[Federal Register Volume 65, Number 42 (Thursday, March 2, 2000)]
[Notices]
[Pages 11353-11359]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-4979]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42452; File No. SR-NASD-99-41]


Self-Regulatory Organizations; Notice of Filing of Amendment No. 
1 to the Proposed Rule Change by the National Association of Securities 
Dealers, Inc. Relating to the Opening of Day-Trading Accounts

February 23, 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 February 18, 2000, the National Association of Securities Dealers, 
Inc. (``NASD''), through its wholly-owned subsidiary, NASD Regulation, 
Inc. (``NASD Regulation''), filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') Amendment No. 1 to the proposed 
rule change, File No. SR-NASD-99-41, as described in Items I, II, and 
III below, which Items have been prepared by NASD Regulation. The NASD 
submitted the proposed rule change to the Commission on August 20, 
1999, which was published in the Federal Register on September 21, 1999 
(``Original Notice'').\3\ The Commission is publishing this notice to 
solicit comments on Amendment No. 1 to 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.
    \3\Securities Exchange Act Release No. 41432 (September 14, 
1999), 64 FR 51165.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    As described in the Original Notice, NASD Regulation is proposing 
to amend the 2300 Series of the Rules of the NASD to include new Rule 
2360 and Rule 2361 regarding the opening of day-trading accounts. Below 
is the text of the proposed rule change, as amended. Proposed new 
language from Amendment No. 1 is in italics. Proposed deletions from 
the language proposed in the Original Notice is in [brackets].
Rule 2360. Approval Procedures for Day-Trading Accounts
    (a) No member that is promoting a day-trading strategy, directly or 
indirectly, shall open an account for or on behalf of a non-
institutional customer, unless, prior to opening the account, the 
member has furnished to the customer the risk disclosure statement set 
forth in Rule 2361 and has:

[[Page 11354]]

    (1) Approved the customer's account for a day-trading strategy in 
accordance with the procedures set forth in paragraph (b) and prepared 
a record setting forth the basis on which the member has approved the 
customer's account; or
    (2) Received from the customer a written agreement that the 
customer does not intend to use the account for the purpose of engaging 
in a day-trading strategy, except that the member may not rely on such 
agreement if the member knows that the customer intends to use the 
account for the purpose of engaging in a day-trading strategy.
    (b) In order to approve a customer's account for a day-trading 
strategy, a member shall have reasonable grounds for believing that the 
day-trading strategy is appropriate for the customer. In making this 
determination, the member shall exercise reasonable diligence to 
ascertain the essential facts relative to the customer, including [his 
or her financial situation, tax status, prior investment and trading 
experience, and investment objectives.]:
    (1) Investment objectives:
    (2) Investment and trading experience and knowledge (e.g., number 
of years, size, frequency and type of transactions);
    (3) Financial situation, including: estimated annual income from 
all sources, estimated net worth (exclusive of family residence), and 
estimated liquid net worth (cash, securities, other);
    (4) Tax status;
    (5) Employment status (name of employer, self-employed or retired);
    (6) Marital status; number of dependents; and;
    (7) age.
    (c) If a member that is promoting a day-trading strategy opens an 
account for a non-institutional customer in reliance on a written 
agreement from the customer pursuant to paragraph (a)(2) and, following 
the opening of the account, knows that the customer is using the 
account for a day-trading strategy, then the member shall be required 
to approve the customer's account for a day-trading strategy in 
accordance with paragraph (a)(1) as soon as practicable, but in no 
event later than 10 days following the date that such member knows that 
the customer is using the account for such a strategy.
    (d) Any record or written statement prepared or obtained by a 
member pursuant to this rule shall be preserved in accordance with Rule 
3110(a).
    (e) For purposes of this rule, the term ``day-trading strategy'' 
means 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.
    (f) For purposes of this rule, the term ``non-institutional 
customer'' means a customer that does not qualify as an ``institutional 
account'' under Rule 3110(c)(4).
    (g) A firm will not be deemed to be ``promoting a day-trading 
strategy'' for purposes of this Rule solely by its engaging in the 
following activities:
    (1) Promoting efficient execution services or lower execution costs 
based on multiple trades;
    (2) Providing general investment research or advertising the high 
quality or prompt availability of such general research; and
    (3) Having a Web site that provides general financial information 
or news or that allows the multiple entry of intra-day purchases and 
sales of the same securities.

