13608 Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices

6 17 CFR 200.30–3(a)(12). 1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3Securities Exchange Act Release No. 42343

(January 14, 2000), 65 FR 4005.

4Securities Exchange Act Release No. 42418

(February 11, 2000), 65 FR 8461.

5The NYSE and NASD rule proposals were the

result of deliberations by the 431 Committee, which

convenes regularly on margin issues. The

Committee is generally comprised of NYSE and

NASD staff, attorneys from the NYSE’s outside

counsel, the Board of Governors of the Federal

Reserve System, and representatives from several

clearing firms and broker-dealers. See letter from

Alden Adkins, Senior Vice President and General

Counsel, NASD, to Katherine England, Assistant

Director, Division of Market Regulation

(‘‘Division’’), Commission, dated October 3, 2000

(‘‘NASD Response to Comments’’).

6See letter from James Buck, Senior Vice

President, NYSE, to Nancy Sanow, Assistant

Director, Division, Commission, dated September 8,

2000 (‘‘Amendment No. 1 to the NYSE Proposal’’).

The amendment clarified that the proposed ‘‘knows

or has a reasonable basis to believe’’ standard not

only applies in the situation where a customer

seeks to open an account, but also in the case where

he or she seeks to resume day trading in an existing

account. For further discussion of the ‘‘knows or

has a reasonable basis to believe’’ standard, see

infra, Section II, ‘‘Description of the Proposed Rule

Changes.’’

7See letter from Alden Adkins, Senior Vice

President and General Counsel, NASD, to Katherine

England, Assistant Director, Division, Commission,

dated October 3, 2000 (‘‘Amendment No. 1 to the

NASD Proposal’’). The amendment: (1) Deleted a

provision relating to a 90-day period in which a day

trader could be designated as a Pattern Day Trader;

(2) clarified that the proposed ‘‘knows or has a

reasonable basis to believe’’ standard would apply

not only where a customer seeks to open an

account, but also where a customer seeks to resume

day trading in an existing account; (3) clarified that

a two-day funds deposit requirement would apply

only to customers who have been designated

Pattern Day Traders; and (4) extended from 30 days

to six months the proposed period for

implementing the proposed rule change.

8Some commenters sent letters in response to

both the NYSE and NASD rule proposals. The

public files for the NYSE and NASD rule proposals,

including all comment letters received on the

proposals and a List of Commenters that was

prepared by Commission staff, are located at the

Commission’s Public Reference Room, 450 Fifth

Street, NW., Washington, DC 20549–0609. See

infra, footnote 28.

9See letter from James Buck, Senior Vice

President and Secretary, NYSE, to Nancy Sanow,

Assistant Director, Division, Commission, dated

September 20, 2000 (‘‘NYSE Response to

Comments’’).

10NASD Response to Comments.

11Since trading securities on margin permits a

customer to purchase securities valued at an

amount greater than the equity available to his or

her account, an increase in the value of those

securities yields a higher return on equity than is

possible if the size of the customer’s purchases is

limited to his or her available equity. On the other

hand, trading securities on margin also makes it

possible for a customer to generate losses that

exceed his or her available equity.

12 15 U.S.C. 78g(a).

13 12 CFR 220 et seq. Regulation T ‘‘imposes,

among other things, obligations, initial margin

requirements, and payment rules on securities

transactions.’’ 12 CFR 220.1(a).

14The definition of ‘‘margin equity security’’

includes any equity security (as defined in Section

3(a)(11) of the Act) which is registered or has

unlisted trading privileges on a national securities

exchange or the Nasdaq Market. 12 CFR 220.2.

15 12 CFR 220.12(a).

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning the foregoing,

including whether the proposed rule

change, as amended, is consistent with

the Act. Persons making written

submissions should file six copies

thereof with the Secretary, Securities

and Exchange Commission, 450 Fifth

Street, NW., Washington, DC 20549–

0609. Copies of the submission, all

subsequent amendments, all written

statements with respect to the proposed

rule change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying at

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to File No.

SR–NASD–01–06 and should be

submitted by March 27, 2001.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.6

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–5329 Filed 3–5–01; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–44009; File Nos. SR–NYSE–

99–47 and SR–NASD–00–03]

Self-Regulatory Organizations; New

York Stock Exchange, Inc., and

National Association of Securities

Dealers, Inc.; Order Approving

Proposed Rule Changes Relating to

Margin Requirements for Day Trading;

Notice of Filing and Order Granting

Accelerated Approval of Amendments

No. 1 to Each Proposed Rule Change

February 27, 2001.

I. Introduction

On December 13, 1999, the New York

Stock Exchange, Inc. (‘‘NYSE’’ or

‘‘Exchange’’) filed with the Securities

and Exchange Commission

(‘‘Commission’’), pursuant to section

19(b)(1) of the Securities Exchange Act

of 1934 (‘‘Act’’) 1 and Rule 19b–4

thereunder,2 a proposal to amend NYSE

Rule 431, Margin Requirements. The

proposed rule change would establish

margin requirements for day trading in

customer accounts of the Exchange’s

member organizations. On January 25,

2000, the NYSE rule proposal was

published for public comment in the

Federal Register.3

On January 13, 2000, the National

Association of Securities Dealers, Inc.

(‘‘NASD’’), through its wholly owned

subsidiary, NASD Regulation, Inc., also

filed a proposed rule change to establish

day trading margin requirements by

amending NASD Rule 2520, Margin

Requirements. On February 18, 2000,

the NASD proposal was published for

comment in the Federal Register.4

Although the NYSE and NASD rule

proposals were substantially similar,

they diverged on certain issues.5 To

reconcile the differences between, and

provide for uniform application of, the

two proposals, the NYSE and NASD

each filed amendments to their

respective proposals. The NYSE filed its

amendment on September 8, 2000.6 The

NASD filed its amendment on October

3, 2000.7 The Commission received 49

letters regarding the NASD proposal and

214 letters regarding the NYSE

proposal.8 The NYSE provided a

response to comments on September 20,

2000.9 The NASD filed its response to

comments on October 3, 2000.10 This

order approves the NYSE and NASD

rule change proposals, as amended.

II. Description of the Proposed Rule

Changes

A. Margin Trading and Regulation

Trading securities on margin involves

the use of credit to finance securities

purchases. A margin transaction takes

place where a customer purchases a

security in reliance on an extension of

credit (i.e., a loan) from his or her

broker-dealer. Use of a margin loan

increases both the customer’s potential

return on investment and his or her

financial risk.11

Section 7(a) of the Act grants

authority to the Board of Governors of

the Federal Reserve System (‘‘Federal

Reserve’’) to regulate the use of margin

credit in order to prevent the excessive

use of credit for the purchase or carrying

of securities.12 Pursuant to this

authority, the Federal Reserve

promulgated Regulation T13 to govern

extensions of credit by brokers and

dealers. Regulation T contains ‘‘initial’’

margin requirements, which limit the

amount of credit that can be extended

by a broker-dealer on certain securities

transactions. Briefly, Regulation T

generally allows broker-dealers to

Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices 13609

16 12 CFR 220.1(b)(2)

17A customer has an ‘‘open’’ position in a

security if, for example, he or she has purchased,

but not resold it.

18The rules define ‘‘day-trader’’ as ‘‘any customer

whose trading shows a pattern of day-trading.’’

NYSE Rule 431(f)(8)(B).

19NYSE Response to Comments.

extend credit to customers on ‘‘margin

equity securities’’ 14 at 50 percent of the

particular security’s market value.15

Regulation T establishes minimum

margin requirements, but expressly does

not preclude any registered securities

exchange or registered national

securities association ‘‘from imposing

additional requirements or taking action

for its own protection. ’’16 Accordingly,

the NYSE and NASD have, consistent

with Regulation T, established their

own maintenance margin requirements,

including special maintenance margin

requirements pertaining to ‘‘daytraders.’’

B. NYSE Proposal

According to the NTSE, the primary

purpose of its rule proposal is to require

that certain levels of equity be deposited

and maintained in day trading accounts,

and that these levels be sufficient to

support the risks associated with day

trading activities. The proposal would

amend NYSE Rule 431, Margin

Requirements, to establish special

maintenance margin requirements for

customers who engage in day trading,

and to specify minimum equity

requirements and buying power

limitations for customers who

demonstrate a pattern of day trading.

The Exchange observed that advances in

technology have contributed to a

dramatic increase in day trading by

customers. In the Exchange’s view,

these advancements have also

contributed to the establishment of

broker-dealers whose primary business

is to provide customers with direct links

to the securities markets, allowing

customers to trade their respective

portfolios on-line. According to the

Exchange, in this environment, day

traders attempt to profit from intra-day

price movements of securities.

Under current NYSE rules, certain

margin requirements must be calculated

based on a customer’s ‘‘open’’

positions 17 at the end of the trading

day. If a customer only day trades, he

or she has no ‘‘open’’ positions at the

end of the day upon which a margin

calculation would otherwise yield a

margin call. Nevertheless, the same

customer has generated financial risk

throughout the day. The NYSE’s rules

for day trading address this risk by

imposing a margin requirement for day

trading that is calculated based on a day

trader’s largest open position during the

day, rather than on his or her open

positions at the end of the day. A

customer who meets the NYSE

definition of ‘‘day-trader’’ 18 must

deposit in his or her account the amount

of margin that would have been

required had he or she not closed his or

her largest open position before the end

of the trading day (i.e., generally 50

percent of the largest open position). If

a customer day trades, but does not

satisfy the definition of ‘‘day-trader,’’ he

or she is still required in general to

deposit 25 percent of the amount of his

or her open positions during the day.

