[Federal Register Volume 65, Number 34 (Friday, February 18, 2000)]
[Notices]
[Pages 8461-8465]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-3873]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42418; File No. SR-NASD-00-03]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To Amend 
NASD Rule 2520 Relating to Margin Requirements for Day-Trading 
Customers

February 11, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder, \2\ notice is hereby given 
that on January 13, 1999, the National Association of Securities 
Dealers, Inc. (``NASD''), through its wholly-owned subsidiary, the 
National Association of Securities Dealers Regulation (``NASD 
Regulation''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II and III below, which Items have been prepared by the NASD. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation proposes to amend NASD Rule 2520 to impose overall 
more stringent margin requirements for day-trading customers. The text 
of the proposal is below. Deletions are in brackets, and additions are 
in italics.

NASD RULE 2520. Margin Requirements

    (a) Definitions No change.
    (b) Initial Margin
    For the purpose of effecting new securities transactions and 
commitments, the customer shall be required to deposit margin in cash 
and/

[[Page 8462]]

or securities in the account which shall be at least the greater of:
    (1) through (3) No change.
    (4) equity of at least $2,000 except that cash need not be 
deposited in excess of the cost of any security purchased (this equity 
and cost of purchase provision shall not apply to ``when distributed'' 
securities in a cash account). The minimum equity requirement for a 
``pattern day trader'' is $25,000 pursuant to paragraph (f)(8)(B)(iv)a. 
of this Rule.
    Withdrawals of cash or securities may be made from any account 
which has a debit balance, ``short'' position or commitments, provided 
it is in compliance with Regulation T of the Board of Governors of the 
Federal Reserve System and after such withdrawal the equity in the 
account is at least the greater of $2,000 ($25,000 in the case of a 
``pattern day trader'') or an amount sufficient to meet the maintenance 
margin requirements of this [paragraph] Rule.
    (c) through (f)(8)(A)(iii) No change.
    (f)(8)(B) Day[-]Trading
    (i) The term ``day[-]trading'' means the purchasing and selling or 
the selling and purchasing of the same security on the same day in a 
margin account except for:
    a. a long security position held overnight and sold the next day 
prior to any new purchase of the same security, or
    b. a short security position held overnight and purchased the next 
day prior to any new sale of the same security.
    (ii) [A ``day-trader'' is any customer whose trading shows a 
pattern of day-trading.] The term ``pattern day trader'' means any 
customer who executes four or more day trades within five business 
days. However, if the number of day trades is 6% or less of total 
trades for the five business day period, the customer will not be 
considered a pattern day trader and the special requirements under 
paragraph (f)(8)(B)(iv) of this Rule will not apply. In the event that 
the originization at which a customer seeks to open an account knows or 
has a reasonable basis to believe that the customer will engage in 
pattern day trading, then the special requirements under paragraph 
(f)(8)(B)(iv) of this Rule will apply. If a pattern day trader does not 
day trade for a 90 day period, the customer will no longer be 
considered a pattern day trader.
    (iii) The term ``day-trading buying power'' means the equity in a 
customer's account at the close of business of the previous day, less 
any maintenance margin requirement as prescribed in paragraph (c) of 
this Rule, multiplied by four for equity securities.
    Whenever day[-]trading occurs in a customer's margin account the 
special maintenance margin required for the day trades in equity 
securities [to be maintained] shall be [the margin on the ``long or 
short'' transaction, whichever occurred first, as required pursuant to 