Rule 2361. Day-Trading Risk Disclosure Statement

    (a) Except as provided in paragraph (b), no member that is 
promoting a day-trading strategy, directly or indirectly, shall open an 
account for or on behalf of a non-institutional customer unless, prior 
to opening the account, the member has furnished to [the] each 
customer, individually, in writing or electronically, the following 
disclosure statement:
    You should consider the following points before engaging in a day-
trading strategy. For purposes of this notice, a ``day-trading 
strategy'' means [a] 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.
     Day trading can be extremely risky. Day trading generally 
is not appropriate for someone of limited resources and limited 
investment or trading experience and low risk tolerance. You should be 
prepared to lose all of the funds that you use for day trading. In 
particular, you should not fund day-trading activities with retirement 
savings, student loans, second mortgages, emergency funds, funds set 
aside for purposes such as education or home ownership, or funds 
required to meet your living expenses.
     Be cautious of claims of large profits from day trading. 
You should be wary of advertisements or other statements that emphasize 
the potential for large profits in day trading. Day trading can also 
lead to large and immediate financial losses.
     Day trading requires knowledge of securities markets. Day 
trading requires in-depth knowledge of the securities markets and 
trading techniques and strategies. In attempting to profit through day 
trading, you must compete with professional, licensed traders employed 
by securities firms. You should have appropriate experience before 
engaging in day trading.
     Day trading requires knowledge of a firm's operations. 
[You should be familiar with a securities firm's business practices, 
including the operation of the firm's order execution systems and 
procedures] Under certain market conditions, you may find it difficult 
or impossible to liquidate a position quickly at a reasonable price. 
This can occur, for example, when the market for a stock suddenly 
drops, or if trading is halted due to recent news events or unusual 
trading activity. The more volatile a stock is, the greater the 
likelihood that problems may be encountered in executing a transaction. 
In addition to normal market risks, you may experience losses due to 
system failures.
     Day trading may result in your paying large commissions. 
Day trading may require you to trade your account aggressively, and you 
may pay commissions on each trade. The total daily commissions that you 
pay on your trades may add to your losses or significantly reduce your 
earnings.
     Day trading on margin or short selling may result in 
losses beyond your initial investment. When you day trade with funds 
borrowed from a firm or someone else, you can lose more than the funds 
you originally placed at risk. A decline in the value of the securities 
that are purchased may require you to provide additional funds to the 
firm to avoid the forced sale of those securities or other securities 
in your account. Short selling as part of your day-trading strategy 
also may lead to extraordinary losses, because you may have to purchase 
a stock at a very high price in order to cover a short position.
    (b) In lieu of providing the disclosure statement specified in 
paragraph (a), a member that is promoting a day-trading strategy may 
provide to the customer, individually, in writing or electronically, 
prior to opening the account, an alternative disclosure statement, 
provided that:
    (1) The alternative disclosure statement shall be substantially 
similar to the disclosure statement specified in paragraph (a); and
    (2) The alternative disclosure statement shall be filed with the 
Association's Advertising Department (Department) for review at least 
10 days prior to use (or such shorter period as the Department may 
allow in particular

[[Page 11355]]

circumstances) for approval and, if changes are recommended by the 
Association, shall be withheld from use until any changes specified by 
the Association have been made or, if expressly disapproved, until the 
alternative disclosure statement has been refiled for, and has 
received, Association approval. The member must provide with each 
filing the anticipated date of first use.
    (c) For purposes of this rule, the term ``day-trading strategy'' 
shall have the meaning provided in Rule 2360(e).
    (d) For purposes of this R[r]ule, the term ``non-institutional 
customer'' means a customer that does not qualify as an ``institutional 
account'' under Rule 3110(c)(4).