The NYSE proposes to amend its

margin rules covering day trading

because, among other things, the current

rule does not adequately address the

risks inherent in certain patterns of day

trading 19and has encouraged practices,

such as the use of cross-guarantees,

which do not require customers to

demonstrate actually financial ability to

engage in day trading.

1. Proposed Definition of ‘‘Day Trading’’

Proposed NYSE Rule 431(f)(8)(B)

generally would redefine ‘‘day trading’’

as ‘‘purchasing and selling or selling

and purchasing the same security in the

same day in a margin account.’’ An

exception to this proposed definition is

provided where a customer: (1) carries

a long position in a security overnight

and sells the security the next day prior

to any new purchases of the security; or

(2) carries a short security position in a

security overnight and purchases the

security the next day prior to any new

sales of the security (i.e., closing

transactions to wrap-up the previous

day’s activities before any new

purchases or sales of the same security).

2. Proposed Definition of ‘‘Pattern Day

Trader’’

A customer would be considered a

‘‘pattern day trader’’ if the customer

made four or more day trades within

five business days in his or her account,

provided that the number of day trades

was more than six percent of the total

trades in the account during that period

(‘‘Pattern Day Trader’’). The NYSE

represented that the six percent

threshold is designed to ensure that

customers who engage in a large number

of transactions overall are not

inappropriately deemed Pattern Day

Traders solely because there are four or

more day trades in their accounts over

the five-day period. Accordingly, a

customer that, for example, transacts

four day trades within five business

days and also has a total of 100

transactions during that period, would

not be deemed a Pattern Day Trader,

since less than six percent of that

customer’s total trades would have been

day trades.

Proposed Margin Requirement for

Pattern Day Traders

The NTSE’s rule proposal would

require Pattern Day Traders to maintain

special maintenance margin

commensurate with their levels of day

trading activity (‘‘Day Trading Margin’’).

For day trades in equity securities, the

required Day Trading Margin (‘‘Day

Trading Margin Requirement’’) would

be 25 percent of either: (1) The cost of

all day trades made during the day; or

(2) the largest open position during that

day. If a customer’s Day Trading Margin

Requirement is to be calculated based

on his or her largest open position

during the day, the customer’s firm

must maintain ‘‘time and tick’’ records

documenting the sequence in which

each day trade is completed. For nonequity securities, the amount of Day

Trading Margin would be computed

using applicable special maintenance

margin requirements pursuant to other

provisions of NYSE Rule 431.

4. Proposed Time To Meet Margin Calls

The NYSE’s rule proposal also would

reduce the time allowed for Pattern Day

Traders to meet special maintenance

margin calls from seven business days

to five business days. If a Pattern Day

Trader did not meet a Day Trading

Margin call within five business days

from the time his or her Day Trading

Margin deficiency occurred, the

customer would be restricted to

executing transactions on a cash

available basis for 90 days, or until he

or she had met the Day Trading Margin

call. The NYSE member organizations

would incur a one-time capital charge

for the amount of any unmet deficiency

on the sixth business day after a

customer receives a Day Trading Margin

call.

5. Proposed Day Trading Minimum

Equity Requirement

Currently, NYSE rule 431 requires

$2,000 minimum equity for a customer

to open a margin account. The NYSE

rule proposal would require that

accounts of Pattern Day Traders

maintain minimum equity of $25,000

(‘‘Day Trading Minimum Equity

Requirement’’). If the account of a

Pattern Day Trader fell below its Day

Trading Minimum Equity Requirement,

the account would be restricted from

further day trades until the Day Trading

Minimum Equity Requirement was

satisfied. In addition, if an NYSE

13610 Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices

20As originally filed, the NYSE proposal would

require the member organization to obtain from a

customer seeking to open a new account a deposit

in satisfaction of the Day Trading Minimum Equity

Requirement if the firm ‘‘knows or has a reasonable

basis to believe’’ that the customer will pattern day

trade. Amendment No. 1 to the NYSE rule proposal

would expand the application of the ‘‘knows or has

a reasonable basis to believe’’ standard to customers

who resume pattern day trading in an existing

account.

21Telephone conversation among Donald Van

Weezel, Managing Director, Credit Regulation,

NYSE; Albert Lucks, Director, Credit Regulation,

NYSE; Mary Anne Furlong, Director, Rules and

Interpretive Standards, NYSE; Olga Davis, Principal

Specialist, Credit Regulation, NYSE; and Nancy

Sanow, Assistant Director; Thomas McGowan,

Assistant Director; Joseph Morra, Special Counsel;

and Steven Johnson, Special Counsel, Division,

Commission, January 23, 2001 (‘‘January 23, 2001

Call with NYSE Staff’’) (confirming operative date

of proposed rule change).

22See explanation of NYSE’s current rules in

Section II.B., supra.

23 12 CFR 220 et seq.

24Current NASD Rule 2520 defines a ‘‘daytrader’’ as ‘‘any customer whose trading shows a

pattern of day-trading.’’ The rule defines ‘‘daytrading’’ as ‘‘the purchasing and selling of the same

security on the same day.’’ NASD Rule 2520(f)(8)(b).

25NASD Response to Comments.

member organization knew, or had

reasonable basis to believe, that a new

account would pattern day trade, or that

a customer would resume day trading in

an existing account, the member

organization would require the

customer to deposit the minimum

$25,000 equity into his or her account

before he or she began trading.20

6. Proposed Day Trading Buying Power

Under the proposed Rule 431

revisions, the accounts of Pattern Day

Traders would be restricted based upon

their ‘‘Day Trading Buying Power.’’ For

equity securities, Day Trading Buying

Power would be equal to the equity in

the customer’s account at the close of

business of the previous day, less any

maintenance margin, multiplied by four.

For non-equity securities, Day Trading

Buying Power would be computed using

applicable special maintenance margin

requirements pursuant to other

provisions of NYSE Rule 431.

7. Proposed Account Restrictions

The NYSE’s rule proposal also would

restrict the accounts of Pattern Day

Traders who trade in excess of their Day

Trading Buying Power. If a customer

exceeded his or her Day Trading Buying

Power, he or she would generate a Day

Trading margin call. Until the customer

meet the margin call, the NYSE member

organization would be required to: (1)

Margin the account based on the cost of

all day trades made during the day; and

(2) limit the customer’s day trading

buying power to the equity in the

customer’s account at the close of

business on the previous day, less any

maintenance margin, multiplied by two.

If the Day Trading Margin call were not

met within 5 business days, the NYSE

member organization would then be

required to restrict the account to

trading on a cash available basis only.

8. Proposed Non-Withdrawal

Requirement

The NYSE represented that, in order

to provide greater financial stability to

the accounts of Pattern Day Traders, its

rule proposal would require that: (1) a

day trading customer deposit into the

day trading account a sufficient amount

of money to meet the Day Trading

Minimum Equity Requirement or a Day

Trading Margin Requirement; and (2)

such deposits not be withdrawn for at

least two business days (‘‘NonWithdrawal Requirement’’).

9. Proposed Prohibition on CrossGuarantees

In addition, the NYSE’s rule proposal

would require the NYSE member

organizations to prohibit Pattern Day

Traders from using guarantees between

customer accounts at the same brokerdealer (‘‘Cross-Guarantees’’) to meet the

Day Trading Minimum Equity

Requirement or a Day Trading Margin

Requirement. According to the NYSE,

this change is designed to address those

instances where maintenance margin

calls for day trading accounts would be

avoided by having guarantees from the

accounts of other customers at the same

broker-dealer. Under the NYSE

proposal, each Pattern Day Trader

account would be required to meet its

applicable requirements independently

by using funds on deposit in that

account.

10. Proposed Implementation

The NYSE proposal would become

operational six months after

Commission approval of the proposed

rule change.21

C. NASD Proposal

Although the NYSE and NASD

proposals differ somewhat in their

structure, they are fundamentally

comparable in their substance. The

NASD rule proposal would amend

NASD Rule 2520, Margin Requirements,

to impose stricter margin requirements

for customers who are Pattern Day

Traders. The NASD observed that the

expansion of day trading activity has

brought increased scrutiny of margin

requirements by self-regulatory

organizations (‘‘SROs’’). The NASD

asserted that its rule proposal would

help to protect the safety and soundness

of member firms and ensure the overall

financial well being of the securities

markets.

The NASD’s current rules on day

trading are similar in substance to those

of the NYSE.22 In its proposal, the

NASD describes that initial margin

requirements under Regulation T23 and

certain standard maintenance margin

requirements under the NYSE and

NASD rules currently are calculated

only at the end of each day. Therefore,

a day trader with no outstanding

positions, including losses, in his or her

account at the end of the day currently

does not incur either an initial margin

or maintenance margin requirement.

