deposit of $50,000 and—collectively—and a minimum disclosed net

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worth of $100,000 to open a day trading account. If a customer

does not meet these two factors, a customer may still appeal their

initial rejection if they demonstrate such factors as prior trading

experience.

No. 5, I believe day trading has made a positive impact on the

securities markets by increasing market liquidity, vastly improving

pre and post-trade transparency, furthering the standards of best

execution, and significantly helping to reduce agency cost. Day

trading also helped break a collusive monopoly and now individual

investors, rather than institutions, are increasingly gaining control

of their transactions.

Moreover, day trading has fostered new technology to transmit

information and accelerate executions, which has resulted in larger

benefits to the overall economy.

No. 6, there have been conflicting press reports regarding profitability of day-trading firms. Based on my years in the business,

and I believe I have some sense for what really occurs with respect

to profitability, in my judgment not every trader will make money

from the start. And many will lose in the first 3 to 5 months in

which traders are learning the skills required to trade.

After the learning curve in which dedicated traders are developing skills and proficiencies with the systems, I believe the number of profitable traders improves significantly. The simple fact is

that many of our traders are successful. I remain proud of their

success.

No. 7, I am sensitive to the concerns regarding the traders who

have, arguably, insufficient risk capital. While in the past there

may have been exceptions with my firm, I believe customers currently in our system either have the means or the experience to be

day traders. Today, the vast majority of our customers are mature,

educated, professional, and financially secure women and men.

No. 8, I am sensitive to the concerns regarding lending practices.

I was recently appointed vice chairman of the NASD task force on

day trading margin rules to help address these issues. To my

knowledge, my firm has at all times complied with the rules that

exist in this area.

No. 9, one of the reasons behind the development of the ETA was

to provide day-trading firms with a forum for discussions about the

very issues we are reviewing today. While I am speaking today for

myself and what I believe and strive for with my own company,

and while I cannot make commitments for other firms, it is my

hope that through responsible leadership we may use the ETA to

encourage other day-trading firms to strive for best practices.

No. 10, at Momentum we strive to improve our company and

learn from our mistakes. We acknowledge that our operation is in

many ways better today than it was when we first started. We suffer immeasurably as an industry when other companies’ practices

are sub par. As with any industry, I believe there are good, wellintended companies who represent industry best practices, and

there are others that fall short. We strive to set ourselves apart

from the latter group through our business ethic, practices, client

services, and proactive policies aimed at full disclosure of risk, balanced and fair advertising, and heightened account opening guidelines.

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While there may be some disagreement about which regulatory

changes are desirable, I welcome the opportunity to work with you

to develop appropriate recommendations for change.

In closing, I wish to emphasize that I am proud of Momentum.

We strive to be a leader. We have made mistakes, but we correct

them. Hopefully today’s discussion will be used to forge an alliance

between thoughtful, legitimate, proactive companies who are working to improve the system and members of the industry who would

like to explore ways to promote efficient markets and design appropriate customer protections.

Thank you, Senators.

Senator COLLINS. Thank you, Mr. Lee. I do want to recognize

that although we did discover several problems with Momentum’s

past practices that you also have made and implemented significant reforms. I want to recognize and commend your firm for recognizing the mistakes that have been made and for implementing

some reforms that should make a difference.

Mr. LEE. Thank you.

Senator COLLINS. Mr. Houtkin, last night on CNN you disputed

information provided to the Subcommittee by one of your branch

managers, that only 10 percent of his customers were profitable.

Yesterday, at our hearing under oath and also in his deposition,

another one of your branch managers, Mr. Parish, testified that 80

percent to 90 percent of the day traders in San Diego were losing

money, at least within the first 6 months.

Another one of your branch managers in Boca Raton testified or

provided information to the Subcommittee that zero—not one of the

customers of that branch office were profitable. Yet another branch

manager, Mr. Zayas, who testified yesterday, said that only one out

of his approximately 50 customers were profitable. Are all your

branch managers wrong?

Mr. HOUTKIN. They are not all my branch managers. As a matter

of fact, those branch managers you are talking about, I do not believe any of them are still with us, and have gone off either to competitive firms or whatever. I do not know what they base those statistics on. As a firm, we do not keep track of how well our customers do in general.

I do not believe it is a practice in the industry. And if this is a

practice the industry would like our people to start keeping, if you

would recommend that firms in general keep track of the profitability of their clients’ investments, then we would go along with

those regulations.

Senator COLLINS. The president of your firm, Mark Shefts, also

told the Subcommittee that three out of 10 day traders, only three

out of 10 would be profitable.

Mr. HOUTKIN. Yes.

Senator COLLINS. So if you are not tracking this, how does the

president know?

Mr. HOUTKIN. It is by observation. I was the one who first said

that several years ago when I was pressed I think by Business

Week magazine, about how many people make it and how many do

not? Let us discuss that.

Senator COLLINS. Are you not concerned that the vast majority

of your customers are losing money?

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Mr. HOUTKIN. I am concerned that people have the best possible

execution, the best possible information, and freedom to perform in

the financial markets as they choose as free American citizens. If

they do—and give them the best possible service for what they can

do. It is up to them to decide.

I believe that people should be responsible for what they do. We

have the highest risk disclosure standards, and have so for the past

5 years. We invented risk disclosure back in 1995. We have maintained the highest suitability standards in the industry for as long

as I can remember.

Now if a person—and we have the best, probably one of the best

training programs in the industry. So if a person is qualified to

trade, if a person has the financial wherewithal to trade, and if the

person has been advised of the risks and they are a mature, responsible person, then it is up to them to decide what they want

to do.

Senator COLLINS. We heard considerable testimony yesterday

that your customers are not apprised of the risk and that the training was not adequate. But let me ask you a question. Senator

Levin yesterday quoted from a deposition and asked Mr. Parish

what All-Tech’s philosophy was concerning customer recruitment,

and Mr. Parish said that the philosophy was, take whoever comes

in.

Mr. HOUTKIN. That is not true.

Senator COLLINS. That is not correct?

Mr. HOUTKIN. That is not true, and Mr. Parish is also the one

who is accused of forging documents and is in a hot seat right

now——

Senator COLLINS. So you have had a lot of——

Mr. HOUTKIN [continuing]. And might be very inclined to say or

will accommodate the panel here because of pressures he is under

by the regulators.

Senator COLLINS. Did you hire Mr. Parish?

Mr. HOUTKIN. Years ago.

Senator COLLINS. Did you hire Mr. Zayas, another branch manager of yours of whom you have been critical?

Mr. HOUTKIN. He was hired by the firm. Mr. Zayas was a CPA,

a practicing CPA.

Senator COLLINS. Did you hire him?

Mr. HOUTKIN. I do not know if I hired him or someone at the

firm hired him.

Senator COLLINS. It is my understanding that you did hire him.

Were you chief compliance officer at the time that all these problems that you have been very critical of Mr. Zayas were occurring?

Mr. HOUTKIN. All these problems?

Senator COLLINS. Were you chief——

Mr. HOUTKIN. How many problems do we have relative to the

millions of transactions and thousands of customers we deal with?