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

    In its Original Notice 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.\4\ 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.
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    \4\See supra note 3.
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A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
Background
    To address investor protection concerns arising from day-trading 
activities, NASD Regulation is proposing to amend the NASD rules to 
include new Rules 2360 and 2361. As described in the Original Notice 
and Amendment No. 1 herein, the proposed rule change would require a 
member firm that is promoting a day-trading strategy to furnish a risk 
disclosure statement to a non-institutional customer prior to opening 
an account for the customer and either to: (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. As part of the account approval process, the 
firm would be required to make a threshold determination that day 
trading is appropriate for the customer.
    In April 1999, NASD Regulation issued Special Notice to Members 99-
32 (``NTM 99-32'') to solicit comment on the proposed rules regarding 
approval procedures for day-trading accounts. In response to NTM 99-32, 
the Association received 39 comment letters. The majority of the 
letters generally supported NASD Regulation's efforts to address the 
investor protection concerns raised by individuals engaging in day-
trading activities. Commenters, however, raised varied suggestions on 
how best to regulate day-trading activities and presented disparate 
views on the scope of the activities that should be covered by the 
rules. The proposal discussed in NTM 99-32 differed in a number of 
respects from the proposal subsequently filed with the Commission as 
the Original Notice.\5\
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    \5\Id.
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    As indicated in the Original Notice, the Association modified the 
proposed day-trading rule outlined in NTM 99-32, in response to the 
comment letters. Many of these changes were significant, and included: 
limiting the application of the rule to those firms that are 
``promoting a day-trading strategy,'' as compared to ``recommending an 
intra-day-trading strategy''; applying the rule to all non-
institutional customers; requiring firms promoting a day-trading 
strategy to have reasonable grounds for believing that the strategy is 
appropriate for the customers and to exercise reasonable diligence to 
ascertain the essential facts relative to the customers; revising the 
definition of ``intra-day-trading strategy''; requiring firms promoting 
a day-trading strategy to deliver the risk disclosure statement to all 
non-institutional customers prior to opening an account for such 
customers; and revising the risk disclosure statement to include the 
additional key point that day trading generally is not appropriate for 
persons of limited resources and limited investment or trading 
experience and low risk tolerance.
    In September 1999, the Commission published the Association's 
modified proposal, the Original Notice, in the Federal Register.\6\ The 
Commission specifically solicited comments on: whether the proposal 
should cover existing day-trading accounts; whether the proposed 
definition of ``day-trading strategy'' is appropriate; whether the 
proposed risk disclosure statement is adequate; and whether the firms 
should be required to obtain a customer's acknowledgment of receipt of 
the risk disclosure document.
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    \6\Id.
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    The Commission received three comment letters in response to the 
Original Notice. The comment letters were from the Electronic Traders 
Association (``ETA''), the North American Securities Administrators 
Association, Inc. (``NASAA''); and the Federal Regulation Committee, 
the Discount Brokerage Committee and Ad-hoc Committee on Technology & 
Regulation of the Securities Industry Association (``SIA'').\7\ In 
addition to the specific questions for which the Commission solicited 
input, the commenters expressed their views on a variety of other 
issues. Many of the issues raised by the commenters in response to the 
Original Notice also were raised in the comments in response to NTM 99-
32. The comments sent to the Commission are summarized by issue below.
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    \7\See Letters from James H. Lee, President, Electronic Traders 
Association (``ETA''), to Jonathan G. Katz, Secretary, SEC, dated 
October 11, 1999; Bradley W. Skolnik, President, Indiana Securities 
Commissioner, North American Securities Administrators Association 
(``NASAA''), to Jonathan G. Katz, Secretary, SEC, dated October 12, 
1999; and Lee B. Spencer, Jr., Chairman, Federal Regulation 
Committee, Everett Lang, Co-Chairman, Discount Brokerage Committee, 
Michael L. Michael, Chairman, Ad-Hoc Committee on Technology and 
Regulation, and Michael Anderson, Co-Chairman, Discount Brokerage 
Committee, Securities Industry Association (``SIA''), to Margaret H. 
McFarland, Deputy Secretary, SEC, dated October 22, 1999. Each of 
these commenters represents a group of interested parties. ETA is a 
trade association of on-site day-trading firms. It has approximately 
15 supporting organizations, including six of the ten largest on-
site daytrading firms. NASAA is an international organization of 
securities regulators devoted to investor protection. Its membership 
consists of the securities administrators in the 50 states, the 
District of Columbia, Canada, Mexico and Puerto Rico. SIA brings 
together the shared interests of more than 740 securities firms. Its 
member firms are active in all U.S. and foreign markets and in all 
phases of corporate and public finance.
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    After considering this most recent set of comments, the Association 
has made additional changes to the subject proposed day-trading rules. 
The text of the proposed rule language provided herein reflects these 
changes, which include: modifying the disclosure statement; revising 
the prescribed method for delivering the disclosure statement; 
describing certain activities that will not trigger application of the 
proposed day-trading rules; and clarifying the information-gathering 
requirements. In addition to describing the proposed amendments, the 
discussion below clarifies some issues raised by the commenters.
Issues Raised in Comment Letters

