Securities Operations: Update on Actions Taken to Address Day Trading Concerns
Published: 2001-11-27T00:00:00

Fast Facts:

Highlights:
section_title: What GAO Found
paragraphs: Concerns arose in the late 1990s about day trading, particularly the use of questionable advertising to attract customers without fully disclosing or by downplaying the risks involved. Concerns were also raised that traders were losing large amounts of money. Day traders as a group and day trading firms have continued to evolve and are generally more experienced and sophisticated about securities markets and investing than was the case several years ago. Likewise, day trading firms' operations have evolved, and many have shifted their primary focus away from retail customers and toward attracting institutional customers, such as hedge funds and money market managers. Furthermore, more firms are likely to engage in proprietary trading activities through professional traders that trade the firms' own capital. Finally, although the number of day trading firms appears to have remained constant, several day trading firms have been acquired by other brokerages and market participants whose customers want the direct access to securities markets and market information that technology used by day trading firms provides. Since GAO's 2000 review, the Securities and Exchange Commission and the self-regulatory organizations have addressed many of the concerns raised about day trading. In addition to the ongoing changes in the industry and regulatory action, day trading firms have responded to changing market conditions and regulatory scrutiny by changing their behavior. The most noticeable changes appear in their advertising and website information, which now generally highlight the risks associated with day trading and the fact that day trading is not for everyone.

section_title: Letter
paragraphs: In 1999, day trading began to receive intense scrutiny from state and  federal regulators and the Congress because of concerns that it posed  significant investor protection and market integrity issues.  In particular  there was concern that broker-dealers promoting day trading as a strategy  (day trading firms) sometimes used questionable advertising to attract  customers without fully disclosing or by downplaying the risks involved.   Many were also concerned that traders were losing large amounts of  money by using a day trading strategy.
This letter responds to your February 5, 2001, request that we review the  status of issues addressed in our 2000 report, Securities Operations: Day  Trading Requires Continued Oversight and concerns raised by the  Permanent Subcommittee on Investigations (Permanent Subcommittee),  Senate Committee on Governmental Affairs in its report, Day Trading:  Case Studies and Conclusions (July 27, 2000).  Our objectives were to (1)  determine how day traders as a group and day trading firms’ operations  have changed since 1999, (2) identify the actions regulators have taken to  address our report recommendations and the Permanent Subcommittee’s  concerns about day trading, and (3) identify any actions day trading firms  have taken in response to concerns raised about day trading.
To fulfill our objectives, we interviewed officials from six of the seven firms  we interviewed for our 2000 report, one additional firm, and state and  federal regulators to learn how day trading has changed since 1999.  We  also collected information on actions regulators have taken to address  concerns previously raised about day trading.  Specifically, we reviewed  examination reports completed by the Securities and Exchange  Commission (SEC) and NASD Regulation, Inc. (NASDR), the regulatory  arm of the National Association of Securities Dealers (NASD), from late  1999 to August 2001.  We also reviewed various new and amended rules  pertaining to day trading.  Finally, we reviewed the Web sites of more than  200 firms identified by SEC, NASD, or GAO as providing day trading  services to determine what types of information are available there.
subsections: section_title: Background
paragraphs: The term “day trading” has various definitions.  In 1999, day trading was  commonly described as a trading strategy that involved making multiple  purchases and sales of the same securities throughout the day in an  attempt to profit from short-term price movements.  Since that time, the  definition has evolved.  For example, NASDR and NYSE use two definitions  of day trading in the recent amendments to their margin rules.  First, NYSE  Rule 431(f)(8)(B)(I) and NASDR Rule 2520(f)(8)(b) generally define day  trading as “the purchasing and selling or the selling and purchasing of the same security in the same day in a margin account.”   Second, both NYSE  and NASD define a “pattern” day trader as a customer who executes four or  more day trades within 5 business days, unless the number of day trades  does not exceed 6 percent of their total trading activity for that period.   Additionally, NASDR’s rule on approval procedures for day trading  accounts defines a day trading strategy as “an overall trading strategy  characterized by the regular transmission by a customer of intra-day orders  to affect both purchase and sale transactions in the same security or  securities.”  In this report, we define day trading as consistently both  buying and selling the same securities intraday via direct access technology  to take advantage of short-term price movements.