Although a day trader may end the

day without any positions, the day

trader and the member firm are

nonetheless at risk during the day, if

credit is extended. To address the risk,

the NASD currently requires day traders

to demonstrate that they have the ability

to meet margin requirements for at least

their open positions during the day.

Specifically, a customer who meets the

definition of ‘‘day-trader’’ 24 under the

current rules must deposit in his or her

account the margin that would have

been required had the customer not

liquidated his or her open positions

during the trading day (i.e., generally 50

percent of the largest open position).

Under current rules, if the customer day

trades, but does not fit the definition of

‘‘day trader,’’ the customer is still

required to deposit 25 percent of his or

her open position during the day. The

NASD proposed to amend its margin

rules covering day trading because

current rules are not adequate to address

added risks in leveraged pattern day

trading.25

1. Proposed Definition of Pattern Day

Trader

The NASD stated that its proposal

would define Pattern Day Trader to

cover ‘‘true’’ day traders only, not

merely incidental or occasional day

traders. According to the NASD, the

current definition of a day trader is

overly broad: it includes customers,

such as institutions and other large

individual accounts, that have a high

volume of trading activity and that

occasionally day trade not as a strategy,

but in response to a specific investment

decision or in response to particular

events. Accordingly, the NASD’s

proposal, like the NYSE proposal,

would define as Pattern Day Traders

those customers who execute four or

more day trades within five business

days, unless the number of their day

trades is six percent or less of their total

trades for that period.

Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices 13611

26Amendment No. 1 to the NASD Proposal.

Telephone conversation between Stephanie

Dumont, Counsel, NASD Regulation, and Steven

Johnston, Special Counsel, Division, Commission,

January 31, 2001 (clarifying the purpose of

Amendment No. 1). 27Amendment No. 1 to the NASD Proposal.

28The public files for the NYSE and NASD rule

proposals are located at the Commission’s Public

Reference Room, 450 Fifth Street, N.W.,

Washington, D.C. 20549–0609. The public files for

both rule proposals contain: (1) All comment letters

on the proposals, including a list of all commenters

on the proposals, which was prepared by

Commission staff; (2) ‘‘Report of Examinations of

Day-Trader Broker-Dealers,’’ Office of Compliance

Inspections and Examinations, Commission (‘‘OCIE

Report’’) dated February 25, 2000; and (3)

‘‘Securities Operations: Day Trading Requires

Continued Oversight,’’ the U.S. General Accounting

Office, dated February 24, 2000. The public file for

the NYSE rule proposal also contains: (1) The

original NYSE Proposal; (2) Amendment No. 1 to

the NYSE Proposal; and (3) NYSE Response to

Comments. The public file for the NASD rule

proposal also contains: (1) The original NASD

proposal; (2) Amendment No. 1 to the NASD

Proposal; and (3) NASD Response to Comments.

The NASD’s proposed rule change

would also require a firm that knows or

has a reasonable basis to believe that a

customer is a Pattern Day Trader to

designate the customer as a Pattern Day

Trader immediately. Under the NASD

proposal, a firm would have a

reasonable basis for believing that a

customer is a Pattern Day Trader if, for

example, the firm provided training to

the customer on day trading in

anticipation of the customer opening an

account. Amendment No. 1 to the NASD

Proposal deleted the provision that

would have required a Pattern Day

Trader to cease trading for 90 days

before he or she would be free of that

designation. According to NASD

Regulation, the provision originally

proposed is unnecessary because, even

without the provision, a Pattern Day

Trader could, under the proposed rules,

shed the Pattern Day Trader designation

by informing his or her broker-dealer

that he or she would not day trade. This

amendment also clarified that if a

Pattern Day Trader claimed he or she

was no longer a day trader, but then

resumed day trading, he or she could be

designated as a Pattern Day Trader

based on the firm’s knowledge or

reasonable belief that the customer fit

the proposed definition of a Pattern Day

Trader.26

2. Proposed Day Trading Minimum

Equity Requirement

The NASD’s proposed rule change

also would establish a Day Trading

Minimum Equity Requirement that is

identical to that proposed by the NYSE.

The NASD represents that the current

minimum equity requirement of $2,000

may not be large enough to prevent day

traders from continuing to generate

losses, without any additional deposit of

funds into their accounts. Under the

NASD proposal, a Pattern Day Trader, in

order to meet the Day Trading Minimum

Equity Requirement, would be required

to maintain $25,000 in his or her

account on any day in which he or she

day trades. The NASD represents that

the Day Trading Minimum Equity

Requirement more appropriately

addresses the additional risks inherent

in leveraged day trading activities and

ensures that customers cover losses

incurred in their accounts from the

previous day before continuing to day

trade.

3. Proposed Day Trading Buying Power

Like the NYSE proposal, the NASD

proposal would permit the use of Day

trading Buying Power at a level up to

four times the difference between the

equity in a customer’s account at the

close of business on the previous day

and any maintenance margin required.

The NASD represents that this

limitation on a customer’s Day Trading

Buying Power, along with the Day

Trading Minimum Equity Requirement,

more appropriately addresses the intraday risks created by customer day

trading. At the firm’s option, the Day

Trading Margin Requirement could be

calculated based on either the largest

open position at any time during the

day (if the customer’s firm maintains

‘‘time and tick’’ records) or the aggregate

total of the customer’s day trades during

the day.

4. Proposed Account Restrictions

In addition, the NASD proposed rule

change would impose a Day Trading

Margin call if a customer exceeded his

or her Day Trading Buying Power.

Customers would have five business

days to deposit funds to meet Day

Trading Margin calls. Until the

customer met the Day Trading Margin

call, his or her Day Trading Buying

Power would be limited to the equity in

his or her account at the close of

business on the previous day, less any

maintenance margin, multiplied by two

for equity securities. The Day Trading

Margin Requirement would be

calculated based on the aggregate cost of

the customer’s total day trades in a day.

If the customer did not meet the Day

Trading Margin call by the fifth business

day, the account would be further

restricted to trading on a cash available

basis for 90 days or until the margin call

was met.

5. Proposed Non-Withdrawal

Requirement

A deposit made to meet the Day

Trading Minimum Equity Requirement

or a Day Trading Margin Requirement

would have to remain in a customer’s

account for two business days following

the close of business on any day when

the deposit is required. Amendment No.

1 to the NASD proposal clarified that

the non-Withdrawal Requirement would

apply only to the accounts of Pattern

Day Traders and not to the accounts of

all day traders.27

6. Proposed Prohibition on CrossGuarantees

Under the NASD proposal, CrossGuarantees could not be used when

calculating the Day Trading Minimum

Equity Requirement or the Day Trading

Margin requirement. Each day trading

account would be required to satisfy

independently the proposed rule’s

requirements, based solely on the

financial resources available in the

account.

7. Proposed Change to Definition of

‘‘Day Trade’’

Finally, the NASD rule proposal

would amend provisions of NASD Rule

2520, which currently requires that the

sale and repurchase on the same day of

a position held from the previous day be

treated as a day trade. Under the NASD

proposal, the sale of an existing position

would be treated as liquidation, and a

subsequent repurchase would be viewed

as the establishment of a new position.

Therefore, the sale of an existing

position and subsequent repurchase

would not be subject to NASD rules

affecting day trades. Similarly, if a short

position were carried overnight, the

purchase to close the short position and

the subsequent new sale would not be

considered a day trade under the

NASD’s proposal.

8. Proposed Implementation Date

Amendment No. 1 to the NASD

Proposal would change the proposed

operational date of the proposal from 30

days after the date the NASD issues a

notice to NASD members announcing

that the proposal has been approved by

the Commission to six months from the

date of such notice.

III. Summary of Comments

The Commission received 214 letters

commenting on the NYSE proposal and

49 letters commenting on the NASD

proposal.28 Comment letters expressed

various degrees of opposition or support

to the approach taken by the proposed

rule changes, although most

commenters opposed the proposals. The

commenters generally addressed issues

13612 Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices

29NYSE Response to Comments; NASD Response

to Comments.

30Under the proposed rules, a day trade is,

generally, the purchase and sale or the sale and

purchase of the same security on the same day.

31NYSE Response to Comments.

32Letter from Cornerstone Securities Corporation

(‘‘Cornerstone Letter’’).

33The Task Force is comprised of representatives

from 15 firms: Advanced Clearing, Inc.; All-Tech

Direct, Inc.; Ameritrade, Inc.; Charles Schwab & Co.,

Inc.; EDGETRADE.com, Inc.; E-Trade Group, Inc.;

iClearing Corporation; Momentum Securities;

NextTrend, Inc.; On-Line Investments Services,

Inc.; Southwest Securities, Inc.; Spear, Leedst &

Kellog; Terra Nova Trading LLC; Tradescape LLC;

and US Clearing (Division Fleet Securities). Letter

from the Task Force (‘‘Task Force Letter’’).

34See, e.g., E-mail from Steven Petrizzi, E-mail

from M. Spetman; Cornerstone Letter; Task Force

Letter.

35According to the SIA, the organization ‘‘brings

together the shared interests of more than 740

securities firms to accomplish common goals.’’

Letter from SIA Brokerage and Technology

Committees (‘‘SIA Brokerage and Technology

Committees Letter’’).