Persons Covered by Proposed Rules

    As proposed in NTM 99-32, proposed Rules 2360 and 2361 would apply 
to new customers only. Several

[[Page 11356]]

commenters to NTM 99-32, including NASAA, responded that all existing 
customers should be covered by day-trading rules or, at a minimum, 
receive a risk disclosure statement. On the other hand, several firms 
argued that the proposal should apply only to new customers because it 
would be difficult to review all existing accounts to determine which 
accounts should be classified as day-trading accounts. In its rule 
filing, the Association revised the proposal so that the day-trading 
rules would apply to all new accounts. The proposed day-trading rules 
would not apply to an existing customer, unless the customer opens a 
new account at a firm that is promoting a day-trading strategy.
    In the Original Notice, the Commission solicited comment on whether 
the proposal should cover existing day-trading accounts. NASAA was the 
only commenter to respond to this question. NASAA continues to believe 
that the proposed rules should apply to both new and existing accounts. 
However, no new arguments were raised in support of this proposition in 
NASAA's letter. Accordingly, the Association continues to believe that 
it struck the appropriate balance in the rule filing.
    Further, in response to the rule filing, NASAA argues that a 
requirement to deliver a disclosure statement should apply to all 
parties whose funds are being handled by third parties. ETA, however, 
is concerned with how such a requirement would apply to entities such 
as hedge funds. The Association believes that as a practical matter, it 
would be difficult (or virtually impossible) for a firm routinely to 
inquire as to the identity of all parties involved in such 
arrangements. The Association will continue to examine for abuses 
involving third parties trading on behalf of others, and notes that 
such arrangements may raise investment adviser or broker-dealer 
registration issues.

Definition of Day-Trading Strategy

    Proposed Rule 2360, set forth in NTM 99-32, stated that an ``intra-
day-trading strategy'' is ``an overall trading strategy characterized 
by the regular transmission by a customer of multiple intra-day 
electronic orders to effect both purchase and sale transactions in the 
same security or securities.'' Several commenters to NTM 99-32 
suggested a broader definition, while others suggested limiting the 
scope of the definition. In its rule filing, NASD Regulation changed 
the proposed rule language to provide that a ``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.'' The rule 
filing explained that the Association believes that this definition 
includes those instances where an individual regularly transmits one or 
more purchase and sale transactions in a single day. The revised 
proposal also amended the definition of ``day-trading strategy'' to 
include orders transmitted by non-electronic means, such as by 
telephone.
    In the Original Notice, the Commission solicited comment on whether 
NASD Regulation's revised definition of ``day-trading strategy'' is 
appropriate. NASAA believes that this definition should be further 
revised to state that a day-trading strategy ``often involves the `use 
of margin borrowing and short-selling' and that trading accounts 
frequently are composed of `equities' only and contain no long-term 
time horizon investments.'' The Association, however, believes that the 
definition included in the rule filing would not benefit from the 
inclusion of this additional language.