Day trading firms use sophisticated order routing and execution systems  technology that allows traders to monitor and access the market on a real- time basis.  This technology allows traders direct access to stock markets  through Nasdaq Level II screens that display real-time best bid (buy) and  ask (sell) quotes for any Nasdaq or over-the-counter security, including  quotes between market makers trading for their own inventories.  Day  traders also conduct transactions through electronic communications  networks (ECNs), which allow customers’ orders to be displayed to other  customers and allow customers’ orders to be paired.  As a result of this  technology, day traders have the tools to trade from their own accounts  without an intermediary such as a stock broker and can employ techniques  that were previously available only to market makers and professional  traders.
Both rules define day trading as the purchasing and the selling or the selling and purchasing  of the same security on the same day in a margin account.  There are two exceptions to this  definition: first, a long security position held overnight and sold the next day prior to any  new purchase of the same security; and second, a short security position held overnight and  purchased the next day prior to any new sale of the same security.
Day trading firms register with SEC and become members of one of the  SROs, such as NASD or the Philadelphia Stock Exchange; they are  therefore subject to regulation by SEC and an SRO. As registered broker- dealers, day trading firms are required to comply with all pertinent federal  securities laws and SRO rules.  SROs generally examine every broker- dealer anywhere from annually to up to every four years, depending on the  type of firm.  Day trading firms are also subject to the securities laws and  oversight of the states in which they are registered.
In 1999, state and federal regulators began to identify concerns about  certain day trading firms’ activities.  In 1999, state regulators examined and  initiated disciplinary action against several day trading firms and identified  several areas of concern.  SEC completed an examination sweep of 47 day  trading firms in 1999 and subsequently issued a report. According to  SEC’s report, the examinations did not reveal widespread fraud, but  examiners found indications of serious violations of securities laws related  to net capital, margin, and customer lending.  However, most of the  examinations revealed less serious violations and concluded that many  firms needed to take steps to improve their compliance with net capital,  short sale, and supervision rules. NASDR also initiated a series of focused  examinations of day-trading firms that focused on the firms’ advertising  and risk disclosures, among other areas.  SEC and NASDR also initiated  several enforcement actions against day trading firms and individuals in  early 2000.
In our 2000 report, we found that day trading among less-experienced  traders was an evolving segment of the securities industry.  Day traders  represented less than one-tenth of 1 percent, or about 1 out of 1,000, of all  individuals who bought or sold securities.  However, day trading was  estimated by some to account for about 15 percent of Nasdaq’s trading  volume.  Although no firm estimates exist for the number of active day  traders, many regulatory and industry officials we spoke with generally  thought 5,000 was a reasonable estimate and believed the number was  stable or had gone down slightly.  However, the number of open accounts at  day trading firms is likely much higher.
We also noted in our 2000 report that before 1997, day traders submitted  most of their orders through the Small Order Execution System (SOES).   We concluded that the effects of day trading in an environment that  depends less on SOES and more on ECNs are uncertain.  Because of these  findings and our work in this area, we recommended that after decimal  trading is implemented, SEC should evaluate the implications of day  traders’ growing use of ECNs on the integrity of the markets.  We also  recommended that SEC do an additional cycle of targeted examinations of  day trading firms to ensure that the firms take the necessary corrective  actions proposed in response to previous examination findings.
Concerns about day trading culminated in hearings before the Permanent  Subcommittee on February 24 and 25, 2000, and the ultimate issuance of a  report by the Permanent Subcommittee in July 2000.  The Permanent  Subcommittee expressed its concerns about certain industry practices at  the hearing and made several recommendations in its subsequent report. In  general, the recommendations suggested changes to NASDR’s disclosure  rules and margin rule amendments and summarized comments Permanent  Subcommittee Members had submitted to SEC when those rules were  published for comment in the Federal Register.  In addition, the Permanent  Subcommittee recommended that NASDR prohibit firms from arranging  loans between customers to meet margin requirements and that firms be  required to develop policies to ensure that individual day traders acting as  investment advisors are properly registered.
section_title: Day Trading Firms Have Continued to Evolve
paragraphs: Since 1999, day traders as a group and firms that offer day trading  capability have continued to evolve.  Most regulators and industry officials  we spoke with said that day traders are generally more experienced and  that fewer customers are quitting their jobs to become day traders.  We also  found that many day trading firms now market to institutional customers,  such as hedge funds and money market managers, rather than focusing on  retail customers.  In addition, more day trading firms are likely to engage in  proprietary trading through professional traders who trade the firms’  capital rather than their own and earn a percent of the profits.  Finally, we  found that traditional and on-line brokers and other entities that want to  offer their customers direct access to securities markets are acquiring day  trading firms.