the other provisions of this Rule. When day-trading occurs in the 
account of a ``day-trader'' the margin to be maintained shall be the 
margin on the ``long'' or ``short'' transaction, whichever occurred 
first, as required by Regulation T of the Board of Governors of the 
Federal Reserve System or as required pursuant to the other provisions 
of this Rule, whichever amount is greater.] 25% of the cost of all day 
trades made during the day. For non-equity securities, the special 
maintenance margin shall be as required pursuant to the other 
provisions of this Rule. Alternatively, when two or more day trades 
occur on the same day in the same customer's account, the margin 
required may be computed utilizing the highest (dollar amount) open 
position during that day. To utilize the highest open position 
computation method, a record showing the ``time and tick'' of each 
trade must be maintained to document the sequence in which each day 
trade was completed.
    (iv) Special Requirements for Pattern Day Traders
    a. Minimum Equity Requirement for Pattern Day Traders--The minimum 
equity required for the accounts of customers deemed to be pattern day 
traders shall be $25,000. This minimum equity must be deposited in the 
account before such customer may continue day trading and must be 
maintained in the customer's account at all times.
    b. Pattern day traders cannot trade in excess of their day-trading 
buying power as defined in paragraph (f)(8)(B)(iii) above. In the event 
a pattern day trader exceeds its day-trading buying power, which 
creates a special maintenance margin deficiency, the following actions 
will be taken by the member:
    1. The account will be margined based on the cost of all the day 
trades made during the day,
    2. The customer's day-trading buying power will be limited to the 
equity in the customer's account at the close of business of the 
previous day, less the maintenance margin required in paragraph (c) of 
this Rule, multiplied by two for equity securities, and
    3. ``Time and tick'' (i.e., calculating margin using each trade in 
the sequence that it is executed, using the highest open position 
during the day) may not be used.
    c. Pattern day traders who fail to meet their special maintenance 
margin calls as required within five business days from the date the 
margin deficiency occurs will be permitted to execute transactions only 
on a cash available basis for 90 days or until the special maintenance 
margin call is met.
    d. Pattern day traders are restricted from using the guaranteed 
account provision pursuant to paragraph (f)(4) of this Rule for meeting 
the requirements of paragraph (f)(8)(B).
    e. Funds deposited into a day trader's account to meet the minimum 
equity or maintenance margin requirements of paragraph (f)(8)(B) of 
this Rule cannot be withdrawn for a minimum of two business days 
following the close of business of the day of deposit.
    (C) When the equity in a customer's account, after giving 
consideration to the other provisions of this [paragraph (c)] Rule, is 
not sufficient to meet the requirements of [subparagraph (i) or (ii) 
hereof] paragraph (f)(8)(A) or (B), additional cash or securities must 
be received into the account to meet any deficiency within [seven] five 
business days of the trade date.
    In addition, on the sixth business day only, members are required 
to deduct from Net Capital the amount of unmet maintenance margin calls 
pursuant to SEC Rule 15c3-1.
    (f)(9) and (f)(10) No change.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD Regulation included 
statements concerning the purpose of and basis for the proposed rule 
change and discussed any comments it received on the proposed rule 
change. The text of these statements may be examined at the places 
specified in Item IV below. NASD Regulation has prepared summaries, set 
forth in Sections A, B, and C below, of the most significant aspects of 
such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Day-trading margin requirements have come under close scrutiny as 
day-trading activities have become more prevalent. Over the past few 
months, the