Disclosure Statement

    Proposed Rule 2360, set forth in NTM 99-32, stated that the account 
approval procedures would require the member, prior to effecting an 
initial day-trading transaction, to provide the disclosure statement 
contained in proposed Rule 2361 to the customer.\8\ The disclosure 
statement lists several factors that a customer should consider before 
engaging in day trading, including that the customer should be prepared 
to lose all of the funds that he or she uses for day trading, and that 
day trading on margin may result in losses beyond the initial 
investment. In the rule filing, NASD Regulation revised the proposed 
disclosure statement to include the additional key point that day 
trading generally is not appropriate for persons of limited resources 
and limited investment or trading experience and low risk tolerance.
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    \8\The firm would be permitted to develop an alternative risk 
disclosure statement, provided that the alternative statement was 
substantially similar to the mandated statement and was filed with, 
and approved by, the Association's Advertising/Investment Companies 
Regulation Department.
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    In the Original Notice, the Commission requested comment on whether 
the proposed disclosure statement is adequate. NASAA responded by 
stating that certain structured arrangement entered into by 
participants of ``day-trading strategies'' may violate laws governing 
investment advisers. NASAA contends that the disclosure statement 
should state that persons trading for others may need to register as 
investment advisers.\9\ The purpose of the disclosure statement, 
however, is to highlight for customers the unique risks posed by their 
engaging in day trading. The Association believes that the issue of 
whether an individual trading for others is required to register as an 
adviser or a broker/dealer should not be addressed in this risk 
disclosure statement.
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    \9\Specifically, NASAA believes that the disclosure statement 
should ``include a warning that parties who trade the accounts of 
others, whether through trading authorizations, partnership 
agreements or otherwise, or who trade with funds furnished by 
others, whether through pooled fund arrangements or otherwise, and 
[sic] may be subject to the law and regulations governing investment 
advisers and may be required to register as investment advisers 
under state and federal law.''
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    ETA supports the concept of a risk disclosure statement. ETA, 
however, proposes alternative language in three sections of the 
disclosure statement. First, ETA proposes that the Association replace 
the following language:

    Day trading requires knowledge of a firm's operations. You 
should be familiar with a securities firm's business practices, 
including the operations of the firm's order execution systems and 
procedures.

    ETA proposes the following alternative language:

    Under certain market conditions, you may find it difficult or 
impossible to liquidate a position quickly at a reasonable price. 
This can occur, for example, when the market for a stock suddenly 
drops, or if trading is halted due to recent news events or unusual 
trading activity. The more volatile a stock is, the greater the 
likelihood that problems may be encountered in executing a 
transaction.
    In addition to normal market risk, you may experience losses due 
to system failures. The firm and its clearing broker rely upon 
sophisticated computer software and hardware to execute 
transactions, which are subject to failure due to a variety of 
factors. Among other events, you may experience losses due to: 
system crashes during both peak and low volume periods; the loss of 
orders on both SOES and SelectNet; and, delayed, conflicting and 
inaccurate confirmations on orders or cancellations which you 
initiate.

    In Amendment No. 1, the Association is modifying its proposed 
disclosure statement based on ETA's comment. NASD Regulation is 
replacing the language in question with the entire first paragraph and 
the first sentence of the second paragraph of ETA's recommended 
language. NASD Regulation believes that this language is an improvement 
over the language proposed by the NASD.\10\ NASD

[[Page 11357]]

Regulation, however, believes the remaining language in ETA's 
recommended second paragraph over emphasizes the fallibility of outside 
systems.
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    \10\The NASD is retaining the caption heading for this 
paragraph: ``Day trading requires knowledge of a firm's 
operations.''
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    ETA also proposes alternative language to two other sections of the 
proposed disclosure statement. ETA recommends changes to the section 
captioned: ``Day-trading may result in your paying large commissions.'' 
ETA suggests language which omits any direct reference to total daily 
commissions possibly adding to an individual's losses. The Association 
rejects this recommendation because it incorrectly assumes that there 
will be earnings. Finally, ETA proposes alternative language to the 
section of the proposed disclosure statement captioned: ``Day-trading 
can be extremely risky.'' In this section, ETA recommends the 
Association include a discussion on the difficulty in earning money 
during the first three to five months of day trading. The Association 
believes that this language may actually encourage people to continue 
day trading in hopes that results will improve with time and 
experience. There does not, however, appear to be any reliable 
statistical evidence that supports such an assertion.
    Finally, in Amendment No. 1, the Association is making a technical 
revision to the definition of ''day-trading strategy.'' The change is 
not the product of any of the comment letters. The definition of day 
trading in the proposed Rule 2361 disclosure statement is being changed 
to conform with the definition as it appears in the text of proposed 
Rule 2360.