A concern raised in 1999 was that day trading firms were marketing to  inexperienced traders who did not fully understand the risks of day trading  and therefore lost substantial amounts of money.  Some industry and  regulatory officials said the combination of intense regulatory scrutiny and  adverse market conditions in late 2000 and into 2001 have driven many  unsophisticated traders out of day trading.  Traders currently engaged in  day trading are more likely to be experienced and to have a greater  knowledge of the risks involved than traders in 1999.  Industry officials said  that many traders gained their experience by day trading for several years,  while others were professional traders who became day traders.
During our first review, regulatory and government officials were  particularly concerned that day trading firms were attracting customers  who were ill-suited for day trading because they lacked either the capital or  the knowledge to engage in such a risky activity.  Since 1999, day trading  firms have begun to focus on institutional as well as retail customers,  including hedge funds and small investment management companies.   According to press reports, All-Tech Direct, Inc., a day trading firm,  announced in August 2001 that it planned to get out of the retail business  completely and was severing its relationship with all of its retail branches.   Overall, institutional investors are increasingly interested in the kind of  high-speed order execution that day traders get from direct access systems  and the relatively low fees day traders pay to execute trades.
In addition, some day trading firms that focused solely on retail customers  in 1999 have since hired professional traders who trade the firms’ capital  (proprietary traders).  For some, this move reflects a departure from their  retail customer focus.  A few officials said many of their retail customers  started as proprietary traders and learned to trade by using the firm’s  capital rather than their own.
Another change involves the growth in the number of day trading firms  being acquired by other brokerages and in market participants that want  the direct access technology.  For example, since 1999 on-line brokers  Charles Schwab and Ameritrade have purchased CyberCorp. (former  CyberTrader) and Tradecast, respectively.  Likewise, in August 2001 T.D.  Waterhouse Group Inc. announced plans to purchase one of the smaller  day trading firms, R.J. Thompson Holdings.  In addition, Instinet, an ECN,  purchased ProTrader as a way to offer direct access technology to its  customers.  Moreover, financial conglomerates are also moving toward  offering fully integrated services, which include all aspects of a securities  purchase, from direct access to securities markets to clearing capabilities.   In September 2000, Goldman Sachs announced its planned acquisition of  Spear Leeds & Kellogg, which offers such fully integrated services.  Other  firms with fully integrated capabilities include on-line brokerages such as  Ameritrade and Datek, as well as an ECN, Instinet.
Some regulatory and industry officials said that they expect traditional and  discount brokerages to continue to acquire day trading firms, as these  brokerages face increased pressure to provide direct market access to their  more active traders (estimated at between 50,000 and 75,000).  Some  analysts also said that the growing trend toward direct access has been  driven not only by competitive pressure but also by SEC’s new disclosure  rules on order handling and trade execution, which require ECNs, market  makers, and specialists to report execution data on order sizes, speed, and  unfilled orders.  In addition, by the end of November 2001 brokers are  required to disclose the identity of the market centers to which they route a  significant percentage of their orders and the nature of the broker’s  relationships with these market centers, including any payment for order  flow.  By offering customers direct access to markets, the customer rather  than the broker determines where trades are executed.
section_title: Regulators Have Taken Actions to Address Some Concerns About Day Trading Firms
paragraphs: Since our 2000 review, SEC and the SROs have taken various actions  involving day trading activities.  Specifically, NASDR has adopted rules that  require firms to provide customers with a risk disclosure statement and to  approve the customer’s account for day trading.  In addition, NASDR and  NYSE have amended their margin rules for day traders to impose more  restrictive requirements for pattern day traders.  NASDR’s margin rule  amendments became effective on September 28, 2001, and NYSE’s became  effective on August 27, 2001.  SEC and the SROs have also continued to  monitor and examine day trading firms and their activities to ensure  compliance with securities laws.  Finally, SEC and NASDR have settled  several pending enforcement cases involving day trading securities firms  and their principals.