Senator COLLINS. Mr. Houtkin, last night on CNN Money Line

you said that Mr. Zayas caused the problems in Massachusetts and

‘‘that he should be in jail.’’

Mr. HOUTKIN. If he did what they accuse him of doing, which is

taking funds, unauthorized funds, and forging documents, the man

committed a serious violation and he should be punished for that.

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1See Exhibit No. 75 which appears in the Appendix on page 714.

Senator COLLINS. Mr. Houtkin, is it not true that you and AllTech were named in the complaint by the State of Massachusetts

for failing to supervise Mr. Zayas and that you settled those

charges, and that included an agreement that All-Tech would not

conduct business in the State of Massachusetts for 2 years?

Mr. HOUTKIN. You are a regulator, Senator Collins. Regulators

always see things as half——

Senator COLLINS. Is that true or is it——

Mr. HOUTKIN [continuing]. The glass is always half empty. Yes,

we settled with Massachusetts because we have a relatively small

firm and I cannot devote the rest of my life in administrative hearings, running around, spending hundreds of thousands of dollars in

legal fees to adjudicate something that was able to be settled basically for a $50,000 contribution to the investor education fund. So

yes, we settled it as a matter of practicality.

Senator COLLINS. Mr. Fahman, I would like to show you an exhibit. It is Exhibit 75 1 and it is in the book that is before you. Are

you familiar with the advertisement that is shown in this exhibit?

Mr. FAHMAN. Yes. I believe this advertisement was prepared by

an outside printer. We used it just briefly and then we canceled because of the claims on the ad. So we did use it but just for a very

brief period of time.

Senator COLLINS. This is an advertisement that Providential

used. It says, and I have highlighted the section, it says, day traders, it is a very simple game. Trading is not complex, but the tough

part is knowing when the stock is falling out of debt or going to

skyrocket. Do you think that day trading is a simple game and not

complex?

Mr. FAHMAN. Trading can be very complex; very complex.

Senator COLLINS. Do you think this advertisement might mislead

people, particularly those who do not have a lot of investment background?

Mr. FAHMAN. Actually, this advertising was designed by an outside group of trainers and we used it just for a very brief period

of time knowing that we should not use it any more. We did not

use it that long, maybe about a week or so and we canceled it

knowing that it was not wholesome in all context.

Senator COLLINS. Mr. Fahman, Mr. Moon who was the branch

manager for Providential’s Los Angeles office told the Subcommittee staff that none of the day traders in his office had ever

made money. None of them were profitable. And he estimated that

the average loss of the day trader customer in Providential’s Los

Angeles office was about $50,000. Do you have any reason to dispute that estimate?

Mr. FAHMAN. I have not had a chance to review the data and I

do not know that the statement is correct or incorrect. That is only

Mr. Moon’s statement and I do not have any——

Senator COLLINS. Mr. Fahman, in the letter to the Subcommittee

staff you wrote that Mr. Cao, whom we heard from yesterday, day

traded at Providential’s Fountain Valley office of himself, for two

family members, for four other individuals. Were you concerned

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that he was not licensed as an investment advisor even though he

was trading for others?

Mr. FAHMAN. Actually, according to certain State laws if you are

authorized to act on behalf of a few number of people I think it is

OK to do that. But beyond a certain limit the person has to be registered, and we have brought that issue with Mr. Cao and he is in

the process of taking classes to be registered. But whether or not

we would like to have him continue to trade at our office is something we have to consider.

Senator COLLINS. At one point Mr. Cao testified he was trading

for 20 to 21 clients. That is clearly over the amount for which licensing is required.

Mr. FAHMAN. I do not think that was a correct statement. Maybe

over his lifetime he might have traded for 21 or 22 traders. But at

any point in time, maybe two, three, or four clients at most, to the

best of my knowledge.

Senator COLLINS. But there is no exemption if you are day trading at your place of business.

Mr. FAHMAN. I beg your pardon?

Senator COLLINS. I am sorry, we are having mike problems

which we are trying to get rectified. There is no exemption if you

are day trading at your place of business as opposed to at your

home.

Mr. FAHMAN. I do not know if there is any distinction as far as

if an individual authorizes or allows or another person to act as attorney on his or her behalf, that person can execute orders for the

owner of the account.

Senator COLLINS. Let me approach the issue of Mr. Cao from a

different perspective. As a result of his trading for Amy Le your

firm has already had to pay a judgment to Amy Le; is that correct?

Mr. FAHMAN. Let me clarify the issue here a little bit, Madam

Chairman. As I mentioned earlier, Amy Le’s case and even Linda

Richardson’s case, those cases were brought to us from the Go

Trading Company. Providential Securities did not start with those

accounts. Those accounts happened way back. And because Mr.

Moon being a registered person with our company, that is why we

were named in those arbitrations.

Senator COLLINS. Right. But why would you allow Mr. Cao to

continue to day trade on behalf of other individuals at one of your

offices when he has already had a judgment entered against him

by the National Association of Securities Dealers?

Mr. FAHMAN. The judgment happened a couple months ago.

Some of the accounts Mr. Cao has brought over to our firm, and

even his own account are still active at our firm at a very minimum level. And right now actually we just had a meeting in the

last 2 weeks to consider measures that needs to be taken in order

to address issues that would be of concern to the regulators in that

regard.

Senator COLLINS. But he is trading even though he has filed

bankruptcy?

Mr. FAHMAN. I do not know if there is any law that prohibits a

person from trading if he has filed bankruptcy.

Senator COLLINS. I am going to yield at this point to Senator

Levin in the hopes that we can get the mike working.

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Senator LEVIN. I am not sure mine is working any better, but we

will give it a go. Thank you, Madam Chairman.

First, Mr. Houtkin, let me ask you about the profitability issue.

I think my mike is equally problematical. Mr. Zayas testified under

oath yesterday that during his tenure as manager of the Watertown office of All-Tech between September 1997 and November

1998 about 50 customers engaged in day trading and only one person made a profit, and Madam Chairman made reference to that

statement. Were you aware of that statement on his part?

Mr. HOUTKIN. No. I am not really aware of what he said. I am

very dubious of what he said. After the actions, his actions that

were uncovered by the State of Massachusetts, I have no reason to

believe the man. He caused us tremendous problems with our reputation. And at the State, I do not know exactly what happened

there. There were all kinds of accusations about people trading for

one another; all unauthorized by our firm.

There are things called rogue brokers. I believe Mr. Zayas would

be characterized as a rogue broker, and I do not know why his testimony would be taken as the gospel unless there was really a failure on the behalf of the staff to find more substantive people to testify.

Senator LEVIN. I take it your answer is no?

Mr. HOUTKIN. Yes, it is no.

Senator LEVIN. In his deposition Mr. Zayas told the Subcommittee staff that you were aware that most people lose money

in day trading. Is that true? Did you ever make that statement, is

my question.

Mr. HOUTKIN. I have made that statement for years. I said that

about one in three, approximately. And actually, that——

Senator LEVIN. One in three what?

Mr. HOUTKIN. One in three people will succeed as a day trader.

I said that for years. I have been published in many periodicals.

I have written that in books.

Senator LEVIN. Do you tell your customers that one in three will

be profitable?