Customer Acknowledgment

    The proposal, set forth in NTM 99-32, would not require customers 
to sign or otherwise acknowledge receipt of the disclosure statement. 
Commenters to NTM 99-32 expressed divergent views in response to this 
issue. Both ETA and NASAA expressed the view that it was appropriate to 
require a firm to retain a copy of the disclosure document with an 
acknowledgment of its receipt by the customer. Other commenters argued 
that the customer should not be required to sign or otherwise 
acknowledge receipt of the disclosure statement. For instance, E*TRADE 
argued that the customer's acknowledgment is unnecessary in this 
context because the statement is a disclosure of risks, and not an 
agreement between the firm and the customer. After considering the 
comments, NASD Regulation concluded that it is sufficient for firms to 
have written procedures in place for delivery of the document and to be 
able to identify those procedures to any examiners.
    In the Original Notice, the Commission solicited comments on 
whether firms should be required to obtain a customer's acknowledgment 
of receipt of the disclosure statement. Again, NASAA and ETA expressed 
the view that customers should be required to acknowledge in writing 
that they have read and understand the statement. Lastly, NASAA 
suggests that a principal of the firm sign the statement. In response 
to these comments, in Amendment No. 1, the Association is revising 
proposed Rule 2361 to require firms to deliver the disclosure statement 
to each customer individually, by mail or electronic means, prior to 
opening the account. This approach would protect against a firm posting 
the disclosure statement in a remote place on its Web site, and 
claiming that it was delivered to all customers in such manner. The 
Association is not proposing to require customers to sign the 
disclosure statements. The Association believes that any abuses of the 
delivery requirement could be detected during routine examinations.

Individual Solicitations

    As noted above, commenters raised several issues that the 
Commission did not specifically address in the ``Solicitation of 
Comments'' section of the rule filing published in the Original Notice. 
One of these issues is whether the proposed day-trading rule could be 
triggered only by firms' general promotional efforts, or whether 
individual solicitations could alone trigger application of the 
proposed rules. SIA believes that obligations under the proposed rules 
should not arise in situations where there are no general promotional 
efforts by firms. SIA argues that ``[i]ndividual solicitations are 
already covered by suitability and recordkeeping rules and a new rule 
would not add anything new to investor protection.'' This, however, is 
not necessarily true if firms are recommending strategies rather than 
specific securities. Further, SIA argues that ``[e]ven if individually 
targeted promotions [are] subject to the [proposed day-trading] rule, 
the rule does not address whether such a promotion would trigger the 
account opening requirements for all new customers of the firm.'' SIA 
believes that ``in the absence of general promotional efforts, an 
individual solicitation [should] not trigger obligations under the rule 
to any customers but those targeted by the promotion.'' It appears that 
SIA is concerned that the rule filing text could be read to mean that 
if one broker at a full-service firm targeted, for example, five 
customers for day trading without the firm's knowledge, then the firm 
itself would be deemed to be promoting day trading and would need to 
adhere to the rules for all accounts.
    The Association does not believe that such individual solicitations 
alone would trigger application of proposed Rules 2360 and 2361. 
Rather, these proposed rules would only be triggered by firms' general 
promotional efforts or by firm-sponsored promotional efforts. However, 
firms may not promote day trading through individuals in an effort to 
circumvent the rules. In addition, if a principal or officer of the 
firm is aware that brokers in the firm are soliciting customers for day 
trading, then the firm will be deemed to be promoting day trading.
    SIA also notes that the rule filing does not state how long the 
account review obligation continues after a firm stops promoting a day-
trading strategy. Firms, however, working with counsel, if necessary, 
can reasonably determine whether a sufficient amount of time has passed 
to remove a firm from coverage of the rules. Finally, SIA seeks 
``clarification that the rule[s are] not intended to apply to 
discretionary or managed accounts, in which brokers execute a variety 
of strategies that may or may not constitute day trading.'' As noted 
above, however, the proposed rules would apply only to those firms 
promoting a day-trading strategy through general or firm-sponsored 
promotional efforts.