subsections: section_title: SROs Have Finalized Disclosure Rules That Promote Improved Risk Disclosure
paragraphs: In 2000 and 2001, the SROs adopted day trading rules related to improved  risk disclosure and stricter margin requirements. On July 10, 2000, SEC  approved NASDR Rule 2360, Approval Procedures for Day-Trading  Accounts, which requires firms that promote a day trading strategy to  either 1) approve the customer’s account for a day trading strategy or 2)  obtain from the customer a written agreement that the customer does not  intend to use the account for day trading purposes.  SEC also approved  NASDR Rule 2361, Day-Trading Risk Disclosure Statement, which requires  firms that promote a day trading strategy to furnish a risk-disclosure  statement that discusses the unique risks of day trading to customers prior  to opening an account.  The new rules became effective on October 16,  2000.
NASDR Rule 2361 provides a disclosure statement that, among other  things, warns investors that day trading can be risky and is generally not  appropriate for someone with limited resources, little investment or  trading experience, or tolerance for risk (see table 1).  The statement  further maintains that evidence suggests that an investment of less than  $50,000 significantly affects the ability of a day trader to make a profit.
The disclosure statement contained in NASDR Rule 2361 incorporated  many of the recommendations the Permanent Subcommittee Members  made in a comment letter to SEC and subsequently summarized in its July  27, 2000, report.  The italicized text in table 1 generally represents the  Permanent Subcommittee’s recommended changes that NASDR adopted.   Although many of the Permanent Subcommittee’s recommendations were  incorporated into the final disclosure statement, NASDR did not adopt all  of them.  For example, NASDR did not directly adopt the Permanent  Subcommittee’s recommendations that firms presume that customers who  open accounts with less than $50,000 are generally inappropriate for day  trading or that firms be required to prepare and maintain records setting  forth the reasons why customers with less than $50,000 are considered  appropriate for day trading.  Instead, NASDR incorporated the Permanent  Committee’s concern about the significance of the $50,000 threshold into  the disclosure statement.  NASDR decided not to directly incorporate these  recommendations for several reasons.  First, it believed that a $50,000  threshold might make sense for some investors but could be too high or too  low for others.  Second, NASDR was concerned that such a requirement  could encourage investors to inflate the value of their assets.  Lastly,  NASDR’s rule (as proposed) already required a firm to document the basis  on which it approved an account for day trading.
section_title: NASDR and NYSE Amended Their Margin Requirements to Include More Restrictive Requirements for Day Traders
paragraphs: In February 2001, SEC approved substantially similar amendments to  NASDR and NYSE rules proposing more restrictive margin requirements  for day traders. Prior to the adoption of the NASDR and NYSE  amendments, margin requirements were calculated on the basis of a  customer’s open positions at the end of the trading day.  A day trader often  has no open positions at the end of the day on which a margin calculation  can be based.  However, the day trader and the firm are at financial risk  throughout the day if credit is extended.  To address that risk, the NASDR  and NYSE rule amendments require “pattern day traders” to demonstrate  that they have the ability to meet a special maintenance margin  requirement for at least their largest open position during the day.   Customers who meet the definition of pattern day trader under the rules  must generally deposit 25 percent of the largest open position into their  accounts.
Both rule amendments require customers who meet the definition of a  pattern day trader to have minimum equity of $25,000 in their accounts.   Funds deposited into these accounts to meet the minimum equity  requirement must remain there for a minimum of 2 business days following  the close of business on the day a deposit was required.
In addition, the rule amendments permit day trading buying power of up to  four times excess margin and impose a day trading margin call on  customers who exceed their day trading buying power.  In addition, until  the margin call is met, day trading accounts are restricted to day trading  buying power of two times excess margin, calculated on the basis of the  cost of all day trades made during the day.  If the margin call is not met by  the 5th business business day, day traders are limited to trading on a cash- available basis for 90 days or until the call is met.  Funds deposited in an  account to meet a day trading margin call must also remain in the account  for 2 business days.  The rule amendments also prohibit cross-guarantees  to meet day trading minimum equity requirements or day trading margin  calls.
These more stringent margin requirements respond to concerns raised  about the risks day trading can pose to traders, firms, and securities  markets in general.  The amendments as finalized do not fully incorporate  the Permanent Subcommittee’s recommendation that the minimum equity  requirement be raised from $2,000 to $50,000.  Instead, SEC approved a  $25,000 minimum.  NASDR believes that a $25,000 minimum equity  requirement will provide “protection against continued losses in day  trading accounts, while refraining from excessive restrictions on day  traders with limited capital.”  Moreover, both NASDR and NYSE said that  broker-dealers have the option of increasing the minimum requirement  based on their own policies and procedures.