36Letter from Momentum Securities, LLC

(‘‘Momentum Letter’’); Task Force Letter; SIA

Brokerage and Technology Committees Letter.

37See, e.g., Momentum Letter.

38See, e.g., Letter from Empire Programs.

39SIA Brokerage and Technology Committees

Letter; Letter from the SIA Office of General

Counsel (‘‘SIA General Counsel Letter’’). The SIA

Brokerage and Technology Committees and SIA

General Counsel recommended adding the

following exceptions to the proposed definition of

day trading: (1) Exercising a profitable option

position; (2) reopening a long option position that

had been closed out earlier the same day; (3)

reopening a short option position that had been

closed out earlier the same day; and (4) the

purchase of a security by a customer and the sale

of the same security by the customer in a

repurchase or other financing transaction.

40Letter from Brunelle and Hadjikow.

41NASD Response to Comments.

42Status as a Pattern Day Trader is determined on

a rolling five-business-day basis. Telephone

conversation among Donald Van Weezel, Managing

Director, Regulatory Affairs, NYSE; Albert Lucks,

Director, Credit Regulation, NYSE; and Nancy

Sanow, Assistant Director; Thomas McGowan,

Assistant Director; Joseph Morra, Senior Special

Counsel; and Melinda Diller, Attorney; Division,

Commission, January 7, 2000.

43Task Force Letter.

44See, e.g., Momentum Letter.

45Momentum Letter.

46NYSE Response to Comments.

47NASD Response to Comments.

48NASAA is a voluntary association of state,

provincial, and territorial securities administrators

in the 50 states, the District of Columbia, Puerto

Rico, Canada, and Mexico. Letter from NASAA

(‘‘NASAA Letter’’). See also Section II., Description

of the Proposed Rule Changes, supra, for further

discussion of ‘‘knows or has a reasonable basis to

believe’’ standard.

falling into one or more of the categories

discussed below. In addition, the NYSE

and NASD submitted responses 29 to the

comments received by the Commission

regarding the proposed rule changes.

These responses are also incorporated

below.

A. Definition of Pattern Day Trader

The proposed rule changes would

define as Pattern Day Traders customers

who execute four or more day trades 30

within five business days, unless the

number of day trades is six percent or

less of the total day trades for that fiveday period. The NYSE stated that this

definition is directed toward active

Pattern Day Traders and the risk

surrounding their activities.31 A

relatively small number of individuals

raised specific objections to this

definition. These individuals, along

with a broker-dealer 32 and the Industry

Day-Trading Advisory Task Force

(‘‘Task Force’’),33 expressed concern

that the proposed definition could

encourage customers to hold positions

overnight that they might otherwise

have liquidated, thus giving rise to

additional risk of financial loss.34

In addition, a broker-dealer, the Task

Force, and the Discount Brokerage

Committee (‘‘Brokerage Committee’’)

and Ad Hoc Committee on Technology

and Regulation (‘‘Technology

Committee’’) of the Securities Industry

Association (‘‘SIA’’) 35 (collectively, the

‘‘SIA Brokerage and Technology

Committees’’) indicated concern over

the impact that the proposed definition

could have upon professional or

institutional investors. These

commenters stated that the definition

lacks adequate exclusions for those

types of investors.36 Broker-dealers also

opposed the definition of Pattern Day

Trader because it would encompass socalled ‘‘incidental’’ or ‘‘inadvertent’’ day

traders.37 In this regard, a few firms

proposed exceptions for customers who,

as a result of ‘‘inadvertent’’ or ‘‘nonwillful’’ error, temporarily met the

proposed definition of Pattern Day

Trader.38 The SIA Brokerage and

Technology Committees and SIA Office

of General Counsel recommended that

the proposed definition be revised to

explicity exempt specific types of

trading activity, such as the exercise of

a profitable options position.39 A law

firm commenting on the proposed rule

changes recommended exceptions to the

proposed definition of Pattern Day

Trader for certain institutional

investors, arguing that sophisticated

investors with large accounts do not

need to be protected by the proposed

rule changes.40 The NASD responded to

this comment by reasserting its belief

that the proposed six percent exception

adequately addresses institutional

trading. The NASD argued that this

exception was not intended to exempt

all institutions that frequently day trade,

but only those whose day trading

represented a small proportion of their

overall trading activity.41

Finally, the Task Force opposed the

definition because it is based on

transactional activity instead of the

amount of available leverage. The Task

Force asserted, for example, that a

customer that completed five day trades

within a ‘‘week’’ 42 would meet the

definition of Pattern Day Trader ‘‘even

though the customer ha[d] not taken on

any greater level of financial risk or

leverage.’’ 43

B. ‘‘Knows or Has a Reasonable Basis to

Believe’’ Standard

Several securities industry

commenters opposed the requirement to

treat as Pattern Day Traders current or

new customers whom a trading firm

‘‘knows or has a reasonable basis to

believe’’ will engage in pattern day

trading.44 One securities firm opposed

the ‘‘knows or has a reasonable basis to

believe’’ standard because it calls for a

firm to ‘‘subjectively consider the

manner of trading a new customer might

pursue.’’ 45

The NYSE responded to these

criticisms by explaining that a firm

could have a reasonable basis to believe

that a customer would engage in Pattern

Day Trading if this were indicated by

information obtained from a customer’s

representations or by prior trading

patterns of the customer at the firm.46

The NASD responded that the proposed

standard is based on a firm’s knowledge

or reasonable belief only, and would not

require a firm to anticipate a new

customer’s activity unless the firm had

knowledge or a reasonable belief that

the customer would engage in pattern

day trading. The NASD stated that if, for

example, a firm provided a customer

with training on day trading in

anticipation of that customer opening an

account with that firm, then the firm

would have a reasonable basis to believe

that customer would pattern day trade

in his or her account.47

This standard was supported by

comments from the North American

Securities Administrators Association

(‘‘NASAA’’). NASAA contended that

brokerage firms have an affirmative duty

to assess a prospective client’s

suitability to trade, and therefore firms

should determine whether the client fits

the definition of Pattern Day Trader.

According to NASAA, this assessment

should not be overly burdensome to

make. NASAA noted as an example that

where a firm trains a customer in day

trading techniques, that firm would be

presumed to know or have a reasonable

basis to believe that such a customer

would engage in pattern day trading.48

Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices 13613

49See, e.g., E-mail from Susie Brown (‘‘Brown

Letter’’).

50See, e.g., Letter from Serg Palanov.

51See, e.g., E-mail from Brent Aston.

52 Datek Online Holdings Corporation Letter

(‘‘Datek Letter’’); See also May letter.

53The SIA Brokerage and Technology

Committees are opposed, however, to imposing the

Day Trading Minimum Equity Requirement when a

firm ‘‘knows or has a reasonable basis to believe’’

a customer will in engage in pattern day trading.

SIA Brokerage and Technology Committees Letter.

54See, e.g., Cornerstone Letter.

55 Datek Letter.

56See, e.g., Momentum Letter.

57 Datek Letter.

58Momentum Letter. The Task Force also

recommended that the day trading rules

differentiate between customers who trade at a 4:1

ratio and those who trade at a 2:1 ratio. Task Force

Letter.

59NASD Response to Comments.

60See, e.g., Brown Letter.

61NYSE Response to Comments.

62NASD Response to Comments.

63NASD Response to Comments.

64NASAA Letter; Senate Subcommittee Letter.

65Senate Subcommittee Letter.

66NASAA Letter.

67Senate Subcommittee Letter.

68 Id.

69NYSE Response to Comments.

C. Day Trading Minimum Equity

Requirement

The majority of comments the

Commission received on the proposals’

Day Trading Minimum Equity

Requirement were from individuals,

many of whom identified themselves as

day traders. Nearly all of these

individuals characterized the Day

Trading Minimum Equity Requirement

as unfair to small investors.49 Individual

commenters asserted that the Day

Trading Minimum Equity Requirement

would act as a barrier to persons seeking

to enter the day trading market.50

Individual commenters also asserted

that the requirement was designed to

exclude small investors from a type of

trading traditionally dominated by

professional traders.51 A securities firm,

as well as a significant number of

individual commenters, argued that the

proposed Day Trading Minimum Equity

Requirement would be ‘‘paternalistic.’’