Promoting Day Trading Strategy

    As noted above, proposed Rules 2360 and 2361 would apply only to 
firms ``promoting a day-trading strategy.'' Although the proposed rule 
language does not define the phrase ``promoting a day-trading 
strategy,'' the rule filing states that none of the following actions 
alone would trigger the requirements under the proposed rule change: 
(1) The promotion by a member of efficient execution services or lower 
execution costs based on multiple trades; (2) providing general 
investment research or advertising the high quality or prompt 
availability of such general research; or (3) having a Web site that 
provides general financial information or news or that allows the 
multiple entry of intra-day purchases and sales of the same securities. 
SIA believes that the day-trading rules should include a safe harbor 
that codifies the above activity that NASD Regulation does not deem to 
be ``promoting a day-trading strategy'' for purposes of the rules. SIA 
recommends including a new paragraph

[[Page 11358]]

(g) of Rule 2360 that would state that ``[f]or purposes of this rule, 
the term `promoting a day-trading strategy' shall not include [the type 
of activities listed in the rule filing (and above)].''\11\
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    \11\The actual list of activities in the recommended SIA rule 
language is a modified version of the language proposed in the 
Original Notice.
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    NASD Regulation believes that it would be helpful to describe 
actions in the text of the proposed rule language that the Association 
does not consider to be ``promoting a day trading strategy.'' In 
Amendment No. 1, NASD Regulation is modifying the proposed rule 
language to state that a member will not be deemed to be ``promoting a 
day-trading strategy'' for purposes of the rules solely by its engaging 
in the listed activities.

Other-Use Agreement

    As an alternative to approving an account for a day-trading 
strategy, proposed Rule 2361(a)(2) would permit a firm that is 
promoting a day-trading strategy to obtain a written agreement from a 
customer stating that the customer does not intend to use the account 
for day trading (``other-use agreement'').\12\ The firm would be 
required to provide a risk disclosure statement to the customer even if 
the firm obtains an other-use agreement. The firm would not be allowed 
to rely on the other-use agreement if the firm knows the customer 
intends to use the account for day trading. If the firm opens the 
account but later knows that the customer is day trading, the firm 
would then be required to approve the account for day trading.
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    \12\The other-use agreement was proposed in both NTM 99-32 and 
the rule filing.
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    SIA raises a number of concerns with this provision, including that 
it ``sets a dangerous precedent by encouraging customers to `disavow 
their written pledges with impunity' in order to engage in riskier 
forms of trading.'' SIA also fears that ``[e]very customer that loses 
money could claim that he [or she] conveyed an intention to day trade, 
but the firm ignored it.'' They also question how the provision would 
be interpreted when a firm obtains an other-use agreement from a 
customer, stops promoting a day-trading strategy, but later knows that 
the customer is day trading. On balance, the Association believes that 
the provision is workable and not overly burdensome. The standard is 
one of actual knowledge, and it seems unlikely that other-use 
agreements would be widely used at firms that promote day-trading 
strategies. If a firm stops promoting a day-trading strategy, but later 
discovers that a customer that provided an other-use agreement is in 
fact day-trading, the firm should approve that customer for a day-
trading strategy. If the firm determines that a day-trading strategy is 
not appropriate for the person, the firm should prohibit the customer 
from using the account for day-trading purposes or close the account 
and return all funds to the customer.