Mr. HOUTKIN. Absolutely. We probably tell them even worse than

that. We definitely warn people. The reality is, how do you know

what is successful? If someone goes——

Senator LEVIN. That was your word, not mine.

Mr. HOUTKIN. OK. How does one determine—in other words, if

I go—if you decide you have had enough of the Senate and you

want to retire and you decide to go to my school and learn how to

day trade. And we teach you the basics of trading, some basic trading strategies, you begin to trade and you lose a few thousand dollars and you realize that trading really is not for you. Does that

make you a loser?

Senator LEVIN. I think you answered my question. I am not sure,

but I will try it again.

Mr. HOUTKIN. OK.

Senator LEVIN. Mr. Zayas told the Subcommittee that you were

aware that most people lose money at day trading; is that correct?

Mr. HOUTKIN. I have been quoted—I do not know if I told Mr.

Zayas that. I have a fairly large firm. I speak to many, many people.

105

Senator LEVIN. Is that your——

Mr. HOUTKIN I have said repeatedly that the majority—and I

think the number I used was about 70 percent of the people will

not make money as traders. So, yes, it is possible I said that.

Senator LEVIN. All right. Does that mean that most people will

lose money?

Mr. HOUTKIN. That means that trading will not be suitable for

most people and they will probably find that out after they lose a

certain amount of money.

Senator LEVIN. So does that mean that most people will lose

money? To put it in English.

Mr. HOUTKIN. That means that most people will lose some

money.

Senator LEVIN. Yes, that most people will lose some money.

Mr. HOUTKIN. Yes.

Senator LEVIN. And that is what you tell people whom you are

talking to about becoming day traders, that most people lose

money? You specifically tell that to people; is that correct?

Mr. HOUTKIN. Absolutely.

Senator LEVIN. To people who you are asking, or urging, or soliciting, or suggesting, or notifying, or whatever your word is, relative

to day trading, those folks whom you talk to about day trading who

might come and day trade with your firm, you are telling them specifically, most people who engage in day trading will lose money?

That is my question.

Mr. HOUTKIN. I do not know if I use those exact terms.

Senator LEVIN. Do you tell them approximately that?

Mr. HOUTKIN. Yes, I absolutely tell them approximately that. As

a matter of fact, we sent you our——

Senator LEVIN. Would you give us the statements that you have

made, I presume in your advertising, where you inform folks that

most people engaged in day trading lose money? Would you submit

that to the Subcommittee for our record? Not right at this instance.

Mr. HOUTKIN. Every word I have ever said on radio, television,

in print, was presented to me by either the NASD, the SEC, or the

Subcommittee. So every word I have said you probably have already.

Senator LEVIN. Good. Now my question to you is, will you submit

to us any place where you have notified your potential customers

that most people engaged in day trading will lose money? That is

a question. Will you submit that to us for the record?

Mr. HOUTKIN. Just to put on the record that most people who

begin—yes, I think that is an acceptable statement that I could

submit to you.

Senator LEVIN. And that you notified people of that.

Mr. HOUTKIN. The other day I sent to all the Senators on this

Subcommittee an extensive article that was printed—I do not know

if you received it—in the Star Ledger this past weekend.

Senator LEVIN. I read it. My question to you is——

Mr. HOUTKIN. Did you walk away feeling that we did not warn

people that they could probably lose money?

Senator LEVIN. My question to you is, will you submit to this

Subcommittee your printed notice, disclosure to your potential customers that most people who engage in day trading lose money,

106

which is your belief? Will you just submit that to the Subcommittee? It is a simple question.

Mr. HOUTKIN. I do not know what the—you see, excuse me, but

over the years I have learned not to have entire trust for the bureaucratic, for the regulatory, and possibly even for my political aspect of what is going on. I will speak to my attorney, and if they

think it is appropriate and there is no behind-the-scene agenda to

me making that statement, I will be more than happy to submit

it.

Senator LEVIN. That is interesting. That is not my question. I

asked you would you submit disclosures that you have given to potential customers saying that most people engaging in day trading

lose money. You have turned that into a different question, which

is whether or not you would say for the record, which you have now

twice today, that most people lose money. That is not my question.

My question is, will you submit for the record any disclosures

which you have made to your customers that most people engaged

in day trading lose money? That is my question. So if you want to

take that up with your attorney——

Mr. HOUTKIN. Is this the past tense or the present?

Senator LEVIN. Yes, that is past tense.

Mr. HOUTKIN. I would have to go through what I disclose and

what we have. But I know——

Senator LEVIN. Will you do that?

Mr. HOUTKIN. If I could find it, I will do it. If it is there. You

are saying, have I done that in the past?

Senator LEVIN. Exactly.

Mr. HOUTKIN. Does it exist?

Senator LEVIN. Yes.

Mr. HOUTKIN. I would have to check.

Senator LEVIN. Would you do that for the Subcommittee?

Mr. HOUTKIN. If we have that, I would be more than happy to

submit it.

Senator LEVIN. And would you submit to the Subcommittee, if

you can find any such disclosure where you have told potential customers that most people engaged in day trading will lose money,

will you submit those if you can find one?

Mr. HOUTKIN. I believe if you read my books it says that the majority of the people, maybe one in three, will succeed. So by definition, I do not think, you know, it takes a vast intelligence here

if——

Senator LEVIN. I do not claim a vast intelligence, but I claim to

know how to ask a very important and a very precise question.

Mr. HOUTKIN. That is why I want——

Senator LEVIN. Most of your customers and potential customers

do not read your books. You may not believe that. You may think

everybody reads your books.

Mr. HOUTKIN. Most of my customers have read my book.

Senator LEVIN. Fine. Most of your potential customers do not

read your books. Most of the public has not read your books. My

question to you is very simple. When you hand disclosures to people who are your potential customers have you informed them of

what you have said in your books, said here today, that most peoVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00118 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
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ple engaged in day trading lose money? Your answer to that question is, you do not know whether you can find such a statement.

Mr. HOUTKIN. I believe it exists in our risk disclosure documents.

Senator LEVIN. Fine.

Mr. HOUTKIN. I did not memorize them. But if they exist, and if

I have them, which I am pretty sure we do, I would be more than

happy to hand it to you.

Senator LEVIN. That is a very direct, final answer to a question

that took me six times to get an answer to.

Now, next question, on margin lending. Approximately how much

money was transferred between accounts in All-Tech to meet margin calls? Do you know, last year?

Mr. HOUTKIN. I do not have the exact number.

Senator LEVIN. Do you have an approximate number?

Mr. HOUTKIN. I am sure it was a significant amount of money.

Senator LEVIN. Does All-Tech have a policy against firm members arranging or providing uncollateralized loans to help customers to meet margin calls?

Mr. HOUTKIN. We have an internal policy that states that people,

registered and affiliated people in my firm, people who are employees, should not lend money to customers.

Senator LEVIN. Now nonetheless, has it happened at All-Tech?

Despite your policy of——

Mr. HOUTKIN. Based on what I have heard from——

Senator LEVIN. Let me finish my question.

Mr. HOUTKIN. Go ahead.