These commenters asserted that the

risks of day trading are widely known;

therefore, it is unnecessary for the NYSE

or NASD to protect investors from those

risks.52 The SIA Brokerage and

Technology Committees stated,

however, that they had no objection to

the proposed dollar amount of the Day

Trading Minimum Equity Requirement

(i.e., $25,000).53

Most securities firms commenting on

the proposed rule changes opposed the

Day Trading Minimum Equity

Requirement wholly or partially.54 For

example, one firm challenged the

premise that there is a relationship

between the size of a customer’s account

and his or her investment success. The

same firm argued that the imposition of

a higher equity requirement could

encourage investors to put more of their

capital at risk than they would absent

the proposed rules.55 Securities firms

also took the position that imposing the

Day Trading Minimum Equity

Requirement on Pattern Day Traders

would fail to protect either member

firms or the securities markets.56 One of

the firms argued that the health of the

securities markets is not threatened by

accounts that have only small equity

balances, and there is no data to suggest

that a higher equity requirement for day

trading would reduce the risk to

securities firms.57 As an alternative, one

securities firm recommended applying a

$25,000 minimum equity requirement to

customers who seek and receive

approval to trade at a 4:1 margin ratio,

but not to customers who trade at a 2:1

ratio.58

In response to this alternative, the

NASD stated that it believes an objective

standard based on the level of day

trading activity, which can be applied

uniformly to all customers, is an

important component to regulation in

this area. In this regard, the frequency

of day trading is a relevant indicator of

intra-day risk, which in turn is

important in determining whether

additional requirements, such as the

Day Trading Minimum Equity

Requirement, are necessary. The NASD

further stated that it believed requiring

minimum equity of $25,000 would

provide a significant ‘‘cushion’’ to

prevent day traders from continuing to

generate losses in their accounts and, at

the same time, avoid imposition of

excessive restrictions on day traders

with limited capital.59

In response to comment letters

objecting to the proposed imposition of

the Day Trading Minimum Equity

Requirement,60 the NYSE stated that the

current equity requirement of $2,000

does not sufficiently address the

speculative nature and potential

volatility of pattern day trading. Further,

the NYSE stated that the amount of the

proposed minimum Day Trading

Minimum Equity Requirement

appropriately addresses the financial

exposure of firms and the potential for

significant monetary losses by

customers. In the NYSE’s view, the Day

Trading Minimum Equity Requirement

should provide some ‘‘staying power’’ to

day traders (i.e., enable them to

continue day trading) should they incur

trading losses.61 The NASD added that

the current equity requirement of $2,000

does not adequately address day trading

risks.62 The NASD represents that given

the speculative nature of day trading the

proposed Day Trading Minimum Equity

Requirement would provide a better

‘‘cushion’’ in case of financial losses by

customers.63

NASAA and the U.S. Senate

Permanent Subcommittee on

Investigations (‘‘Senate Subcommittee’’)

supported substantial increases in the

size of the equity requirement for day

trading.64 Following increased public

and private sector concern over the risks

associated with day trading, the Senate

Subcommittee conducted an eightmonth investigation of the day trading

industry. Based on the investigation, the

Senate Subcommittee found that

‘‘[securities] industry leaders agreed that

a day trader’s chance of success is

directly and proportionally related to

the amount of capital with which a

person starts trading.’’ 65 NASAA stated

that the Day Trading Minimum Equity

Requirement should reduce the

frequency of margin calls, increase the

chances that day traders will be able to

independently meet margin calls, and

provide a ‘‘cushion’’ when market

corrections occur.66

Finally, the Senate Subcommittee

submitted detailed alternative proposals

regarding, among other things, the

required level of equity and suggested

restrictions on accounts that do not

meet the equity requirement. For

example, the Senate Subcommittee

proposed that day trading rules

establish a rebuttable presumption

‘‘such that a firm must initially presume

that a day trading customer who does

not have $50,000 with which to open an

account in inappropriate for day

trading.’’ The presumption could be

overcome if a firm concluded that other

factors outweighed the fact that the

customer did not have $50,000 with

which to open an account. Under the

Senate Subcommittee’s proposal, a firm

would be required, among other things,

to state its reasons for concluding that

a day trading strategy was appropriate

for such a customer.67

In response to recommendations by

the Senate Subcommittee that the equity

requirement for Pattern Day Traders be

increased to $50,000,68 the NYSE stated

that it believes $25,000 is a sufficient

level of equity, given the fact that firms

may further increase equity

requirements based on their own

policies and procedures, known as

‘‘house requirements.’’ 69 The NASD

stated that the proposed Day Trading

Minimum Equity Requirement should

13614 Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices

70NASD Response to Comments.

71Senate Subcommittee Letter.

72NASD Response to Comments.

73See, e.g., Letter from Jay Marting (‘‘Marting

Letter’’).

74See, e.g., Marting Letter; Senate Subcommittee

Letter.

75See, e.g., Momentum Letter.

76See, e.g., Letter from Matthew Panza (‘‘Panza

Letter’’); Letter from EDGETRADE.com

(‘‘EDGETRADE Letter’’).

77NYSE Response to Comments; NASD Response

to Comments.

78NYSE Response to Comments; NASD Response

to Comments.

79See, e.g., Panza Letter; EDGETRADE Letter.

80See e.g., Panza Letter; Letter from Ed Naylor

(‘‘Naylor Letter’’).

81See e.g., Naylor Letter.

82For the Day Trading Margin Requirement to be

based on a customer’s highest open position, the

customer’s firm must maintain ‘‘time and tick’’

records documenting the sequence in which each

day trade was completed.

83NYSE Response to Comments. January 23, 2001

Call with NYSE Staff (clarifying that this formula

applies solely to Pattern Day Traders who have no

outstanding day trading margin calls).

84See e.g., Ray Letter; Momentum Letter.

85 January 23, 2001 Call with NYSE Staff

(clarifying operation of NYSE proposed rules).

Telephone conversation between Susan Demando,

Director, of Finance/Operations, Member

Regulation, NASD and Thomas McGowan,

Assistant Director, Division, Commission, January

24, 2001 (‘‘January 24, 2001 Call with NASD Staff’’)

(clarifying operation of NASD proposed rules).

86For a customer’s Day Trading Margin

Requirement to be based on his or her highest open

position, the customer’s firm must maintain ‘‘time

and tick’’ records of the customer’s transactions;

otherwise, the customer’s Day Trading Margin

Requirement must be calculated based on the total

cost of a customer’s day trades during the day.

87The proposed rules would define Day Trading

Buying Power for equity securities as the equity

available in a customer’s account as of the close of

business on the previous day less any maintenance

margin requirement, multiplied by four. Because, in

this example, the customer has no open positions

in his or her margin account, the customer has no

maintenance margin requirement.

88The example assumes that the customer closes

one position before opening the next. This would

be the case, for example, if the customer: (1)

Purchased ‘‘Security A’’ for $50,000 at 10:00 a.m.;

(2) sold ‘‘Security A’’ for $50,000 at 11:00 a.m.; (3)

purchased ‘‘Security B’’ for $200,000 at 1:00 p.m.;

and (4) sold ‘‘Security B’’ for $200,000 at 3:30 p.m.

89Had the customer not closed the position in

‘‘Security A’’ before purchasing ‘‘Security B,’’ the

customer’s highest open position would have been

$250,000, the sum of positions open

simultaneously.

90The example assumes that there are no profits

or losses in the account, no commission or interest

charges, and no other items that would affect the

account balance. Therefore, the amount of equity in

the account at the end of Day 0.

provide protection against continued

losses in day trading accounts while

refraining from excessive restrictions on

day traders with limited capital. The

NASD also observed that firms have the

option of increasing equity requirements

on day traders by imposing house

requirements.70

In addition, the Senate Subcommittee

recommended that customers who fail

to maintain sufficient funds in their

accounts be restricted to trading on a

cash basis only.71 In response to this

suggestion, the NASD stated that if a

customer continued to day trade in his

or her account without maintaining the

proposed Day Trading Minimum Equity

Requirement, the NASD would expect

that the customer’s firm would restrict

that account to trading on a cash

available basis.72

D. Margin Ratio

A small number of individual

commenters expressed opposition to

increasing to a 4:1 ration the amount of

leverage available to customers who

satisfy the Day Trading Minimum

Equity Requirement.73 These individual

commenters, as well as the Senate

Subcommittee, expressed concern that

increasing the margin ratio would

multiply any losses of, and increase

speculation by, those persons who trade

at the higher ratio.74 On the other hand,

securities firms generally did not object

to allowing customers to trade at a 4:1

ratio.75

In response to concerns about

increasing the amount of leverage

available to Pattern Day Traders,76 the

NYSE and NASD represented that

permitting the use of leverage at a 4:1

ratio is appropriate when considered in

conjunction with other provisions of the

proposed rule changes.77 The NYSE

stated that as a whole, its proposal

would encourage customers to avoid

margin calls by trading only within their

Day Trading Buying Power. The NYSE

and NASD also indicated that allowing

pattern Day Traders to trade at the 4:1

ratio would bring day trading accounts

into parity with ordinary margin

accounts, where the standard

maintenance margin is also 25

percent.78

E. Method of Computing Margin Calls

A substantial number of individuals

and securities firms commenting on the

rule proposals were opposed to the

proposed method of computing the Day

Trading Margin call.79 Some of these

commenters objected to calculating the

margin call based on all day trades

during a day, once a Pattern Day Trader

had exceeded his or her Day Trading

Buying Power.80 Individual commenters

asserted that using this method would

result in customers receiving margin

calls many times larger than the amount

of equity in the customer’s account. A

few of these comments apparently

believed that a customer with no

outstanding Day Trading margin calls

who exceeded his or her Day Trading

Buying Power would, under the

proposed rules, face a Day Trading

Margin call equal to 50 percent of the

total cost of all day trades executed on

the day in which the customer exceeded

his or her Day Trading Buying Power.81

The NYSE has clarified that if a Pattern

Day Trader had no outstanding Day

Trading Margin calls, his or her Day

Trading Margin Requirement would

equal 25 percent of either (1) the

customer’s highest open position during

the day,82 or (2) 25 percent of the total

cost of the customer’s day trades during

the day.83 Many of the individual and

industry commenters lodging concerns

regarding the calculation of Day Trading

Margin calls stated that such margin

calls would be unfairly punitive to day

traders.84

The NYSE and NASD explained the

calculation of Day Trading Margin calls

as follow.85 In accounts not subject to

restrictions under the proposed rules,

Day Trading Margin calls would be

calculated based on a customer’s highest

open position in a day.86 For example,

assume that a customer who is a Pattern

Day Trader had $30,000 cash equity and

no security positions in his or her

account at the close of business on Day

0. The customer’s Day Trading Buying

Power for Day 1 would be $120,000

(four times the equity in the customer’s

account at the close of business on Day

0).87 Also assume that the customer

executed two day trades on Day 1—a

$50,000 purchase and sale, followed by

a $200,000 purchase and sale.88 Under

these conditions, the customer’s highest

open position on Day 1 is $200,000.89

Since the customer’s highest open

position exceeds her or her Day Trading

Buying Power, the customer incurs a

Day Trading Margin call of $20,000,

calculated as followings:

