NASD Regulation Announces Eight Day-Trading Enforcement Actions
Nancy A. Condon
Washington, D.C.—NASD Regulation, Inc. today announced the filing of eight new enforcement actions in the day-trading area. These formal disciplinary actions are the direct result of NASD Regulation’s focused examinations of day-trading firms conducted over the course of the past year.
These eight cases include allegations and, in some settled cases, findings of violations in the following areas:
- Misuse of customer funds and securities;
- Improper lending and margin practices;
- Exaggerated and misleading advertising;
- Violations of National Association of Securities Dealers, Inc. (NASD®) short sale rules;
- Improperly registered persons;
- Improper use of the Small Order Execution SystemSM (SOESSM); and
- Supervisory inadequacies.
Barry R. Goldsmith, Executive Vice President of NASD Regulation for Enforcement, stated, "While we do not intend to discourage day trading by individuals who understand and knowingly assume the risks, it is a highly risky form of trading that requires new regulatory initiatives and close attention by securities regulators. The eight enforcement cases that we announce today are examples of our strong commitment to compliance by member firms and their personnel in the day-trading area," Goldsmith said. Mr. Goldsmith will testify before the Senate Committee on Governmental Affairs’ Permanent Subcommittee on Investigations’ hearings on day trading, tomorrow, February 25, 2000.
Misuse of Funds
Two of the cases announced today involve allegations of misuse of funds, including one in which the owner of a day-trading management company solicited more than $150,000 from outside investors, falsely representing that these moneys would be used for "risk-free" loans to day-trading customers of the firm. In addition, the investors were promised returns of at least 15 percent per year or 20 percent of the profits earned by the day traders to whom the money was lent. Instead, the funds were loaned to customers with no controls or restrictions, were improperly used for branch operating expenses, and were eventually lost.
Improper Lending/Margin Practices
In two other cases, NASD Regulation found violations of its rules in connection with margin calls, including one in which a firm’s principal allowed a customer to effect 120 transactions after the customer’s account was coded "no more business" by the clearing firm for failing to meet a margin call. In another case, the firm’s registered representative established a separate entity account, which then loaned funds to firm customers to meet Regulation T margin calls.
Violations of Advertising Rules
Four of the day-trading actions announced today include allegations or findings of violations of the NASD’s advertising rules, including instances in which firms placed exaggerated and potentially misleading advertising on the Internet, as well as in local print and radio media. These firms typically exaggerated the ability of customers to access markets immediately, without disclosing the risks inherent in day-trading strategies, including market volatility. One advertisement told prospective day traders that they could "control [their]r own destiny through electronic day trading" without any corresponding disclosure of the risks.
Violations of Short Sale Rules
Violations of the NASD’s short sale rules were found in three cases, including failures to make affirmative determinations that securities could be delivered prior to the execution of each customer short sale transaction. In one case, a firm impermissibly allowed its day-trading customers to review daily postings of securities available to be borrowed and to make their own affirmative determinations of whether the securities could be borrowed prior to executing short sale transactions.
Inadequate Supervision/Improper Registration
NASD Regulation, in its formal complaints alleged and, in certain settled cases, made findings that firms failed to ensure that individuals actively engaged in their day-trading operations were properly registered, including one case in which the individual running the firm’s day-trading business was not registered as a principal. In other cases, employees of the firm were acting as equity traders without having completed the NASD’s Series 55 registration requirements. In one case, the firm allowed individuals to input trades for customers for periods of several weeks, without registering them in any capacity with the firm.
Certain of the actions taken today involve serious supervisory deficiencies, including one case in which a firm engaged in day-trading activities without having any written procedures in place to address that area of the firm’s business.
The sanctions in the group of settled actions announced today include censures, suspensions and individual fines, and fines against firms ranging from $13,000 to $37,500.
These actions were investigated and filed by NASD Regulation District Offices in New Orleans, Dallas, and Chicago.
To address the risks presented by day-trading, NASD Regulation also has undertaken several rulemaking initiatives. These include newly proposed rules in the areas of risk disclosure, appropriateness determinations, and margin requirements for day traders. In particular, NASD Regulation has proposed new rules to require that firms that promote day trading to individuals fully disclose the risks involved as well as assess whether such a strategy is "appropriate" for the individual. NASD Regulation is also working closely with the New York Stock Exchange to amend margin requirements applicable to day traders to promote further the safety and soundness of member firms that use credit to finance day-trading activities.
The issuance of a disciplinary complaint represents the initiation of a formal proceeding by NASD Regulation in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint. Because the complaints are unadjudicated, the respondents should be contacted before drawing any conclusion regarding the allegations in the complaints.
Under NASD rules, the individuals and the firms named in the complaints can file a response and request a hearing before an NASD Regulation disciplinary panel. Possible sanctions include a fine, suspension, bar, or expulsion from the NASD.
Investors can obtain the disciplinary record of any NASD-registered broker or brokerage firm by calling (800) 289-9999.