Senator LEVIN. Has it happened at All-Tech, that firm members

have indeed arranged or provided loans to help customers meet

margin calls? Has that happened?

Mr. HOUTKIN. I believe that in a few instances, if you want to

stretch the regulations and interpret them to suit your purpose as

a regulator, you could say that there might have been a small instance, unbeknownst to me, of people making loans to certain customers.

Senator LEVIN. Thank you. To cover margin?

Mr. HOUTKIN. They made loans to other customers, presumably,

I assume, to meet a margin or maintenance requirement.

Senator LEVIN. Now yesterday Mr. Parish testified that the

transfer of funds between accounts, which he called journals, in

order to satisfy margin calls occurred hundreds of times. Mr. Zayas

said the same thing.

The vice president for margin, Ms. Esposito, testified before our

staff that there were two accounts at her disposal from which she

could make margin loans to customers. One was held by a former

All-Tech employee, David Waldman, someone who had a senior position and set of responsibilities in the organization. She said that

Mr. Waldman had signed a blank journal authorization and she repeatedly photocopied it and used it to make loans at her discretion.

Mr. Waldman charged a $40 fee for each loan, and for every

$10,000 in principal he received a fee of $10. This was all administered by Ms. Esposito.

She also had discretionary access to an account belonging to the

sister of the manager of All-Tech’s Edison branch. Moreover, she

noted that both Mr. Lefkowitz, the senior vice president for operVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00119 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
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ations, and Mark Shefts, I believe he is the All-Tech president,

knew that she had been using those two accounts to make margin

loans. My question to you, were you aware of the fact, if it is a fact,

that those kinds of violations of margin requirements and regulations had occurred?

Mr. HOUTKIN. First of all, I do not believe that what transpired

was a violation of margin requirements under the current law, as

you probably found out during the last hearing, that those were not

violations of the margin rules. And I did not know that this was

going on, nor do I believe Mr. Shefts knew that it was going on.

And as far as Mr. Lefkowitz, I did not—I do not believe that he

believed there was a problem with it.

Senator LEVIN. If it did go on it was a violation of your internal

rules.

Mr. HOUTKIN. It would have been a violation of my own internal

rules, yes.

Senator LEVIN. My time is up.

Senator COLLINS. Mr. Lee, I want to share with you some of the

testimony that we heard yesterday regarding your Atlanta branch

manager, Justin Hoehn, and also particularly the account of Scott

Webb. As you know, we heard from Scott Webb’s mother, Alyce

Wenzel, yesterday concerning the opening of her son’s account.

Both of them testified that Mr. Webb, prior to opening his day

trading account, had lost two jobs, including one as a retail stockbroker; had lost $10,000 of borrowed money trading at another

firm; had a very poor credit record; had very little cash; and had

to borrow all of the money that he used to open up his day trading

account. He borrowed $30,000 from his father, and your firm arranged for him to get a $30,000 loan from another customer.

Was that appropriate? Should Mr. Webb have been accepted as

a day-trading customer of your firm?

Mr. LEE. Madam Chairman, I did not know Scott Webb, and

after the horrific incident that happened last summer in Atlanta,

obviously began to look at the situation in hindsight. I understand

in discussions with the people involved in the situation that Mr.

Webb was a registered broker, I believe with Dean Witter. I understand and what I have learned from our people, that he had day

trading experience, not at one but at two firms. And given our

opening account requirements at the time I believe he met the financial requirements at the time to become a trader.

Senator COLLINS. Even though he had had no income for the last

6 months, had a very low net worth, he had virtually no money at

all, you think he was a suitable customer?

Mr. LEE. I think today that—again, I do not know the circumstances until they just came up here in these hearings. I think

that we have to look at the situation at a policy level, and I think

it is constructive to set a bright line test so that operations and

branch managers are not called upon to make these kind of judgments on their own. I think that we should raise the standards,

which we did in April, to a bright line financial test, and that once

that test is met they are presumed to be suitable. I think it is an

appropriate level.

I think though that there are circumstances that if somebody

does not meet those tests that he/she could rebut that presumpVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00120 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
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tion—the customer, if they chose to—and I understand that Mr.

Webb sought this out. He asked to become a day trader. And you

mentioned the loans arranged there, and I have looked into that

as well, and I understand that he asked for those.

Senator COLLINS. But do you think it is appropriate for Momentum to accept a customer of limited financial means, who has not

had a job, who is using money that is entirely borrowed, to open

an account? I mean, I have to say I am troubled if your answer to

that is yes. I mean, today would Momentum accept a customer that

has that profile?

Mr. LEE. Madam Chairman, I would look at the profile slightly

differently. The gentleman, I understand, was highly educated. He

was a licensed securities broker by the NASD and the SEC. He is

permitted to sell mutual funds to the elderly. I would think he was

capable of making his own investment decisions. I just look at the

facts and circumstances slightly different.

I think the whole thing is very tragic and I think that there are

constructive points to be made on both sides. I try to look at this

at a policy level and how a firm may establish guidelines universally that people can abide by throughout the country.

Senator COLLINS. Does Momentum today allow an individual

who is relying entirely on borrowed funds to open an account?

Mr. LEE. I do not think that his new account records reflected

that he was relying entirely on borrowed funds.

Senator COLLINS. I would really like a direct answer to my question. Do you allow—will you open an account today for someone

who is relying entirely on borrowed funds for the minimum deposit?

Mr. LEE. Today we do not have an internal policy to look beyond

what the customer discloses, and the source of those funds. Whether they are their own or from borrowed sources outside of the organization. Today it is not our policy to look into that, nor do I believe that it is the policy of online and full-service firms. But I do

think, since you have made this point, that we should look at this

and perhaps there is a more constructive approach to it going forward. Today it is not our policy.

Senator COLLINS. In September 1998, which was 3 months after

Scott Webb opened his account, one of Momentum’s own internal

auditors flagged the account, they flagged both of his accounts and

advised Momentum’s home office in Houston that they were ‘‘only

marginally suitable.’’ Why, after your own auditor had flagged

Scott Webb’s two accounts and raised questions about the suitability of allowing him to day trade, was he allowed to continue to

trade?

Mr. LEE. I think the time frame here, that office opened in the

middle of 1998, and in the first 3 months—I kind of look at this

from a different perspective. I think it is very constructive that we

sought outside help. We went to a former NASD examiner and selfimposed these types of examinations on our own home office and

branch offices. You are correct, records show that that examiner

came back to us with deficiencies in the office, and I believe that

the office has been improved significantly since that time.

110

1See Exhibit No. 104 which appears in the Appendix on page 832.

Senator COLLINS. I want to show you another excerpt from that

same audit. I have talked about—it is Exhibit 104 1 and it should

be in the exhibit book before you as well. This is the same audit,

it is another section of the same audit that flagged Scott Webb’s

accounts as being questionable.

As you can see, the auditor concluded that neither Justin Hoehn

nor Kevin Dial—Justin Hoehn being the branch manager—‘‘have a

clue as to how to supervise. Despite supplying copies of the written

supervisory procedures to each of them, neither one of them had

read it. They have received little if any guidance from the Tyler office. Reports printed out entirely for a period of time were not forwarded to the Atlanta office until the SEC walked on.’’ It goes on

and on and is very critical.

