[Federal Register Volume 66, Number 44 (Tuesday, March 6, 2001)]
[Notices]
[Pages 13608-13618]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-5402]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44009; File Nos. SR-NYSE-99-47 and SR-NASD-00-03]


Self-Regulatory Organizations; New York Stock Exchange, Inc., and 
National Association of Securities Dealers, Inc.; Order Approving 
Proposed Rule Changes Relating to Margin Requirements for Day Trading; 
Notice of Filing and Order Granting Accelerated Approval of Amendments 
No. 1 to Each Proposed Rule Change

February 27, 2001.

I. Introduction

    On December 13, 1999, the New York Stock Exchange, Inc. (``NYSE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposal to amend NYSE Rule 431, Margin Requirements. The proposed rule 
change would establish margin requirements for day trading in customer 
accounts of the Exchange's member organizations. On January 25, 2000, 
the NYSE rule proposal was published for public comment in the Federal 
Register.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 42343 (January 14, 
2000), 65 FR 4005.
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    On January 13, 2000, the National Association of Securities 
Dealers, Inc. (``NASD''), through its wholly owned subsidiary, NASD 
Regulation, Inc., also filed a proposed rule change to establish day 
trading margin requirements by amending NASD Rule 2520, Margin 
Requirements. On February 18, 2000, the NASD proposal was published for 
comment in the Federal Register.\4\ Although the NYSE and NASD rule 
proposals were substantially similar, they diverged on certain 
issues.\5\ To reconcile the differences between, and provide for 
uniform application of, the two proposals, the NYSE and NASD each filed 
amendments to their respective proposals. The NYSE filed its amendment 
on September 8, 2000.\6\ The NASD filed its amendment on October 3, 
2000.\7\ The Commission received 49 letters regarding the NASD proposal 
and 214 letters regarding the NYSE proposal.\8\ The NYSE provided a 
response to comments on September 20, 2000.\9\ The NASD filed its 
response to comments on October 3, 2000.\10\ This order approves the 
NYSE and NASD rule change proposals, as amended.
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    \4\ Securities Exchange Act Release No. 42418 (February 11, 
2000), 65 FR 8461.
    \5\ The NYSE and NASD rule proposals were the result of 
deliberations by the 431 Committee, which convenes regularly on 
margin issues. The Committee is generally comprised of NYSE and NASD 
staff, attorneys from the NYSE's outside counsel, the Board of 
Governors of the Federal Reserve System, and representatives from 
several clearing firms and broker-dealers. See letter from Alden 
Adkins, Senior Vice President and General Counsel, NASD, to 
Katherine England, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated October 3, 2000 (``NASD Response 
to Comments'').
    \6\ See letter from James Buck, Senior Vice President, NYSE, to 
Nancy Sanow, Assistant Director, Division, Commission, dated 
September 8, 2000 (``Amendment No. 1 to the NYSE Proposal''). The 
amendment clarified that the proposed ``knows or has a reasonable 
basis to believe'' standard not only applies in the situation where 
a customer seeks to open an account, but also in the case where he 
or she seeks to resume day trading in an existing account. For 
further discussion of the ``knows or has a reasonable basis to 
believe'' standard, see infra, Section II, ``Description of the 
Proposed Rule Changes.''
    \7\ See letter from Alden Adkins, Senior Vice President and 
General Counsel, NASD, to Katherine England, Assistant Director, 
Division, Commission, dated October 3, 2000 (``Amendment No. 1 to 
the NASD Proposal''). The amendment: (1) Deleted a provision 
relating to a 90-day period in which a day trader could be 
designated as a Pattern Day Trader; (2) clarified that the proposed 
``knows or has a reasonable basis to believe'' standard would apply 
not only where a customer seeks to open an account, but also where a 
customer seeks to resume day trading in an existing account; (3) 
clarified that a two-day funds deposit requirement would apply only 
to customers who have been designated Pattern Day Traders; and (4) 
extended from 30 days to six months the proposed period for 
implementing the proposed rule change.
    \8\ Some commenters sent letters in response to both the NYSE 
and NASD rule proposals. The public files for the NYSE and NASD rule 
proposals, including all comment letters received on the proposals 
and a List of Commenters that was prepared by Commission staff, are 
located at the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC 20549-0609. See infra, footnote 28.
    \9\ See letter from James Buck, Senior Vice President and 
Secretary, NYSE, to Nancy Sanow, Assistant Director, Division, 
Commission, dated September 20, 2000 (``NYSE Response to 
Comments'').
    \10\ NASD Response to Comments.
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II. Description of the Proposed Rule Changes