[[Page 8463]]

431 Committee \3\ has been meeting frequently to consider responses to 
various problems that it identified. The proposed rule change is based 
on the Committee's recommendations. The NASD believes that the proposal 
will more appropriately protect the safety and soundness of member 
firms and ensure the overall financial well-being of the securities 
markets.
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    \3\ After the Board of Governors of the Federal Reserve System 
extensively amended Regulation T, an informal ad hoc committee (the 
``431 Committee'') was formed to consider changes to the NYSE's and 
NASD's margin rules (NYSE Rule 431 and NASD Rule 2520, 
respectively). The 431 Committee also was formed to ensure that the 
NYSE's and NASD's margin rules were consistent in order to prevent 
confusion and to avoid conferring advantages on members that are 
required to comply with one rule and not the other. The 431 
Committee is composed of NYSE staff, attorneys from the NYSE's 
outside counsel, NASD staff, Federal Reserve staff, and 
representatives from several clearing firms and broker/dealers.
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    Because Regulation T initial margin requirements and NASD/NYSE 
standard maintenance margin requirements \4\ are calculated only at the 
end of each day, a day trader who has no positions, including losses, 
in his or her account at the end of the day would not incur a 
Regulation T initial margin or a standard maintenance margin 
requirement. However, current NASD/NYSE initial margin provisions 
generally require a customer to deposit margin of at least $2,000, 
except that cash need not be deposited in excess of the cost of any 
security purchased.
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    \4\ NASD Rule 2520 and NYSE Rule 431, the margin provisions for 
the NASD and the NYSE, respectively, are substantially similar.
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    Although a day trader may end the day with no position, the day 
trader and the firm, if credit is extended, are at risk during the day. 
To address this risk, the NASD and NYSE require day traders to 
demonstrate that they have the ability to meet the initial margin 
requirements for at least their largest open position during the day. 
Specifically, a customer who meets the definition of ``day trader'' 
under the rule must deposit in his or her account the margin that would 
have been required under Regulation T (i.e., the 50 percent initial 
margin requirement) if the customer had not liquidated the position 
during the trading day. If the customer day trades but is not 
considered a ``day trader,'' the customer is still required to post 25% 
of the largest open position during the day.
    Currently, if a customer's day trading results in a day-trading 
margin call, the customer has seven days to meet the call by depositing 
additional cash or securities. Because day traders typically end the 
day flat and this day-trading ``margin'' deposit is not securing a 
margin loan, the customer is not required to leave the margin deposit 
in the account and may withdraw the deposit the day after the deposit 
is made. Additionally, if a customer fails to meet a day-trading margin 
call, the firm is not required to take specific action against the 
customer's account. Because day traders typically end the day flat, 
there are no securities to liquidate, as there would be for an existing 
position.
    NASD Regulation believes that the proposed rule change would 
address the following deficiencies in the existing rules relating to 
day-trading margin activities.
    First, the proposed rule change would amend the definition of 
``pattern day trader'' to cover only true day traders. Day-trading 
margin requirements should be imposed only on true day traders, not 
just incidental or occasional day traders. NASD Regulation believes 
that the current definition is too broad because 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 
reaction to events. Accordingly, under the proposal day traders would 
be defined as those customers who day trade four or more times in five 
business days, unless their day-trading activities do not exceed 6% of 
their total trading activity for that period.
    Additionally, the proposal requires a firm that knows or has a 
reasonable basis to believe that the customer is a pattern day trader, 
to designate the customer as a pattern day trader immediately, instead 
of delaying such determination for five business days. 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. If a 
pattern day trader does not day trade for a 90-day period, he or she 
will no longer be considered a pattern day trader.
    Second, the proposed rule change would revise the minimum equity 
requirement. NASD Regulation believes that the current minimum equity 
requirement of $2,000 does not sufficiently prevent day traders from 
continuing to generate losses in their accounts, without any additional 
deposit of funds. Accordingly, the proposed rule change would require a 
day trader to have $25,000 of minimum equity in his or her account on 
any day in which the customer day trades. This minimum equity must 
remain in the account for at least two subsequent business days 
following the close of business on any day the deposit was required. 
NASD Regulation believes that a minimum requirement of $25,000 would 
more appropriately address the additional risks inherent in leveraged 
day-trading activities and would better ensure that customers cover any 
loss incurred in the account from the previous day prior to day 
trading.
    Third, the proposed rule change would permit day-trading buying 
power of up to four times the day trader's maintenance margin excess. 
NASD Regulation believes that current day-trading margin calls 
represent illusory liabilities because the funds used to meet a call 
are deposited after the day-trading risk has already been incurred and 
need only remain in the account overnight. Accordingly, the proposal 
would not permit day-trading buying power to exceed four times the day 
trader's maintenance margin excess. This calculation would be based on 
equity maintained in the account prior to each day's trading and, at 
the firm's option, could be based either on the largest open position 
at any time during the day or the customer's total trading commitment 
during the day. By limiting a customer's day-trading buying power to 
four times maintenance margin excess and requiring that amount to be in 
the account prior to day trading, NASD Regulation believes that the 
intra-day risks to firms caused by customer day trading would be more 
appropriately addressed.
    Fourth, the proposed rule change would impose a day-trading margin 
call if day-trading buying power was exceeded. Under the proposal, if a 
day-trading customer exceeded his or her day-trading buying power 
limitations, additional restrictions would be imposed on the day trader 
to protect the firm from the additional risk and help prevent the 
recurrence of such prohibited conduct. The proposal requires member 
firms to issue a day-trading margin call to day traders that exceed 
their day-trading buying power. Customers would have five business days 
to deposit funds to meet this day-trading margin call. Funds used to 
meet a day-trading margin call would be required to remain in the 
account for two business days. Until the call is met, the day-trading 
account would be restricted to day-trading buying power of two times 
the maintenance margin excess based on the customer's daily total 
trading commitment. If the day-trading margin call is not met by the 
fifth business day, the account would be further restricted to trading 
only on a cash available basis for 90 days or until the call is met.