$200,000 (largest open position on Day

1)

¥120,000 (Day Trading Buying Power)

80,000

x .25 (Day Trading Margin)

$20,000 (Day Trading Margin call)

In addition to incurring a Day Trading

Margin call on Day 1, the customer’s

account is restricted until the margin

call is met. On Day 2, for example, the

customer’s Day Trading Buying Power is

restricted to $60,000 (two times the

assumed equity 90 in the customer’s

account at the close of business on Day

1). Further, the customer’s account is

margined based on the total cost of all

day trades executed on Day 2. For

example, assume that on Day 2 the

customer executes two day trades—a

$40,000 purchase and sale and $30,000

Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices 13615

91The Day Trading Margin rises to 50 percent

because the customer has an outstanding Day

Trading Margin call. January 23, 2001 Call with

NYSE Staff; January 24, 2001 Call with NASD Staff

(both clarifying use of 50 percent margin under

proposed rules).

92See, e.g., Letter from Terry Laughlin (‘‘Laughlin

Letter’’).

93Laughlin Letter.

94NYSE Response to Comments; 12 CFR 220.2;

12 CFR 220.4(c)(3)(i).

95See, e.g., Naylor Letter; Cornerstone Letter

(addressing imposition of 2:1 ratio).

96See, e.g., E-mail from Jeff Landau.

97Cornerstone Letter; SIA Brokerage and

Technology Committees Letter. 12 CFR 220 et seq.

98SIA Brokerage and Technology Committees

Letter; Cornerstone Letter.

99Task Force Letter.

100NYSE Response to Comments

101See, e.g., Letter from Brent Johnson.

102NASD Response to Comments.

103Senate subcommittee Letter.

104NASAA Letter

105See, e.g., Cornerstone Letter. Letter from SIA

Rules and Regulations Committee (‘‘SIA Rules and

Regulations Committee Letter’’).

106 12 CFR 220 et seq.

107Cornerstone Letter.

108SIA Rules and Regulations Committee Letter.

109NYSE Response to Comments.

110NYSE Response to Comments; NASD

Response to Comments.

111NYSE Response to Comments.

112NASD Response to Comments.

purchase and sale. Since the total cost

of the customer’s day trades ($70,000)

exceeds his or her Day Trading Buying

Power ($60,000), the customer incurs a

second Day Trading Margin call of

$5,000, calculated as follows:

$70,000 (cost of all day trades on Day 2)

¥60,000 (Day Trading Buying Power)

10,000

× 91.50

$5,000 (Day Trading Margin call)

F. Time Allowed to Meet Margin Call

Some 91 commenters stated that they

were opposed to the requirement that,

once a customer receives a Day Trading

Margin call, he or she must meet the

margin call within five business days.92

One commenter, for example, protested

that along with other provisions of the

proposed rule changes, this requirement

would force customers to liquidate

positions based on non-market

considerations.93 In response to

objections to reducing the time to meet

a margin call from seven to five business

days, the NYSE stated that this change

was made to conform its proposed rule

revisions to the time frame included in

Regulation T for standard margin

accounts.94

G. Actions Required When Day Trading

Buying Power Is Exceeded

A significant number of comment

letters from individuals, and roughly

half of the letters from securities

industry commenters, addressed the

subject of the actions to be taken if a

customer exceeds his or her Day

Trading Buying Power.95 For example,

individual commenters objected to the

provisions restricting use of leverage to

a 2:1 ratio once a Pattern Day Trader has

incurred a Day Trading Margin call.96 A

securities firm and the SIA Brokerage

and Technology Committees criticized

provisions that would reduce the degree

of leverage available to customer who

has received a Day Trading Margin call

because, they argued, it departs from the

approach used in Regulation T.97 This

firm and the SIA Brokerage and

Technology Committees were opposed

to the imposition of immediate

restrictions on the accounts of

individuals who exceeded their Day

Trading Buying Power, and the SIA

Brokerage and Technology Committees

favored imposing as few restrictions as

possible during the five-business-day

period for meeting a Day Trading

Margin call.98 Finally, the Task Force

proposed that no restrictions be

imposed on the account of a Pattern Day

Trader during the five business days

specified for meeting a Day Trading

Margin call.99

In response, the NYSE stated that the

proposed actions are appropriate and

will help to minimize financial risk to

securities firms and markets.100 In

response to concerns that the

companion actions required may

‘‘penalize’’ customers,101 the NASD

represented that immediate

consequences are necessary to

discourage customers from exceeding

their Day Trading Buying Power.102

The Senate Subcommittee supported

the proposed restrictions on Pattern Day

Traders who exceed their Day Trading

Buying Power.103 NASAA also

supported the Day Trading Margin call

provisions and other restrictions

imposed by the proposed rule changes.

NASAA described the proposed

measures as the placement of regulatory

‘‘speed bumps’’ to ensure compliance

with reasonable margin risk levels and

to enforce penalties for day trading in

accounts with little or no equity.104

H. Non-Withdrawal Requirement

Most securities firms, and The Rules

and Regulations Committee of the SIA’s

Credit Division (‘‘SIA Rules and

Regulations Committee’’), opposed the

requirement that funds deposited into a

customer’s account to satisfy the Day

Trading Margin Requirement or Day

Trading Minimum Equity Requirement

of the proposed rule changes must

remain in the account for two business

days.105 One trading firm, for example,

stated that the Non-Withdrawal

Requirement is unnecessary because

positions are not held overnight and,

therefore, funds are not at risk. The firm

also contrasted the proposed NonWithdrawal Requirement with the

treatment of deposits made to satisfy

Regulation T106 margin calls. The firm

observed that customers are permitted

to withdraw those deposits the day after

the deposits have been made.107

The SIA Rules and Regulations

Committee argued that the NonWithdrawal Requirement is overly

restrictive, and that customers should be

able to use funds available in their

accounts, absent a pattern of activity

demonstrating that they lack sufficient

financial resources to engage in Pattern

Day trading.108 The NYSE, however,

represented that the effectiveness of

other provisions of its proposed rule

change could be limited if a customer

were permitted to withdraw funds prior

to trading on the day after that customer

had been required by the proposal to

deposit them. The NYSE explained that

if a customer is permitted to withdraw

such funds prior to the next day’s

trading, he or she could shield the funds

from day trading losses through

overnight borrowing. The NYSE

observed that overnight borrowing to

meet margin calls does not demonstrate

a customer’s fitness to engage in Pattern

Day Trading.109

The NYSE and NASD stated that they

believe the Non-Withdrawal

Requirement would result in greater

caution by entities lending funds to

customers who must meet Day Trading

Margin calls. In their view, this is

because funds deposited to meet Day

Trading Margin calls would be placed at

risk of day trading losses.110 This, the

NYSE argued, may encourage entities

lending funds to more carefully evaluate

the creditworthiness of Pattern Day

Traders. The NYSE believed that this

increased caution should provide a

better foundation for reducing financial

risk to the securities industry and to

individual investors.111 The NASD

believed that the Non-Withdrawal

Requirement would also force Pattern

Day Traders to more frequently rely

upon their own funds and assets in

meeting margin requirements and

thereby decrease financial risk to

securities firms.112

I. Cross-Guarantees

Many individual commenters, as well

as a significant number of firms,

expressed opposition to the exclusion of

Cross-Guarantees from the calculation of

13616 Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices

113See, e.g., Momentum Letter.

114Momentum Letter. See also Task Force Letter.

115NYSE Response to comments.

116NASD Response to Comments.

117NASAA Letter.

118Senate Subcommittee Letter.

119See, e.g., SIA General Counsel Letter.

120SIA Brokerage and Technology Committees

Letter.

121Task Force Letter.

122 Datek Letter (referring to Task Force

recommendations).

123NYSE Response to Comments. January 23,

2001 Call with NYSE Staff (confirming operative

date of proposed rule change).

124NYSE Response to Comments.

125NASD Response to Comments.

126A day trading strategy is ‘‘an overall trading

strategy characterized by the regular transmission

by a customer of intra-day orders to effect both

purchase and sale transactions in the same security

or securities.’’ Senate Subcommittee Letter (Citing

definition in proposed NASD Rule 2360(e)).