The Permanent Subcommittee also recommended that the margin ratio not  be increased to four times excess equity from its previous level of two  times.  NASDR and NYSE disagreed with this proposed change, because  allowing day traders to trade at a 4:1 ratio brings day trading accounts into  parity with ordinary NASDR and NYSE maintenance margin account  requirements, which are 25 percent, or 4:1.  Moreover, officials said the  change was appropriate when considered in conjunction with the other  changes to the margin rules, such as the increased minimum equity  requirement, the immediate consequences imposed if day trading buying  power is exceeded, and the 2-day holding period for funds used to meet day  trading margin requirements.
The Permanent Subcommittee also recommended that NASDR propose a  rule prohibiting firms from arranging loans between customers to meet  margin calls.  NASDR is continuing to review this issue but has not  proposed rules that directly address firms’ involvement in arranging such  loans.  However, industry officials believe that the new margin rules  indirectly address this issue because the amendments will make such  lending arrangements less attractive to lenders.  For example, as  mentioned previously, funds deposited to meet a margin call must be left in  a trader’s account for two full business days following the close of business  on any day when a deposit is required, substantially increasing the risks to  the lender.  Previously, funds could be held in an account overnight to meet  the margin call requirement.
section_title: SEC and the SROs Continue to Find Violations at Day Trading Firms
paragraphs: Consistent with our 2000 report recommendation, SEC has continued to  examine the activities of day trading firms.  Specifically, since SEC’s initial  sweep of 47 day trading firms from October 1998 to September 1999 and  subsequent report, SEC, NASDR, and Philadelphia Stock Exchange staff  have conducted examinations of all the 133 day trading firms that were  identified in 2000.  In addition, SEC and the SROs have done follow-up  examinations to determine whether the previous violations have been corrected.   Moreover, NASDR officials said they prepared a special  examination module for these follow-up examinations that focused on  identified problem areas.  According to SEC, in 2001 and 2002, SRO staff  will continue to conduct routine examinations of existing day trading firms  and of newly registered firms to determine compliance with applicable  rules.  For example, NASDR officials said that they are no longer  prioritizing day trading firms for review; instead, these firms are now  examined during the routine broker-dealer examination cycle or when they  first register.  As of August 2001, NASDR had completed about 62 such  examinations.  In addition, SEC said that it would continue to initiate cause  examinations when appropriate.  From late 1999 to early 2001, almost half  of the day trading firm examinations completed by SEC were cause  examinations.
According to SEC and NASDR officials, day trading firms’ overall  compliance with rules has improved since the 1999 sweep.  Officials said  that while the examinations revealed violations of margin rules, short sale  rule violations, misleading advertisements, and net capital deficiencies,  these types of violations were occurring less frequently.  SEC also  identified violations of SRO and SEC rules related to supervision,  maintenance of books and records, and the net capital calculation.  SEC  and NASDR officials said that net capital and supervision violations are not  uncommon among broker-dealers in general.
We reviewed 42 SEC and 62 NASDR examination reports completed  between the end of the 1999 sweep and August 2001 that looked at broker- dealers and their branches offering day trading as a strategy.  Overall,  written supervisory procedure failures were the most frequent violation, followed by net capital rule miscalculations.  Table 2 shows the number of  examinations that included violations in each area.  However, many of the  violations cited in the examination reports were violations that are often  cited at all types of broker-dealers and were not directly related to the  firm’s day trading activity, which in some cases was a small part of the  firm’s overall operation.  Common supervisory procedure violations  involved failure to have adequate written procedures that reflect the types  of business in which the firm engages.  For example, some broker-dealers  had added day trading to their offered services but had not changed their  written supervisory procedures to address this new activity.  Other firms  were cited for failure to follow their internal supervisory procedures.  Many  of the net capital rule violations involved calculation and reporting errors.