A. Margin Trading and Regulation

    Trading securities on margin involves the use of credit to finance 
securities purchases. A margin transaction takes place where a customer 
purchases a security in reliance on an extension of credit (i.e., a 
loan) from his or her broker-dealer. Use of a margin loan increases 
both the customer's potential return on investment and his or her 
financial risk.\11\
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    \11\ Since trading securities on margin permits a customer to 
purchase securities valued at an amount greater than the equity 
available to his or her account, an increase in the value of those 
securities yields a higher return on equity than is possible if the 
size of the customer's purchases is limited to his or her available 
equity. On the other hand, trading securities on margin also makes 
it possible for a customer to generate losses that exceed his or her 
available equity.
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    Section 7(a) of the Act grants authority to the Board of Governors 
of the Federal Reserve System (``Federal Reserve'') to regulate the use 
of margin credit in order to prevent the excessive use of credit for 
the purchase or carrying of securities.\12\ Pursuant to this authority, 
the Federal Reserve promulgated Regulation T \13\ to govern extensions 
of credit by brokers and dealers. Regulation T contains ``initial'' 
margin requirements, which limit the amount of credit that can be 
extended by a broker-dealer on certain securities transactions. 
Briefly, Regulation T generally allows broker-dealers to

[[Page 13609]]

extend credit to customers on ``margin equity securities'' \14\ at 50 
percent of the particular security's market value.\15\
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    \12\ 15 U.S.C. 78g(a).
    \13\ 12 CFR 220 et seq. Regulation T ``imposes, among other 
things, obligations, initial margin requirements, and payment rules 
on securities transactions.'' 12 CFR 220.1(a).
    \14\ The definition of ``margin equity security'' includes any 
equity security (as defined in Section 3(a)(11) of the Act) which is 
registered or has unlisted trading privileges on a national 
securities exchange or the Nasdaq Market. 12 CFR 220.2.
    \15\ 12 CFR 220.12(a).
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    Regulation T establishes minimum margin requirements, but expressly 
does not preclude any registered securities exchange or registered 
national securities association ``from imposing additional requirements 
or taking action for its own protection. ''\16\ Accordingly, the NYSE 
and NASD have, consistent with Regulation T, established their own 
maintenance margin requirements, including special maintenance margin 
requirements pertaining to ``day-traders.''
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    \16\ 12 CFR 220.1(b)(2)
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B. NYSE Proposal