Given that critique from your own auditor that the branch manager did not have a clue how to supervise, why was Mr. Hoehn allowed to continue to run the office?

Mr. LEE. I think that what the auditor did on our behalf—and

I look at the process as something constructive and positive—at

least the deficiencies were pointed out. It was internal. I do understand in having discussions with Mr. Hoehn since that time and

also the independent auditor who performed this function for us,

that things have improved markedly.

If I can point out something—may I? Just 2 or 3 months after

that disclosures were sent to all of our customers in the organizations including those in that office. And if you would like, I can

read over some of those and point this—I think there are issues

here as to risk disclosure. I think that there are issues as to appropriateness and suitability. Those words have meaning in a regulatory context as well as in a casual context. I think the whole area

should be examined and that we could always do better.

Senator COLLINS. The auditor goes on to say in Exhibit 104—and

I will only read the last line of it. She warns that this could be a

disastrous experience if a well-seasoned regulatory team from the

SEC would come in, considering the shape of the Atlanta office. In

short, this audit is a pretty serious indictment of the Atlanta office.

Did it lead you to implement reforms? What specifically was

done? You have mentioned that there were some changes in the

disclosures. But what did you do as far as the criticisms of the employees that you had running the office?

Mr. LEE. Senator, I understand, again, this was within the first

3 months of operation of that office. Nearly 2 years, or over 2 years

have passed since then. I do not have and I am not aware of any

other issues that have been raised out of that office, and I trust

that the people charged with compliance in the area took corrective

action with these people. I think there was some testimony as to

that yesterday, although I have not read the exact record.

Senator COLLINS. Senator Levin.

Senator LEVIN. Thank you, Madam Chairman.

Mr. Lee, at the last hearing or the hearing last year of this Subcommittee, Mr. Saul Cohen representing your organization, the

Electronic Traders Association, testified as follows: That earlier

this year ETA informally surveyed its members to obtain a rough

111

estimate of customer profitability. These estimates were that after

an initial period of 5 months of losses, 60 percent to 65 percent netted in the range of $28,000 per month with the balance of customers losing $6,500 to $8,000 per month. Was that accurate?

Mr. LEE. Sir, I think that those were based off of an informal

survey that our organization conducted between, I believe it was

September 1998 and January 1999. And I think it was a snapshot

in time in or about January 1999, of a 5-month period. I believe

those figures were based on the findings of that review.

Senator LEVIN. What were the months of the study?

Mr. LEE. I believe he was referencing what we have submitted

to the Subcommittee and is known as Texas Facts, and I think it

was September 1998 through January 1999; I believe so.

Senator LEVIN. Did you personally participate in that?

Mr. LEE. I had some participation in the design of it. I did not

construct it, no, sir.

Senator LEVIN. Do you believe that represents an accurate picture of the profitability of day trading?

Mr. LEE. Senator, I am testifying here on my own behalf, my

judgments and observations. I think it was a fair reflection of a

snapshot in time of our organization and what we were surveying.

Senator LEVIN. Do you believe it is a fair representation of profitability of day traders now?

Mr. LEE. I think that there could be inferences made to the larger organizations. I think that there is a big difference——

Senator LEVIN. I do not know what that means, inferences made?

Mr. LEE. There could be inferences. There are, in my opinion,

large capable organizations with the infrastructure that can marginally improve results. And I am just not familiar with the practices of the vast number of other firms that are out there, so I

could not possibly comment on their results. I am aware——

Senator LEVIN. Do you think two-thirds of your customers make

money?

Mr. LEE. I think that is what Texas Facts showed at that snapshot in time?

Senator LEVIN. Do you think two-thirds of your customers today

make money these days?

Mr. LEE. Sir, I think it said that two-thirds of experienced people, with more than 5 or 6 months, are profitable.

Senator LEVIN. Do you believe that?

Mr. LEE. I believe it sounds relatively accurate, yes, sir.

Senator LEVIN. You believe that two-thirds of your customers

who have been there more than 5 months are profitable?

Mr. LEE. I believe that represents the numbers at that time. I

do not think that the conditions have changed significantly since

then, so I would think that it would hold true, but I do not have

numbers to support that.

Senator LEVIN. Could you provide those numbers to us?

Mr. LEE. They are not readily available.

Senator LEVIN. Could you provide those to us?

Mr. LEE. I would be happy to work with the staff and Subcommittee to open our books, as we have very cooperatively done,

for any information that you choose or any other oversight body,

sir.

112

1See Exhibit No. 156 which appears in the Appendix on page 1195.

2See Exhibit No. 23 which appears in the Appendix on page 365.

Senator LEVIN. Does that mean yes?

Mr. LEE. Would I construct that for you?

Senator LEVIN. Would you inform the Subcommittee as to what

percentage of your clients are profitable?

Mr. LEE. I think we could produce whatever you would like, sir.1

Senator LEVIN. Thank you.

Now did you have an executive committee meeting last August

to talk about the figures?

Mr. LEE. At my organization?

Senator LEVIN. No, did ETA have an executive committee meeting last August to go over those Texas figures?

Mr. LEE. I think, in preparation for the Senate testimony, that

there was a board meeting by telephone among the ETA members.

And I would, if I could, give a brief profile of ETA.

NASAA and others, and certainly this committee, have pinpointed that there are many, many, many organizations in the day

trading business. ETA has about six members. I believe, though,

the memberships are among the larger firms, and I think they are

60 to 70 percent of all the volume in day trading in those firms.

So if I could qualify, it was not a meeting among everybody in

the industry. It was among, I think, four or five of the six or seven

largest firms. Yes, sir, there was a telephone conference.

Senator LEVIN. Was it the ETA executive committee that met by

that telephone conference?

Mr. LEE. Our board. I think there is not a difference.

Senator LEVIN. And did you make a decision as to whether those

numbers were still representative?

Mr. LEE. I recall there being a discussion on that point, and I

do not recall that there was opposition to those general findings on

that telephone call, sir.

Senator LEVIN. And then ETA, at that point, was going to retain

an accounting firm to conduct a day trading profitability study; is

that correct?

Mr. LEE. There was consideration given to that, yes, sir.

Senator LEVIN. Were you in the process of retaining KPMG?

Mr. LEE. Yes, we did. We went through an engagement process

with that firm, yes, sir.

Senator LEVIN. And decided not to engage them?

Mr. LEE. I think there were two parts of that. The engagement

was not ultimately concluded for two reasons, and we did get to an

engagement letter. No. 1, it was cost prohibitive.

Senator LEVIN. How much was it?

Mr. LEE. Over $250,000. And I believe that there were also some

internal conflict issues that they pinpointed in their ability to

produce the study.

Sir, if I may add, that is twice the budget of ETA.

Senator LEVIN. Were you aware of the Washington State study 2

which found that 77 percent of day traders are found to have net

losses?

Mr. LEE. I just learned of it in these hearings, sir.

113

1See Exhibit No. 156 which appears in the Appendix on page 1195.

Senator LEVIN. And that was unrelated to how long somebody

was day trading?

Mr. LEE. I just heard that this morning.