Compared with the written supervisory procedure and net capital rule  violations, fewer examinations had short sale, advertising, and margin  and customer-lending rule violations.  The short sale rule violations  included failing to properly indicate trades as “short” (sale) or “long”  (purchase), effecting short sales below the price at which the last sale was  reported or on a zero-minus tick, and improperly marking short orders as  long without first making an affirmative determination that the securities  were in the trader’s account or ready to be delivered prior to settlement.   Although examiners continued to find some advertising violations  involving omissions of fact and misstatements, many of the violations  involved failure to properly maintain advertising files and other  documentation requirements.  For example, firms were cited for failure to  document advertising approvals and make required submissions to  NASDR.  The customer lending and margin violations involved failure to  secure additional funds to cover margin calls and allowing traders to trade  when the Regulation T margin requirement had not been met.  Numerous  other deficiencies were also cited, including failure to inform customers  who access SelectNet that NASD monitors trading activity and that the  customers can be subject to prosecution for violations of securities laws,  improper registration issues such as failure to properly register branches,  and improper registration of traders.
Of the SEC examinations reviewed, 34 resulted in deficiency or violation  letters, 3 indicated that no violations had been found, and 7 resulted in a  referral to an SRO or to SEC’s Division of Enforcement.  Of the NASDR  examinations we reviewed, 39 resulted in a letter of caution, 5 resulted in  a compliance conference, 12 were filed without action, and at least 2  resulted in formal complaints or referrals to SEC or NASDR Enforcement.
section_title: SEC and NASD Have Settled Disciplinary Actions Against Day Trading Firms and Principals
paragraphs: Since the enforcement actions announced in February 2000, NASDR and  SEC have settled several disciplinary actions against day trading firms and  their principals, including fines, civil money penalties, censures, and the  expulsion of one firm from the business.  SEC brought several enforcement  actions related to day trading in June 2001.  First, SEC instituted and settled  proceedings against JPR Capital Corporation and several of the firm’s  current and former executives.  SEC found that the firm had violated  federal margin lending rules, among other things.  All of the respondents to  the proceedings consented to SEC’s order without admitting or denying the  allegations, agreed to pay civil money penalties, and consented to other  relief.  The firm was censured and ordered to pay a civil penalty of $55,000  to “cease and desist” from committing or causing any violations of  specified laws and rules and to comply with initiatives designed to improve  its own compliance department.  Second, SEC settled its previously  instituted proceeding against All-Tech Direct, Inc. and certain of its  employees for extending loans to customers in excess of limits allowed  under federal margin rules.  SEC censured All-Tech Direct and ordered the  firm to cease and desist from committing or causing any violations of the  federal margin lending rules, to pay a $225,000 civil penalty, and to retain an  independent consultant selected by SEC to review and recommend  improvements to All-Tech Direct’s margin lending practices.
As shown in table 3, NASDR also announced enforcement actions in June  2001 against six firms and several individuals that addressed violations of  federal securities laws and NASDR rule violations in the following areas:  advertising, registration, improper loans to customers, improper sharing of  commissions, short sale rules, trade reporting, and deficient supervisory  procedures. Without admitting or denying the allegations, the firms and  individuals agreed to the sanctions, which included censures, the expulsion  of one firm, suspensions, and fines against the firms and individuals  ranging from $5,000 to $250,000.
According to NASDR officials, these settlements resulted from violations  that occurred in prior years.  While any violation is a serious issue,  regulatory officials said that many of these issues have been addressed and  that compliance among day trading firms is generally improving.  For  example, NASDR officials said that they are seeing far fewer misleading  advertisements than in 1999.
In August 2001, All-Tech Direct also lost an arbitration proceeding involving  allegations of misleading advertising.  Four traders filed arbitration  proceedings against All-Tech Direct for losses incurred in their day trading  accounts.  Although firm officials said that the traders lost money when  they held open positions overnight—a practice day trading firms usually do  not recommend—the arbitration panel ruled in favor of the plaintiffs and  awarded them a total of over $456,000.  All-Tech Direct officials said they  plan to appeal the ruling.  As mentioned previously, All-Tech Direct has  announced plans to sever its relationship with all of its retail branches.  In  October 2001, All-Tech Direct filed the necessary paperwork to withdraw  its registration as a broker-dealer.
section_title: Day Trading Firms Have Also Taken Steps to Address Concerns About Day Trading
paragraphs: In addition to the ongoing changes in day trading and in regulatory  oversight of the activity, many day trading firms have responded to  changing market conditions and regulatory scrutiny.  According to some  industry and regulatory officials, day trading firms are generally viewed as  more knowledgeable and sophisticated in terms of regulatory compliance  and management than they were in 1999.  We found that most Web sites of  day trading firms prominently highlighted the risks associated with day  trading or provided easy-to-access risk disclosures or disclaimers.  In  addition, the sites focused on the speed of trade executions and lower fees  rather than on profits.  We interviewed officials from seven day trading  firms and found that many of these firms no longer actively advertise for  retail customers, relying instead on personal referrals.  However, other day  trading firms continue to advertise, and many allow customers to open an  account online via their Web site.