127See, e.g., ‘‘State Securities Regulators

Investigate Practices of Securities Firms as Part of

a Broad-Based Inquiry Into Day Trading,’’ The Wall

Street Journal, Sec. C., pp. 1, col. 6, August 25,

1999; ‘‘Critical Report by North American Securities

Administrators Association,’’ The Wall Street

Journal, Sec. A, pp. 26, col. 1; ‘‘Senators Lambaste

Actions by Day Traders,’’ USA Today, Sec. B, pp.

2, February 25, 2000; ‘‘Day Trading: A Study in

Temptation; Senate Panel to Investigate Risk

Disclosure,’’ The Washington Post, February 24,

2000, Sec. E., pp. 1.

128OCIE Report.

129 Day Trading: An Overview: Hearing Before the

Permanent Subcommittee on Investigations of the

Committee on Governmental Affairs, 106th Cong.,

1st Sess. 106–285 (1999). The Senate Subcommittee

also reviewed and provided recommendations

concerning the NYSE and NASD rule proposals on

the use of margin. Senate Subcommittee Letter.

130See e.g., Securities Exchange Act Release No.

43021 (July 10, 2000), 65 FR 44082 (July 17, 2000)

(File No. SR–NASD–99–41) (approving new rules

pertaining to the opening of day trading accounts

and delivery of a risk disclosure statement).

the Day Trading Margin Requirement.113

In addition, one commenter proposed to

exclude accounts trading at the 2:1 ratio

from the application of the proposed

provisions on Cross-Guarantees.114 The

NYSE believes that the provision in its

rule proposal on Cross-Guarantees

‘‘suitably addresses concerns of whether

[a] customer has the financial resources

to day trade, and allows for separate

evaluation of customers’ day trading

risks.’’115 The NASD also believes that

its proposed provision on CrossGuarantees is necessary to address those

concerns.116

NASAA also expressed support for

the proposed provisions on CrossGuarantees. NASAA suggested that

Cross-Guarantees circumvent the

purpose of margin requirements. In

addition, NASAA expressed concern

regarding the potential harm to

investors if securities firms that are

strongly recommending an investment

or an investment strategy to a customer

also take steps to arrange margin

guarantees for that same customer.117

Similarly, the Senate Subcommittee

stated that Cross-Guarantees would

‘‘undermine margin requirements’’ and

could ‘‘evade the purpose’’ of equity

requirements as well.118

J. Burdens on Firms

Most securities industry commenters

expressed concern over the

implementation, administration, and

enforcement burden that they believed

would be placed upon securities firms

by the proposed rule changes.119 The

SIA Brokerage and Technology

Committees argued, for example, that

the system enhancements required to

monitor such parameters as Day Trading

Buying Power and to impose restrictions

on accounts would be ‘‘significant,

complicated, and costly.’’ The SIA

Brokerage and Technology Committees

asserted that such burdens should not

be imposed on firms that do not

promote day trading strategies. The

committees also expressed particular

concern regarding the burden of

implementing provisions of the

proposed rule changes that would

exclude from the definition of Pattern

Day Trader those customers whose day

trades represent six percent or less of

their total trades.120 In addition, the

Task Force argued that the proposed

rule changes would require firms to

classify and monitor their entire

customer base on a daily basis.121 As an

alternative, one firm proposed that

customers desiring to trade at a 4:1 ratio

should be required to apply for approval

to trade at that level, and that brokerdealers should only be required to

monitor the accounts trading at a 4:1

ratio. The firm believed this would

reduce a firm’s burden of implementing

day trading margin rules.122

Responding to these concerns, the

NYSE stated that the programming and

monitoring of its proposed rule would

not be unduly burdensome, and stated

that it would delay the operative date by

six months from the date of commission

approval, in order to allow firms to

implement its proposed rule.123 In

response to specific concerns regarding

the burden of implementing the

proposed exclusion from the definition

of Pattern Day Trader for customers

whose day trades represent six percent

or less of their total trades, the NYSE

stated that the exclusion is not

mandatory, i.e., members may choose

not to exclude such investors from the

operation of the NYSE’s proposed

rules.124 With regard to the same

concern, the NASD responded that its

staff consulted with members of the

Rule 431 Committee who advised that

programming and monitoring the

exception would not be overly

burdensome.125

IV. Discussion of the NYSE and NASD

Proposed Rule Changes

Day trading generally refers to a kind

of trading system involving frequent,

rapid-fire purchase and sale transactions

(or sale and purchase transactions) in

securities in a single day. Day trading

transactions are often effected by

persons who typically have

computerized links to market centers

and who attempt to capture small

differences in stock prices.126 As day

trading activity increased, so did media

attention and public concern over the

risks inherent in day trading.127 Given

the potential for significant losses to

those persons who engage in day trading

activities, legislators and regulators have

scrutinized the practice and have taken

steps to protect investors and limit

financial risks to investors, brokerdealers, and securities markets.

For example, from October 1998

through September 1999, the

Commission’s Office of Compliance

Inspections Examinations (‘‘OCIE’’)

examined 47 registered broker-dealers

that were providing day trading

facilities to the general public. In

February 2000, OCIE issues a report of

its findings and recommendations,

addressing risk disclosure, net capital

compliance, lending arrangements,

supervisory infrastructure, and other

issues associated with day trading.128

In addition, the Senate Subcommittee

held hearings on day trading that

focused on investor suitability, the use

of margin, advertising, and

profitability.129 Moreover, various SROs

filed, and the Commission approved,

other rule proposals regulating day

trading practices.130 The NYSE and

NASD rule proposals relating to margin

requirements for day traders represent

further regulatory responses to issues

raised by day trading.

The rule proposals submitted by the

NYSE and NASD were the result of

collaborative efforts by these SROs,

through the Rule 431 Committee—

comprised of NYSE and NASD staff,

attorneys from the NYSE’s outside

counsel, staff of the Board of Governors

of the Federal Reserve, and

representatives from several brokerdealers and clearing firms—to develop

special margin rules that better reflect

the risks inherent in day trading.

Because initial margin requirements

under Regulation T and standard

maintenance margin requirements

under current NYSE and NASD rules

are calculated only at the end of the day

incurred, a day trader with no

Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices 13617

131 15 U.S.C. 78f(b)(5).

132 15 U.S.C. 78o–3(b)(6).

133 15 U.S.C. 78f(c)(3)(A).

134 15 U.S.C. 78o–3(g)(3)(A).

135For further discussion of Cross-Guarantees,

see, Section II, supra. Description of the Proposed

Rule Charges.

136 12 CFR 220.3(d).

outstanding positions, including losses,

in his or her account at the end of the

day currently incurs neither an initial

margin nor a maintenance margin

requirement. Although current NYSE

and NASD special maintenance margin

requirements apply to day traders, those

requirements do not adequately address

the potential financial risks posed by

day trading, and may have encouraged

practices, such as the use of CrossGuarantees, that do not require

customers to demonstrate actual

financial ability to engage in day

trading.

The Commission has reviewed the

NYSE and NASD proposed rule

changes, and has considered carefully

the comment letters submitted in

response to these proposals, as well as

the NYSE and NASD responses to the

comment letters, and finds that the

proposed rule changes are consistent

with the requirements of the Act and the

rules and regulations thereunder

applicable to a national securities

exchange and national securities

association, respectively. The

Commission finds that the NYSE

proposal is consistent with section

6(b)(5) of Act,131 which requires the

rules of a national securities exchange to

be designed to prevent fraudulent and

manipulative act and practices, to

promote just and equitable principles of

trade, and, in general, to protect

investors and the public interest.

Section 15A(b)(6) of the Act132 imposes

the same requirement on a national

securities association. The Commission

also finds that the NASD proposal is

consistent with section 15A(b)(6) of the

Act.

In addition, the Act specifically grants

to SROs the authority to establish and

enforce standards of financial

responsibility among their members.

Section 6(c)(3)(A) of the Act133

provides, among other things, for a

national securities exchange to deny or

condition membership privileges on

compliance with the exchange’s own

financial responsibility rules. Section

15A(g)(3)(A) of the Act134 grants the

same authority to national securities

association. Pursuant to this authority,

the SROs are authorized to promulgate

rules governing the financial

responsibility requirements of their

members. The Commission finds that

the NYSE proposal is consistent with

goals of section 15a(g)(3)(A) of the Act

and the NASD proposal is consistent

with the goals of section 15A(g)(3)(A) of

the Act.

The Commission finds that the NYSE

and NASD proposals are designed to

protect Pattern Day Traders, the firms

where those traders have their accounts,

and the markets on which they trade.

The intra-day risk of substantial losses

to both the customer and the firm

increases in day trading accounts that

do not have sufficient equity capital.

Moreover, customers’ and firms’

reliance on cross-guarantees among

customer accounts to meet margin

requirements exacerbate these risks.

These potential losses can be magnified

if a sudden and substantial adverse

movement were to occur in the prices of

securities popular among day traders or

in the markets as a whole. In the

Commission’s view, the integrity of U.S.

financial markets will be better

protected through appropriate margin

and similar requirements on customers

who engage in day trading practices.