Appropriateness Determination

    ETA does not believe that the appropriateness determination for day 
trading is either useful or necessary. ETA disagrees with the concept 
that day trading is not appropriate for someone of limited resources 
and limited investment or trading experience. For example, ETA states 
that day trading does not require great resources (risk resources of 
$50,000 to $100,000 are sufficient), and that the proposed rules ignore 
the benefits provided by training on day-trading techniques. ETA also 
questions at what point NASD Regulation would consider day traders to 
be sophisticated given that these traders often make more than 2,000 
trading decisions in 30 market days.
    The Association does not find ETA's arguments persuasive. The rules 
are aimed at preventing firms that are actively promoting day-trading 
strategies from opening accounts for customers who may have limited 
resources and experience and low risk tolerance. A firm promoting day 
trading should be required to assess whether a strategy that may 
require a person to make thousands of trading decisions is appropriate 
for that individual. The Association recognizes that a person with 
$50,000 to $100,000 of risk capital may have sufficient resources to 
open a day-trading account. This factor should be considered as part of 
the total mix in making the appropriateness determination.

Options Model

    ETA argues that the NASD's options rules offer a good model for any 
proposed day-trading rule. ETA notes that, under the options rules, an 
individual receives a ``risk disclosure document, signs a new account 
form verifying the accuracy of the information [the customer has] 
provided regarding his [or her] finances and market experience, and 
then, based on this information, is initially allowed to trade the 
spectrum of available strategies.'' ETA states that ``[t]his sensibly 
is a one-time analysis, and under the Rule[,] suitability applies only 
to recommended transactions.'' The day-trading proposal, however, does 
incorporate many of the same principles contained in the options rules. 
The appropriateness determination is in fact a one-time analysis to be 
made by a firm prior to opening the day-trading account.
    Further, in Amendment No. 1, the Association is modifying proposed 
Rule 2360 to incorporate an additional principle from the options 
rules. The NASD options rules set forth obligations that members must 
fulfill before conducting certain forms of options trading. NASD 
Interpretive Material 2860-2 states that in fulfilling their 
obligations under the NASD rules with respect to options customers who 
are natural persons, members shall obtain the following information at 
a minimum: (1) Investment objectives; (2) employment status; (3) 
estimated annual income from all sources; (4) estimated net worth; (5) 
estimated liquid net worth; (6) marital status and number of 
dependents; (7) age; and (8) investment experience and knowledge. The 
Association is amending proposed Rule 2360 to incorporate a similar 
information-gathering requirement in the day-trading context.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change, as amended, 
is consistent with Section 15A(b)(6) of the Act\13\ in that the 
proposed rule change is 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 codifying the 
obligation of firms promoting day-trading strategies to disclose the 
risks of these strategies to non-institutional customers and to 
determine whether the strategy is appropriate for a customer will help 
to protect investors and the public interest in an increasingly more 
sophisticated trading environment.
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    \13\15 U.S.C. 78o-3(b)(6).
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(B) Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed rule change, as 
amended, will result in 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 proposed rule change was published for comment in NASD Special 
Notice to Members 99-32 (April 15, 1999). The comment period expired

[[Page 11359]]

on May 31, 1999. Thirty-nine comment letters were received in response 
to the Notice. Copies of the comment letters and a brief summary of the 
comment letters have been provided to the Commission. Of the 39 comment 
letters received, approximately 13 were in favor of the proposed rule 
change, 8 supported risk disclosure only, 12 were opposed to the 
proposed rule change, and 6 expressed no opinion or addressed broader 
issues. Further, on September 21, 1999, the Commission published the 
Association's modified proposal and solicited comments in the Federal 
Register on the Original Notice. This comment period expired on October 
12, 1999. The Commission received three comment letters in response to 
the Original Notice. Many of the issues raised by the commenters in 
response to the Original Notice, also were raised in the comments in 
response to NTM 99-32. After considering this most recent set of 
comments, the Association is proposing Amendment No. 1 to the rule 
filing, as outlined above.

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 self-regulatory organization consents, the Commission will:
    A. By order approve such 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, 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, N.W., Washington, 
D.C. 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 in 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-99-41 and should be submitted by March 23, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-4979 Filed 3-1-00; 8:45 am]
BILLING CODE 8010-01-M