Day trading firms have adjusted the way they operate in response to  changing market conditions and regulatory scrutiny.  Firm management is  generally viewed as more seasoned and sophisticated than it was in 1999.   Industry officials said that in general most firms have matured and provide  more vigorous oversight than in the past.  In addition to the downturn in  the securities markets, particularly in the technology sector, day traders  and the firms in which they trade have had to adjust to certain market  changes.  The first of these was decimalization, which resulted in smaller  spreads between bid and ask prices.  Some industry officials said that the  change has made it more difficult for day traders to make profits.  As a  result, these officials said that they have advised their traders to trade less  frequently and in smaller lot sizes.  The second change, the movement to SuperSoes and ultimately SuperMontage, is also expected to result in  changes to how day traders operate.  However, SuperMontage is not  expected to be fully implemented until 2002.  Given these ongoing changes  in markets, SEC has not evaluated the growing use of ECNs by day traders  on the integrity of the markets.
Regulators and industry officials also said that firms now have more  sophisticated monitoring systems, an area of concern identified by  regulators in 1999.  The firms we visited all had systems that allowed them  to monitor the activity of each of their traders (retail and proprietary).  In  addition, many had set preestablished loss limits for traders.  For example,  one firm halted trading for customers who lost 30 percent of their equity in  a single day.  Further, some had systems that allowed them to prevent short  sale violations by keeping traders from shorting ineligible stocks. These  firms also had compliance departments that were responsible for  monitoring the activities of the traders, and some provided regular reports  to traders that detailed each trader’s daily activity and positions.
Consistent with the findings of SEC and the SROs, we found that the Web  sites of firms identified as offering day trading services provided  prominent, easy-to-find risk disclosures or disclaimers about day trading.   Specifically, 122 of 133 or about 92 percent of the Web sites we were able to  access between July and November 2000 had risk disclosures or  disclaimers.  Many of the firms (and branches) used the NASDR risk  disclosure statement or some similar variation.  In addition, some provided  links to SEC and NASDR Web sites for additional information about the  risks of day trading.  Rather than claims of easy profitability, many of the  sites now focus on trade execution speed and low fees and commissions.   Of the 125 firms accepting customers, some 57 firms and their branches  allowed customers to file applications online, while 67 required that account applications be faxed or mailed.  Some 40 offered training  opportunities or links to other providers, and 20 had employment  opportunities for traders.
section_title: Conclusions
paragraphs: Since 1999, day trading has continued to evolve.  In general, today’s day  traders appear to be more experienced and knowledgeable about securities  markets than many day traders in the late 1990s.  Likewise, many day  trading firms have begun to focus on institutional traders as well as retail  customers, and more firms are likely to engage in proprietary trading.   Finally, other market participants are seeking the direct access technology  offered by day trading firms in order to be able to offer fully integrated  services.
Regulators have taken various actions in response to concerns raised about  day trading.  Implementation of disclosure rules and amendments to  margin rules have directly or indirectly addressed many of the concerns  raised by the Permanent Subcommittee.  Moreover, SEC and the SROs have  continued to scrutinize the activities of day trading firms since our 2000  report.  We recommended that SEC conduct another sweep of day trading  firms, given their growing portion of Nasdaq trading volume and the fact  that day trading is an evolving part of the industry.  SEC addressed this  recommendation through follow-up examinations of the firms included in  the previous day trading sweep and ongoing examinations of day trading  firms.  The SROs have performed and plan to continue to perform routine  examinations of broker-dealers offering day trading as a strategy.   Moreover, SEC plans to continue to conduct cause examinations as needed  to maintain a certain degree of scrutiny of these firms’ activities.  Given the  recent move to decimals and ongoing changes in the securities markets,  SEC has not yet formally evaluated day trading’s effect on markets but  officials generally believe that many of the initial problems surrounding  these firms have been addressed.