NASD Regulation oversees all U.S. stockbrokers and brokerage firms. NASD Regulation, and The Nasdaq Stock Market, Inc., are subsidiaries of the NASD, the largest securities-industry self-regulatory organization in the United States.
Day trading enforcement actions include:
1. 1 800DAYTRADE.COM, Inc., Richardson, Texas – Case No. C06000006
1-800DAYTRADE.COM, Inc. settled the following charges without admitting or denying NASD Regulation allegations. The findings include:
- using radio and newspaper advertisements that reflect exaggerated and unwarranted statements and failing to file advertisements with the NASD;
- failing to register traders;
- executing short sale on a "downtick" violations;
- failing to maintain accurate books and records; and
- failing to maintain adequate supervisory procedures.
The firm was censured and fined $25,000, which includes unlawful profits of $7,500.
2. Donnelly & Co., Inc., Midland, Texas – Case No. C06000004
Donnelly & Co., Inc., along with its President, George Arthur Donnelly, III, settled the following charges without admitting or denying NASD Regulation allegations. The findings include:
- executing proprietary trades through Small Order Execution System ("SOES") in violation of the SOES rules;
- distributing a press release and promotional materials reflecting exaggerated and unwarranted statements in violation of the advertising rules;
- failing to adhere to continuing education - firm element - requirements; and
- failing to maintain adequate supervisory procedures.
Both the firm and Donnelly were censured and fined. The firm was fined $17,500, of which the firm and George Donnelly are jointly responsible for $15,000.
3. Self Trading Securities, Inc., Austin, Texas – Case No. C06000005
Self Trading Securities, Inc., along with John A. Pearson, are named as respondents in this complaint. The complaint sets forth allegations of:
- registration violations (use of licensed, but unregistered order input personnel);
- advertising violations (use of an Internet Web site to reflect exaggerated and unwarranted statements);
- continuing education -- firm element; and
- inadequate supervisory procedures.
4. LaSalle St. Securities, L.L.C., Chicago, Illinois – Case No. C8A000015
LaSalle St. Securities, L.L.C. settled the following charges without admitting or denying NASD Regulation allegations. The findings include:
- failing to designate a branch as an Office of Supervisory Jurisdiction;
- publishing newspaper advertisements which contained exaggerated and unwarranted statements;
- failure to evidence principal approval of new day-trading accounts; and
- trade reporting violations.
The firm was censured and fined $13,000.
5. Heath A. Butler, et al., New Orleans, Louisiana – Case No. C05000006
Heath A. Butler and Don A. Rouzan are named in this complaint, which alleges:
- misuse of funds and fraud in the sale of securities consisting of investment contracts by which investors financed day-traders -- to date, less than 10 percent of investors’ money has been repaid having been lost by day traders or consumed by branch office expenses and
- conducting private securities transactions in connection with the sale of these same securities.
6. Addison Securities, Inc., et al., Dallas, Texas – Case No. C050000
Addison Securities, Inc., along with Abel Garcia, Jr., without admitting or denying NASD Regulation allegations, settled the following charges. The findings include:
- the firm, acting through Garcia, lent funds to public customers through an entity owned in part by Garcia, for the purpose of meeting Regulation T margin calls;
- Garcia exercised discretion in a customer account without written authorization; failed to mark trades in the account as discretionary; and signed the customer’s name to documents, including letters of authorization, with oral, but not written authorization;
- the firm allowed Garcia to actively engage in the management of the firm’s day-trading operations without requiring him to be registered as a principal;
- short sale rule violations, including exercising short sale transactions on a "downtick"; failing to make affirmative determination that stocks sold shorts could be delivered or borrowed; and failing to appropriately mark transactions as short sale; and
- deficiencies in its written supervisory procedures, specifically with respect to its day-trading operations, which were in draft form only, despite the fact that the firm conducted this business for sixteen months.
- The firm is censured and fined $37,500, portions of which are joint and several against Garcia; Garcia is fined an additional $5000 and suspended for three weeks.
7. James Han, Case No. C05000005
The allegations in this complaint against James Han, formerly with Landmark Securities Corporation, include the following:
- unauthorized transfer of customer funds to Han’s account;
- unauthorized transfer of customers’ securities to Han’s account; and
- failure to respond to staff requests for information.
8. Choice Investments, Inc., Austin, Texas – Case No. C050000
Choice Investments, Inc., along with a firm principal, Mark Wright, settled the following charges without admitting or denying NASD Regulation allegations. The findings include:
- Wright allowed a customer to continue trading after the account had been coded "no more business by the clearing firm; specifically, Wright transferred the customer’s transactions into an account that he controlled, and then, after three weeks, transferred positions back into the customer’s account after it had been cleared to trade again;
- the firm permitted an individual to execute equity security trades without the proper registration;
- the firm executed short sale transactions without having made an affirmative determination that the stock could be borrowed; and
- the firm’s supervisory procedures were deficient and the firm relied on customers to make their own affirmative determinations that stock could be borrowed, prior to entering into short sale transactions.
The firm is censured and fined $27,000. The firm and Wright are jointly responsible for $12,500 of that amount. Wright is also suspended for three weeks in all capacities.