Senator LEVIN. Do you have any reason to disagree with that

study, from what you heard this morning?

Mr. LEE. I have not seen it. I could not possibly comment. I do

not know what the qualifications are. I do not know the firms.

Senator LEVIN. If you would take a look at that study and tell

us, not now——

Mr. LEE. Is it part of the record?

Senator LEVIN. Yes, for the record.

Mr. LEE. No, I mean is it part of the record? I have not seen it.

Senator LEVIN. I am saying would you take a look at that study

and then get back with us, for the record, your reaction to it, as

to whether you state any disagreement with its procedures?

Mr. LEE. I would be happy to.1 Is it available?

Senator COLLINS. We will provide you with a copy.

Senator LEVIN. Mr. Houtkin, just a couple of more questions for

you. That has to do with the question of suitability. Ms. Esposito,

who is your vice president for margins, testified to our staff that

she had customers who opened accounts with less than your

$50,000 minimum deposit. At the time, that was your regulation

and rule. Were you aware of that fact?

Mr. HOUTKIN. That was our company policy.

Senator LEVIN. To take them at less than $50,000?

Mr. HOUTKIN. No, the company policy was $50,000. For your information, the NASD has no suitability standards whatsoever.

Senator LEVIN. I understand.

Mr. HOUTKIN. For accounts that do unsolicited business. Our pol- icy of $50,000 was relatively high. I believe it was the highest in

the industry.

Senator LEVIN. Let me ask my question again. Your vice president for margins, Ms. Esposito, testified to the Subcommittee staff

that she had customers who opened accounts with less than the

$50,000 minimum deposit which was your rule.

My question to you is were you aware of that?

Mr. HOUTKIN. I was aware that there would be exceptions made

based on the client opening the account.

Senator LEVIN. In 1999, you lowered your minimum deposit requirement from $50,000 to $25,000 and when you were asked

about this by our staff you said, ‘‘ I still think, as a day trader, an

active day trader should have $100,000 on deposit. But once again,

I discussed with you before, there are competitive aspects of the

business that we have to be cognizant of.’’ Is that correct? It is a

very brief, direct question. Is that what you told our staff?

Mr. HOUTKIN. That sounds correct.

Senator LEVIN. You published a book around the time that you

lowered your minimum deposit to $25,000, which included the following: ‘‘Before the market was booming to new record setting

heights every other day and stock prices were uniformly lower, you

could have had success trading with $50,000 on margin. Today,

probably $150,000 is the most advantageous amount of capital for

114

trading, $100,000 is adequate, and $50,000 is a minimum.’’ That is

what you wrote in your book?

Mr. HOUTKIN. Yes.

Senator LEVIN. Did you write that?

Mr. HOUTKIN. Yes.

Senator LEVIN. Is that your minimum?

Mr. HOUTKIN. Our minimum now is $25,000, sir.

Senator LEVIN. So even though you said that $50,000 is a minimum in your book for successful trading, you now accept people

at $25,000; is that true? What I just said.

Mr. HOUTKIN. To the extent, but it goes beyond that. Many

things have happened over the last year, year-and-a-half, that

changes my opinion that could make it different. Right now market

makers are only required to post markets for 100 shares. They

have lowered the minimum size requirements. A lot of lower priced

stocks have become very active and very tradeable.

So while I do believe that a larger amount of money is preferable, and I do not believe there is anyone in the industry who

would disagree with that, that in order to be competitive with

many firms who are offering $5,000 minimum or $10,000 minimum, and to offer our services more practicably to the public investor, we lowered it to $25,000.

That is a minimum standard. That is not what we advise.

Senator LEVIN. First of all, you lowered it to $25,000 not a year

later based on different market factors. At about the same time

your book came out, saying $50,000 is a minimum, you lowered it

to $25,000; is that not correct?

Mr. HOUTKIN. I do not know the exact dates. Relative to when

I wrote the book, I started the book about 2 years before it finally

became published. So when it finally came out and when we actually lowered it, I really cannot say.

Senator LEVIN. But you really have lowered it in order to stay

competitive, have you not?

Mr. HOUTKIN. I believe most businesses take steps in order to

maintain somewhat of a competitive—like I said, I believe our

standards are still higher than most others, but we had to do something to be more practicably competitive.

Senator LEVIN. But is it not fair to say that even though you believed that $50,000 was the minimum for successful day trading,

you lowered yours to $25,000 in order to meet the competition? Is

that a fair statement?

Mr. HOUTKIN. My personal opinion in the book, it was written by

myself, I believe $50,000 would be an appropriate minimum. There

are other people in the firm and we have other contributing opinions into what we had to do to maintain a competitive business. It

was not just my decision to drop it. It was a decision of——

Senator LEVIN. Your firm.

Mr. HOUTKIN. Of the firm.

Senator LEVIN. Are you not CEO of this firm?

Mr. HOUTKIN. Yes, but I am not a dictator.

Senator LEVIN. You may or may not be that, but you are the

CEO of a firm.

Mr. HOUTKIN. Yes, I am.

115

Senator LEVIN. And that firm has now got a minimum lower

than what its CEO said was a minimum needed for successful day

trading. That is, I believe, a fact. And you can say you have done

that in order to meet what your competitors are doing.

That is well and good, but you are also then taking people and

their money and you are doing it, although you believe the $25,000

is less than what is a minimum necessary for them to be successful

(and I doubt very much that you have told your potential customers that directly in disclosure statements, but we will find that

out); and you are doing that at the same time you tell us two-thirds

of the day traders are going to lose money.

Now that is something you may not be happy to hear, but I think

what I stated is a very careful statement of fact, both as to what

you have told us here this morning, what you have said in your

book, and what your minimum standard is.

Mr. HOUTKIN. There are other factors. I believe you are making

an assumption based on half facts. They also, as you noted, speaking to the people from the SEC and the NASD, they proposed about

a year ago to increase day trade margin to 4-to-1. So if you were

using $50,000 at 2-to-1, you would be able to use $25,000 at 4-to1, and have the same working capital available to you.

Senator LEVIN. Is that 4-to-1 in place yet?

Mr. HOUTKIN. Well, it was——

Senator LEVIN. Is it in place yet?

Mr. HOUTKIN. They have been planning for it to be in place now

for over a year.

Senator LEVIN. Is it in place?

Mr. HOUTKIN. I do not believe it is in place, sir.

Senator LEVIN. And you reduced yours to $25,000 before that

was in place; is that not accurate?

Mr. HOUTKIN. We reduced it to $25,000.

Senator LEVIN. Before any change to 4-to-1; is that not factually

accurate?

Mr. HOUTKIN. Yes, that is factually accurate.

Senator LEVIN. Thank you.

Senator COLLINS. Mr. Houtkin, if your minimum standard was

$50,000 originally, and you agree that that is the ideal amount,

why did you run an ad for day trading that mentions $10,000 as

the amount? The ad that enticed Carmen Margala to come open an

account?

Mr. HOUTKIN. I am glad you asked that question, because the

$10,000 minimum was not for day trading.

Senator COLLINS. That is what the whole ad was on. The whole

ad is a day trading ad.