Finally, the firms themselves have adjusted their behavior in response to  market changes and regulatory scrutiny.  The most noticeable changes  appear in their advertising and Web site information, which in many cases  now generally highlight the risks associated with day trading and the fact  that day trading is not for everyone.  Changes in market conditions appear  to have driven many unsophisticated traders out of day trading, and  increased disclosure about risks and continued regulatory oversight should  help deter such traders from being lured into day trading by prospects of  easy profits when market conditions improve.
section_title: Agency Comments and Our Evaluation
paragraphs: We requested comments on a draft of this report from the Chairman, SEC,  and the President, NASDR.  The Director, Office of Compliance Inspections  and Examinations, SEC, and the President, NASDR, responded in writing  and agreed with the report’s findings and conclusions. We also received  technical comments and suggestions from SEC and NASDR that have been  incorporated where appropriate.
section_title: Scope and Methodology
paragraphs: To determine how day traders and day trading firms’ operations have  changed since 1999, we collected data from day trading firms, SEC,  NASDR, and other relevant parties.  To determine what types of changes  have occurred in day trading, we reviewed available research on the  subject and interviewed state and federal regulators, as well as several  knowledgeable industry officials from seven of the larger day trading firms  (including six of the seven we had interviewed previously).  We compared  these responses with the information we obtained in our 2000 report.   Specifically, we obtained insights from regulatory and industry officials on  overall changes in day trading and in the number of day traders.  We  discussed changes in the markets, such as decimalization, and how the  move to decimals has impacted day traders.  We also discussed common  trends among day traders and day trading firms.  In addition, we collected  information on changes specific to individual firm operations.  Finally, we  also discussed the concerns raised and recommendations made by the  Permanent Subcommittee and GAO in the respective 2000 reports.
To identify the actions regulators have taken to address the Permanent  Subcommittee’s concerns about day trading and our report  recommendations, we met with officials from SEC and NASDR to discuss  their actions involving day trading oversight.  We also reviewed 104  examination reports that had been completed since 1999.  We determined  the frequency of the violations and the actions taken by SEC and NASDR in  response to those violations.  We spoke with a state regulatory official from  Massachusetts and an official of the North American Securities  Administrators Association about day trading and state regulatory  oversight activities.  Finally, we reviewed newly implemented or amended  rules affecting day trading to determine whether they addressed the  Permanent Subcommittee’s recommendations.
To identify any actions taken by day trading firms in response to concerns  raised about day trading, we interviewed officials from six of the seven day  trading firms we identified in our 2000 report and from one additional firm  about the initiatives the firms were taking pertaining to issues raised by the  regulators and Congress.  These issues included advertising, risk  disclosure, margin issues, and determinations of appropriateness.  We also  discussed how the firms’ operations had changed over the previous 2 years.   In addition, we reviewed the Web sites of over 200 firms that we identified  as day trading firms (some were actually branches of other firms).  We  reviewed the sites and obtained information on the account opening  process, training offers, proprietary trading opportunities, and risk  disclosures, among other things.
We conducted our work in Jersey City and Montvale, NJ; New York, NY;  Austin and Houston, TX; and Washington, D.C., between April and  November 2001 in accordance with generally accepted government  auditing standards.
As agreed with your offices, unless you publicly release its contents earlier,  we plan no further distribution of this report until 30 days from its issuance  date.  At that time, we will send copies of this report to the Chairman and  Ranking Minority Member of the Senate Committee on Banking, Housing  and Urban Affairs; the Chairmen and Ranking Minority Members of the  Senate Committee on Governmental Affairs and Permanent Subcommittee  on Investigations; Chairmen of the House Committee on Financial Services  and its Subcommittee on Capital Markets, Insurance and Government  Sponsored Enterprises; Chairmen of the House Energy and Commerce  Committee and its Subcommittees on Commerce, Trade and Consumer  Protection and on Telecommunications and the Internet; and other  congressional committees.  We will also send copies to the Chairman of  SEC, the Presidents of NASDR and NYSE.  Copies will also be made  available to others upon request.
If you or your staff have any questions regarding this report, please contact  Orice M. Williams or me at (202) 512-8678.  Key contributors to this report  were Toayoa Aldridge, Robert F. Pollard, and Sindy Udell.
section_title: Comments From the Securities and Exchange Commission
section_title: Comments From the NASD Regulation, Inc.
subsections: section_title: GAO’s Mission
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section_title: Public Affairs