The proposed NYSE and NASD rules

are not designed to prevent day trading,

but to reduce the risk of financial losses

by Pattern Day Traders and their firms.

For example, by increasing the

minimum equity requirement for

Pattern Day Trades, the proposed rule

help ensure that day traders have an

appropriate amount of equity for the

potential losses that may be incurred

through day trading. Finally, the

Commission finds that overall market

integrity is increased by rules, such as

those here proposed by the NYSE and

NASD, that are designed to reduce

excessive and unnecessary risk of

financial loss to market participants.

The Commission finds that the

proposed definition of Pattern Day

Trader takes a reasonable approach to

specifying the type of trading activity

for which the use of margin should be

further regulated. In particular, the

definition focuses on day trading

behavior, while providing an exception

for accounts where the number of day

trades executed represents only a small

percentage of all trading activity. The

Commission finds that it is reasonable

for the NYSE and NASD to use objective

standards to identify and regulate

accounts that may be at greatest risk as

a result of day trading.

The Commission also finds that the

proposed Day Trading Minimum Equity

Requirements strikes a balance between,

and responds to, the diverging concerns

of the various commenters on this issue.

While there was a range of views

regarding the dollar amount of equity

that should be required in connection

with day trading, the Commission finds

that the proposed rule changes are

designed to accomplish the objective of

assuring the financial well-being of

broker-dealers, which in turn promotes

the integrity of the securities markets.

Regarding the imposition of Day

Trading Margin calls on Pattern Day

Traders, the Commission notes that the

proposed rules would impose relatively

larger margin calls for accounts that

have already generated but not yet

satisfied a Day Trading Margin call. In

those accounts, Day Trading Buying

Power would be limited to a 2:1 ratio for

leverage and Day Trading Margin would

be calculated based on the aggregate

cost of all day trades that occurred in a

single day. The Commission finds that

provisions would reduce Day Trading

Buying Power, and those that would

produce relatively larger Day Trading

Margin calls for accounts already under

restrictions, are in keeping with the

NYSE and NASD’s stated objectives of

reducing risk by encouraging Pattern

Day Traders to assume increased

financial responsibility for their trading

activities.135

The Commission also finds that the

proposed rule changes take reasonable

steps to require investors who day trade

to assume a greater obligation for the

intra-day financial risks associated with

Pattern Day Trading. The Commission

observes, for example, that the use of

Cross-Guarantees in the calculation of

Day Trading Margin calls could dilute

the impact of proposed provisions

designed to encourage greater

independent financial responsibility.

The Commission finds that this

approach is consistent with Regulation

T, which does not permit initial margin

requirements to be met through the use

of a guarantee for a customer’s

account.136

Finally, the Commission recognizes

the concerns of commenters regarding

the burden on securities firms of

implementing the proposed rules. The

Commission understands that practical

implementation of the proposed rules

may require systems changes by firms.

However, the Commission finds that, by

the NYSE and NASD delaying the

operative dates of the proposed rule

changes for six months, there should be

sufficient time for securities firms to

institute measures for monitoring and

enforcing the new rules and to bring any

interpretive issues to the attention of the

NYSE or NASD.

The Commission finds good cause for

approving Amendment No. 1 to the

NYSE proposal and Amendment No. 1

to the NASD proposal prior to the

13618 Federal Register / Vol. 66, No. 44 / Tuesday, March 6, 2001 / Notices

137 15 U.S.C. 78s(b)(2).

138 In approving the proposals, the Commission

has considered their impact on efficiency,

competition, and capital formation.

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See January 5, 2001 letter from Cindy L. Sink,

Senior Attorney, Regulatory Policy, PCX to Nancy

Sanow, Assistant Director, Division of Market

Regulation (‘‘Division’’), SEC and attachments

(‘‘Amendment No. 1’’). In response to a request

from the Division, the PCX converted the proposal

from effective upon filing pursuant to section

19(b)(3)(A) of the Act, to being considered pursuant

to Section 19(b)(2) in Amendment No. 1. 15 U.S.C.

78s(b)(3)(A). 15 U.S.C. 78s(b)(2).

4Securities Exchange Act Release No. 43846

(January 16, 2001), 66 FR 7526.

5The Commission notes that when the PCX

imposes a sanction in excess of $2,500, it must

comply with Rule 19d–1 under the Act. 17 CFR

240.19d–1.

6 In approving this rule, the Commission has

considered its impact on efficiency, competition,

and capital formation. 15 U.S.C. 78c(f).

7 15 U.S.C. 78f(b).

8 15 U.S.C. 78f(b)(5).

thirtieth day after the date of

publication of notice of filing thereof in

the Federal Register. Amendment No. 1

to the NYSE proposal ensures that the

NYSE and NASD approaches to the

regulation of day trading margin rules

are consistent so that they can be

applied and interpreted uniformly.

Amendment No. 1 to the NASD’s rule

proposal also ensures that the NASD’s

and NYSE’s approaches to the

regulation of day trading are consistent

and provides for additional time for

firms to implement its proposed rule

change. For these reasons, the

Commission finds good cause for

accelerating approval of both

amendments.

V. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning the Amendment

No. 1 to each proposed rule change,

including whether they are consistent

with the Act. Persons making written

submissions should file six copies

thereof with the Secretary, Securities

and Exchange Commission, 450 Fifth

Street, NW., Washington, DC 20549–

0609. Copies of the submission, all

subsequent amendments, all written

statements with respect to the proposed

rule change that are filed with the

Commission, and all written

communications relating to the

proposed rule changes between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Section. Copies of Amendment No. 1 to

the NYSE proposed rule change will

also be available for inspection and

copying at the principal office of the

NYSE. Copies of Amendment No. 1 to

NASD proposed rule change will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to File Nos.

SR–NYSE–99–47 or SR–NASD–00–03

and should be submitted by March 27,

2001.

VI. Conclusion

It is Therefore Ordered, pursuant to

section 19(b)(2) of the Act,137 that the

proposals SR–NYSE–99–47 and SR–

NASD–00–03 as amended, be and

hereby are approved.138

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–5402 Filed 3–5–01; 8:45 am]

BILLING CODE 6717–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–44010; File No. SR–PCX–

00–37]

Self-Regulatory Organizations; the

Pacific Exchange, Inc.; Order Granting

Approval to Proposed Rule Change to

Increase Fines for Violations of

Exchange Rules Under the Exchange’s

Minor Rule Plan

February 27, 2001.

I. Introduction

On December 11, 2000, the Pacific

Exchange, Inc. (‘‘PCX’’ or ‘‘Exchange’’)

filed with the Securities and Exchange

Commission (‘‘Commission’’ or ‘‘SEC’’),

pursuant to section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’) 1 and Rule 19b–4 thereunder,2 a

proposed rule change to increase fines

for members, floor brokers and market

makers for violating Exchange rules

under the Minor Rule Plan. The

Exchange amended the proposal on

January 8, 2001.3 The proposed rule

change was published for comment in

the Federal Register on January 23,

2001.4 The Commission received no

comments on the proposal. This order

approves the proposed rule change, as

amended.

II. Description of the Proposal

The Exchange proposes to amend PCX

Rule 10.13(k) governing Minor Rule

Plan violations to increase most of the

fines. The PCX believes the current

average Minor Rule Plan fine of $250 is

too low to deter violations of PCX rules.

The Exchange believes that an increase

in fines will more adequately sanction

violations of the PCX’s order handling

and investigating rules, many of which

are processed under the Minor Rule

Plan.

Most PCX Minor Rule Plan violations

currently specify a fine of $250 for a

first violation, $500 for a second, and

$750 for a third. Multiple violations are

calculated on a two-year basis. Under

the proposed increases, most fines will

be $1,000 for a first violation, $2,500 for

a second and $3,500 for a third,5

calculated on the same two-year basis.

Some violations, such as disruptive

conduct or abusive language on the

options floor, will be $500 for a first

violation, $2,000 for a second, and

$3,500 for a third.

Other violations, such as a member’s

failure to cooperate with a PCX

examination of its financial

responsibility or operational condition,

will be fined $2,000 for a first violation,

$4,000 for a second, and $5,000 for a

third. A member that impedes or fails to

cooperate in an Exchange investigation

will be fined $3,500 for a first violation,

$4,000 for a second, and $5,000 for a

third. Less serious violations, such as

fines for improper dress under the PCX

dress code, remain unchanged at $100

for the first violation, $200 for the

second, and $500 for the third.

Under the proposal, the Enforcement

Department would continue to exercise

its discretion under PCX Rule 10.13(f)

and take cases out of the Minor Rule

Plan to pursue them as formal

disciplinary matters if the facts or

circumstances warrant such action.

III. Discussion

The Commission has reviewed

carefully the PCX’s proposed rule

change and finds, for the reasons set

forth below, that the proposal is

consistent with the requirements of the

Act and the rules and regulations

thereunder applicable to a national

securities exchange,6 and with the

requirements of section 6(b).7 In

particular, the Commission finds the

proposal is consistent with section

6(b)(5) 8 of the Act in that it is designed

to prevent fraudulent and manipulative

acts and practices, to promote just and

equitable principles of trade, to remove

impediments to and perfect the

mechanism of a free and open market

and a national market system, and, in

general, to protect investors and the