Mr. HOUTKIN. The $10,000 minimum was for people who wanted

to trade through All-Tech because All-Tech does not accept payment for order flow and gives very fast response. It was for a basic,

more conventional, on-line type service, not for day trading. We

never offered a $10,000 account for day trading.

Senator COLLINS. Well, why does the ad say if you have $10,000

or more in working capital, along with the will and desire to take

advantage of the incredible opportunities offered by day trading,

you need to call All-Tech Investment Group today?

116

Mr. HOUTKIN. But you would not be using our Attain trading

system, the automated system. You would be able to trade similar

to the way someone could trade at E-Trade or Waterhouse or DLJ

Direct, where the minimum requirement is $1,000.

Senator COLLINS. It says day trading, Mr. Houtkin. Is this bait

and switch then? Get them in and then switch them over?

Mr. HOUTKIN. No, people day trade all day long on E-Trade, on

Waterhouse, on DLJ, on NDB, just to name a few. Probably more

day trading is being done through these firms than through the direct access firms. This was not an offer for direct access services.

Senator COLLINS. It says day trading in the ad.

Mr. HOUTKIN. It does not say direct access Attain system, does

it?

Senator COLLINS. Let me ask you another question. Ms. Margala,

as a result of this ad, went into the All-Tech San Diego office and

tried to open a day trading account, was able to open a day trading

account with only $20,000. It was not even risk capital. It was her

savings. It was not money she could afford to lose. She was able

to open a day trading account with $20,000 at a time when AllTech’s minimum standard was $50,000. How did that happen?

Mr. HOUTKIN. If that happen, it would have been—it should have

been picked up by compliance. I do not believe that happened. And

I believe we are currently in litigation with this woman, and I really do not want to go into more on the record here.

Senator COLLINS. Did you do audits of your branch offices when

you were the chief compliance officer?

Mr. HOUTKIN. Yes, we did.

Senator COLLINS. Is there a reason why your firm did not provide

then copies of those audits in response to the Subcommittee’s request?

Mr. HOUTKIN. I am not sure exactly, our general counsel provided whatever documentation was available. But we did supervise

and audit our offices, what we believe was in compliance. Once

again, this is a new, growing business. Were we doing everything

to perfection? I cannot say.

Senator COLLINS. Did you personally conduct any audits, as the

chief compliance officer?

Mr. HOUTKIN. I went out to several of the offices, but I usually

assigned those duties to other people in the firm.

Senator COLLINS. Well, perhaps you should review your files

again because, in response to our request, we did not receive a single audit from your firm from the time that you were the chief compliance officer.

Mr. HOUTKIN. This is the first I heard of it, and if these documents exist, and if I have them, we would be more than happy to

supply them.

Senator LEVIN. Just one question for you, Mr. Fahman, or one

series of questions. You were both president and CEO at Providential and, until recently, the chief compliance officer; is that correct?

Mr. FAHMAN. Yes, sir.

Senator LEVIN. I believe that, in your compliance manual, you

say that suitability is the key to client recommendation; is that correct?

117

1See Exhibit No. 83b. which appears in the Appendix on page .

Mr. FAHMAN. Yes, generally, because our firm is not only doing

day trading. We first started the firm as a retail brokerage. And

that is the majority of our business. Day trading is only just a

small portion of our overall business. We also do fixed income. We

also have package products like annuities, insurance, some investment banking, the bulk of business is still traditional retail. And

we also have on-line investment and trading, like E-Trade, and so

forth. So it is just a small portion of our overall business, as far

as day trading is concerned.

Senator LEVIN. Does the suitability requirement apply to day

trading?

Mr. FAHMAN. Actually, that is an area that we——

Senator LEVIN. In your manual, do you intend that statement,

suitability is the key to client recommendation, to apply to day

traders? It is a very simple question.

Mr. FAHMAN. That is a general statement being used for all accounts, including day trading. But day trading is a little bit different because we do not directly recommend a purchase or a sell

for security for day traders.

Senator LEVIN. But it does apply to all accounts, including day

traders?

Mr. FAHMAN. Right.

Senator LEVIN. If you would put up that other form, if you look

at Exhibit 83,1 this is a typical account opening form. Just the form

itself, this is a typical form; is that correct?

Mr. FAHMAN. Yes, that is correct.

Senator LEVIN. On this form, all the approval signatures are in

place; is that correct? Down at the bottom there, where you say approved? Do you see those signatures?

Mr. FAHMAN. I believe those signatures were Mr. Moon’s signatures.

Senator LEVIN. So this was approved. And yet there is no indication, if you will look at the blanks there, you see there, about annual income and net worth? Do you see that? In the middle there,

those two lines? Those are blank, right?

Mr. FAHMAN. Yes, those are blank.

Senator LEVIN. In one office, the Hahna Global office, where Mr.

Cao and Mr. Moon worked, apparently 74 percent of the forms

lacked required information. Are you aware of that?

Mr. FAHMAN. These accounts came from Go Trading and when

they were transferred over, I think what happened Mr. Moon, in

order to expedite the process, he might have submitted the information without all the full documentation. But I am very sure

those accounts came over from the Go Trading era, not started

with our firm to begin with.

Senator LEVIN. Now you lowered your minimum capital deposit

as well; is that correct? From $50,000 to $10,000; is that correct?

Mr. FAHMAN. Yes, the $50,000 was a suggested or recommended

level in the beginning.

Senator LEVIN. And you lowered that to $10,000?

Mr. FAHMAN. We lowered it to $10,000 and then to $15,000.

118

Senator LEVIN. And even though you testified that a $50,000

trader would have enough buying power to get into more shares of

stock, in order that he could trade more effectively, you lowered it

to $10,000 in order to meet the competition; is that correct?

Mr. FAHMAN. No, I do not think we were trying to beat the competition.

Senator LEVIN. No, meet.

Mr. FAHMAN. Oh sorry, to meet, yes. I think there was tremendous competitive pressure in the market at that time. And in hindsight, we might not have done that.

Senator LEVIN. Because in order to keep up with your competi- tors, you lowered it from $50,000 to $10,000; is that correct? Even

though you recommended $50,000 as the minimum needed to be

successful; is that correct?

Mr. FAHMAN. Yes, we did lower the suggested level to $10,000 and then back to $15,000, and then to $25,000 again.

Senator LEVIN. Correct. But you did it to meet the competition, even though you believe that $50,000 was needed in order to have

a successful experience at day trading; is that correct?

Mr. FAHMAN. Actually, at that time, the day trading business

was still very new and there was a tremendous lack of guidance

from regulators.

Senator LEVIN. I am not talking about guides. I am talking about what you believed. Did you not testify to our staff that a $50,000

level was what was needed in order to have a better day trading

outcome?

Mr. FAHMAN. Internally, we believe, we thought that would be a

good level to start with. That is why we——

Senator LEVIN. In order that there be a successful day trading

experience; is that fair?

Mr. FAHMAN. I would say so.

Senator LEVIN. And so you lowered it despite that, in order to

keep up with your competitors; is that correct?

Mr. FAHMAN. Yes.

Senator LEVIN. Thank you.

Mr. FAHMAN. You are welcome.

Senator COLLINS. Thank you, Senator Levin.