[[Page 8464]]

    Fifth, the proposed rule change would prohibit cross-guaranteeing 
of day-trading accounts. The proposal would prohibit day traders from 
meeting the day-trading margin requirements through the use of cross-
guarantees. Each day-trading account would be required to meet the 
applicable requirements independently, using only the financial 
resources available in the account. Accordingly, day traders would be 
prohibited from using cross-guarantees to meet the minimum equity 
requirements or to meet day-trading margin calls.
    Finally, the proposal would revise the current requirement that the 
sale and repurchase on the same day of a position held from the 
previous day must be treated as a day trade. Under the proposed rule 
change, the sale of an existing position would be treated as a 
liquidation and a subsequent repurchase viewed as the establishment of 
a new position and therefore not subject to the rules affecting day 
trades. Similarly under the proposal, if a short position was carried 
overnight, the purchase to close the short position and subsequent new 
sale would not be considered a day trade.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\5\ 
which requires, among other things, that the NASD's rules must be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. NASD Regulation believes 
that the proposed rule change will more appropriately address the 
deficiencies in the existing day trading margin rules, promote the 
safety and soundness of member firms, and further investor protection.
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    \5\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation believes that the proposed rule change will not 
impose any burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received from Members, Participants or Others

    The NASD did not solicit written comments. However, the NASD 
received a petition to the NASD Board of Directors dated December 2, 
1999, from Steven H. Levine, Special Credit Counselor to the Electronic 
Traders Association (``ETA''). The petition requested that the NASD 
make certain modifications to its proposed rule change. In general, the 
petition supported the increase in the minimum equity requirement from 
$2,000 to $25,000 and the increase in day-trading buying power from two 
times to four times maintenance margin excess. It also supported the 
use of ''time and tick'' as part of the proposed rule and raised no 
objection to the five business day requirement for day traders to meet 
the day-trading margin call.
    The petition opposed the proposed definition of a pattern day 
trader and indicated that for almost 65 years, a general standard of 
three day trades in a twelve-month period resulting in a person being 
deemed a day trader has worked. It also noted that many of the NYSE's 
largest carrying clearing firms only allow one or two day trades as an 
indication of a day trading pattern.
    The petition disagreed with the proposed requirement that funds 
deposited to meet day-trading margin calls must remain in the account 
for two full business days. It noted that such a rule will increase the 
day trader's ability to further day trade with the deposited funds for 
additional days, will expose the lender to needless risk, and will 
needlessly penalize the customer for the use of funds, including the 
use of their own funds.
    In addition, the petition opposed the restriction on the use of 
cross guarantees to meet day-trading margin requirements on the basis 
that it constituted discrimination against the day trader margin 
investor and violates his or her constitutional right to trade and to 
enter into agreements with others.
    The NASD believes that the proposed rule change is appropriate to 
address the additional risks inherent in leveraged day-trading 
activities. The NASD also believes that the proposed rule change will 
provide greater financial stability to a day trader's account and will 
provide a more accurate indicator of the financial means and resources 
of each individual day-trading customer than is provided under current 
rules.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding, or (ii) as to 
which the NASD consents, the Commission will:
    A. by order approve the proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. In particular, commenters are 
invited to address the following issues: (1) Is the requirement that a 
firm ``knows or has a reasonable basis to believe'' that a customer 
will engage in pattern day trading too difficult to apply in practice? 
(2) Does the 6% minimum requirement within the definition of a 
``pattern day trader'' appropriately address trading by institutional 
accounts or would a different standard, including a possible blanket 
exemption for institutional accounts, be more appropriate? (3) Is the 
requirement that funds remain in the account for two business days 
appropriate? (4) Should a customer be provided an opportunity (e.g., 
one business day) to meet a day-trading margin call prior to imposing 
the two times maintenance margin excess requirement based on the 
customer's daily total trading commitment? (5) Would it be more 
appropriate to immediately require a day trader that exceeds his or her 
day-trading buying power to trade on a cash available basis only until 
the day-trading margin call is met? (6) Should customers be permitted 
to use cross-guarantees to meet day-trading margin requirements? Would 
it be more appropriate to limit the use of cross-guarantees up to a 
certain multiple of the assets in an account or based on the funds 
available in an account? (7) Is 90 days the appropriate period for a 
customer to no longer be considered a pattern day trader, if the 
customer does no day trading during that period? \6\
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    \6\ Cf., Securities Exchange Act Release No. 42343, 65 FR 4005 
(January 25, 2000) (SR-NYSE-99-47). A copy of this proposed rule 
change is also available on the Commission's web-site (www.sec.gov).
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    Persons making written submissions should file six copies thereof 
with the Secretary, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Washington, D.C. 20549-0609. Copies of the submissions, 
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

[[Page 8465]]

Commission and any persons, 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, 450 Fifth Street, N.W., Washington, D.C. 20549. 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. 
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SR-NASD-00-03 and should be submitted by March 10, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority. \7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-3873 Filed 2-17-00; 8:45 am]
BILLING CODE 8010-01-M