I am going to excuse this panel now. I would like to thank all

of the witnesses who have testified before us during the past 2

days.

In the Subcommittee’s first hearing on day trading last September, I expressed my concern about the risks that day trading

poses, particularly to the small, unsophisticated investor. After

hearing the testimony from a variety of witnesses over the past 2

days, I must say that my concerns have only increased.

We have learned that the best evidence suggests that 77 percent

of all day traders will lose money; that they pay enormous commissions, in some cases over $200,000 annually, before they are earning a cent of profit that they can keep; and that people of limited

means are opening day trading accounts with money that they can

ill afford to lose.

I am certain, based on the testimony that we have heard, that

the industry and the regulators must do much more to clean up the

abuses that we have uncovered. As I have indicated, I do not beVerDate 11-SEP-98 09:02 Jun 08, 2000 Jkt 000000 PO 00000 Frm 00130 Fmt 6601 Sfmt 6601 64133.TXT SAFFAIRS PsN: SAFFAIRS
119

lieve that day trading should be banned. I think that if people are

fully apprised of the risks, and if they have adequate capital, they

should be allowed to day trade. And who knows, maybe they will

be one of the very few who are lucky enough to make it profitable.

However, we cannot continue to allow a system to go forward

that does not adequately disclose the tremendous risks of day trading, and that continues to accept people for whom day trading is

clearly unsuitable. We will continue to work with the regulators to

assist them in strengthening their enforcement efforts, and also

their regulatory guidance.

I would also call upon the industry to do its part. We have seen

some firms increase their risk disclosure over the past few months,

particularly as regulatory and Congressional scrutiny of the industry has increased. But it is clear that the industry still has a very

long way to go.

I want to take this time to also thank the Subcommittee staff for

its very hard work on this investigation. They deposed over 100

people, handled thousands of pages of documents, and did a very

thorough and professional investigation. Many of the staff members

were involved and did a terrific job, but I particularly want to salute the efforts of Lee Blalack, our Subcommittee staff director, and

of Deborah Field, who is our detailee from the SEC. We may never

allow her to go back to the SEC.

I also want to thank Senator Levin for his outstanding participation. He always brings a great deal to the Subcommittee’s effort.

Senator LEVIN. Thank you.

Madame Chairman, very briefly, let me first thank you and your

staff for the extraordinary effort that you have made here, and for

the great value which you are producing for our constituents.

I think the American people want the kind of freedom that we

all believe in, but they also want to be treated fairly, they want disclosure of risks, and they also want regulators to regulate, to make

sure that there are not abuses.

We have heard evidence that there is misconduct obviously, as

there is in any large kind of operation. We heard today that there

are too many examples of misuse of customer funds, exaggerated

and misleading advertising, improperly registered persons, violations of NASD short sale rules, improper lending and margin practices, and so forth in the day trading business.

That does not mean that day trading, per se, should be banned.

It should not be, but it has got to be regulated. It is something new

and it has got to be regulated, taking into account the fact that it

is so different from traditional stock trading.

One of the things about which I am most concerned is the disclosure of the odds. Our Chairman talked about the disclosure of the

risk, and I could not agree with her more. But we have a Washington State study now which confirms another study, which is

that over two-thirds of people in day trading, regardless of how

long they have been in day trading, and unrelated to that question,

lose money. Mr. Houtkin today basically confirmed that two-thirds

of people in day trading lose money.

I believe that if people who are being solicited or being informed

about day trading knew what those odds were against them, that

120

1See Exhibit No. 156 which appears in the Appendix on page 1195.

you would have a lot fewer tragedies and financial losses of the

kind that we have heard about.

So disclosure is absolutely critical, both of the risk and included

in the risk I would say, a very significant part of that, will be the

odds. So we will look forward, Mr. Houtkin, to you and to you, Mr.

Lee, sharing with this Subcommittee two things, if they exist in the

first case. One, is any time you have disclosed in a disclosure document to your potential customers that two-thirds of them are going

to lose money, or that most of them will lose money. I look forward

to receiving such a written disclosure to customers, not a book, not

a newspaper article, but a disclosure form to your customers.

And for you, Mr. Lee, I look forward to data, which the Subcommittee I believe would welcome, about your profit and loss figures of your customers.1 Your organization represented to this Subcommittee that 65 percent of the people made significant profits.

That runs exactly counter to what the Washington State study is,

and dollar-wise is inconsistent with the SEC study, in terms of the

amount of profit and loss.

And so we will look forward to you sharing with us data that

supports your statement here today that you believe that Mr.

Cohen’s representation to this Subcommittee is still accurate, relative to your firm. We look forward to that data, as well.

Again, Madame Chairman, thank you for your leadership in this

area.

Senator COLLINS. Thank you very much, Senator Levin.

The hearing record will remain open for 14 days. In addition, the

Subcommittee will, within the next several weeks, be issuing a

comprehensive report summarizing the results of its investigation

and including its findings and recommendations.

The Subcommittee is now adjourned.

[Whereupon, at 12:28 p.m., the Subcommittee was adjourned.]

(121)

A P P E N D I X

PREPARED STATEMENT OF SENATOR AKAKA

Thank you Madam Chairman. I want to commend you and the Ranking Member

for holding these series of hearings on day trading and focusing on the questionable

practices, which surround this emerging industry.

In conversations with officials from the Hawaii Securities Commission, I learned

that there are no active day-trading firms in my State. Interestingly, one firm

opened a few years ago, but closed up and left town as soon as inquiries and complaints were made to the State Commission. Although there are people in my State

who are day trading on an individual basis, problems associated with day-trading

activities have not been of a serious nature. However, I am mindful that the lack

of complaints to my State’s Securities Commission only means that Hawaii has

some breathing room. I would rather see Hawaii remain free of deceptive and abusive day-trading activities, and one way to do that is through these hearings.

It is for that reason that I am so pleased that this Subcommittee, through the

Chairman and Ranking Member’s leadership, is examining the ever-emerging problems with day trading. I am concerned that people are involving themselves in a

speculative and risky business where they generally have no background and may

stand little to gain. The financial risk is sizeable, and it appears from the testimony

heard yesterday that there are companies luring customers under the guise of

amassing substantial sums of money without adequate capital.

I am equally concerned with an issue raised by the Ranking Member who reported that seven firms accounted for 80 percent of all day traders and 80 percent

of all day-trading volume. He rightly noted that the impact of day trading on the

volatility of the market is unknown. SEC Chairman Levitt noted in his testimony

from our first series of hearings that day traders do not look at the value of a company’s stock, and indeed, are gambling more than investing. A day trader may make

upwards of 100 trades per day, far exceeding the average number of trades that a

normal investor would make over a year.

Madam Chairman, I hope that these hearings will continue to shed light on an

industry where there are few consumer protection standards. Just this week, the

SEC charged two companies, one a focus of this hearing, with ‘‘margin lending,’’ or

providing customers with more money for trading than permitted by Federal regulations. We heard from witnesses yesterday that the over-extension of funds can have

disastrous consequences. I believe that an industry, where an estimated nine out

of ten participants lose money, must be held accountable for its actions.

Thank you, and I look forward to hearing from today’s witnesses.

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