    According to the NTSE, the primary purpose of its rule proposal is 
to require that certain levels of equity be deposited and maintained in 
day trading accounts, and that these levels be sufficient to support 
the risks associated with day trading activities. The proposal would 
amend NYSE Rule 431, Margin Requirements, to establish special 
maintenance margin requirements for customers who engage in day 
trading, and to specify minimum equity requirements and buying power 
limitations for customers who demonstrate a pattern of day trading. The 
Exchange observed that advances in technology have contributed to a 
dramatic increase in day trading by customers. In the Exchange's view, 
these advancements have also contributed to the establishment of 
broker-dealers whose primary business is to provide customers with 
direct links to the securities markets, allowing customers to trade 
their respective portfolios on-line. According to the Exchange, in this 
environment, day traders attempt to profit from intra-day price 
movements of securities.
    Under current NYSE rules, certain margin requirements must be 
calculated based on a customer's ``open'' positions \17\ at the end of 
the trading day. If a customer only day trades, he or she has no 
``open'' positions at the end of the day upon which a margin 
calculation would otherwise yield a margin call. Nevertheless, the same 
customer has generated financial risk throughout the day. The NYSE's 
rules for day trading address this risk by imposing a margin 
requirement for day trading that is calculated based on a day trader's 
largest open position during the day, rather than on his or her open 
positions at the end of the day. A customer who meets the NYSE 
definition of ``day-trader'' \18\ must deposit in his or her account 
the amount of margin that would have been required had he or she not 
closed his or her largest open position before the end of the trading 
day (i.e., generally 50 percent of the largest open position). If a 
customer day trades, but does not satisfy the definition of ``day-
trader,'' he or she is still required in general to deposit 25 percent 
of the amount of his or her open positions during the day.
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    \17\ A customer has an ``open'' position in a security if, for 
example, he or she has purchased, but not resold it.
    \18\ The rules define ``day-trader'' as ``any customer whose 
trading shows a pattern of day-trading.'' NYSE Rule 431(f)(8)(B).
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    The NYSE proposes to amend its margin rules covering day trading 
because, among other things, the current rule does not adequately 
address the risks inherent in certain patterns of day trading \19\and 
has encouraged practices, such as the use of cross-guarantees, which do 
not require customers to demonstrate actually financial ability to 
engage in day trading.
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    \19\ NYSE Response to Comments.
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1. Proposed Definition of ``Day Trading''
    Proposed NYSE Rule 431(f)(8)(B) generally would redefine ``day 
trading'' as ``purchasing and selling or selling and purchasing the 
same security in the same day in a margin account.'' An exception to 
this proposed definition is provided where a customer: (1) carries a 
long position in a security overnight and sells the security the next 
day prior to any new purchases of the security; or (2) carries a short 
security position in a security overnight and purchases the security 
the next day prior to any new sales of the security (i.e., closing 
transactions to wrap-up the previous day's activities before any new 
purchases or sales of the same security).
2. Proposed Definition of ``Pattern Day Trader''
    A customer would be considered a ``pattern day trader'' if the 
customer made four or more day trades within five business days in his 
or her account, provided that the number of day trades was more than 
six percent of the total trades in the account during that period 
(``Pattern Day Trader''). The NYSE represented that the six percent 
threshold is designed to ensure that customers who engage in a large 
number of transactions overall are not inappropriately deemed Pattern 
Day Traders solely because there are four or more day trades in their 
accounts over the five-day period. Accordingly, a customer that, for 
example, transacts four day trades within five business days and also 
has a total of 100 transactions during that period, would not be deemed 
a Pattern Day Trader, since less than six percent of that customer's 
total trades would have been day trades.
Proposed Margin Requirement for Pattern Day Traders
    The NTSE's rule proposal would require Pattern Day Traders to 
maintain special maintenance margin commensurate with their levels of 
day trading activity (``Day Trading Margin''). For day trades in equity 
securities, the required Day Trading Margin (``Day Trading Margin 
Requirement'') would be 25 percent of either: (1) The cost of all day 
trades made during the day; or (2) the largest open position during 
that day. If a customer's Day Trading Margin Requirement is to be 
calculated based on his or her largest open position during the day, 
the customer's firm must maintain ``time and tick'' records documenting 
the sequence in which each day trade is completed. For non-equity 
securities, the amount of Day Trading Margin would be computed using 
applicable special maintenance margin requirements pursuant to other 
provisions of NYSE Rule 431.
4. Proposed Time To Meet Margin Calls
    The NYSE's rule proposal also would reduce the time allowed for 
Pattern Day Traders to meet special maintenance margin calls from seven 
business days to five business days. If a Pattern Day Trader did not 
meet a Day Trading Margin call within five business days from the time 
his or her Day Trading Margin deficiency occurred, the customer would 
be restricted to executing transactions on a cash available basis for 
90 days, or until he or she had met the Day Trading Margin call. The 
NYSE member organizations would incur a one-time capital charge for the 
amount of any unmet deficiency on the sixth business day after a 
customer receives a Day Trading Margin call.
5. Proposed Day Trading Minimum Equity Requirement
    Currently, NYSE rule 431 requires $2,000 minimum equity for a 
customer to open a margin account. The NYSE rule proposal would require 
that accounts of Pattern Day Traders maintain minimum equity of $25,000 
(``Day Trading Minimum Equity Requirement''). If the account of a 
Pattern Day Trader fell below its Day Trading Minimum Equity 
Requirement, the account would be restricted from further day trades 
until the Day Trading Minimum Equity Requirement was satisfied. In 
addition, if an NYSE

[[Page 13610]]

member organization knew, or had reasonable basis to believe, that a 
new account would pattern day trade, or that a customer would resume 
day trading in an existing account, the member organization would 
require the customer to deposit the minimum $25,000 equity into his or 
her account before he or she began trading.\20\
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    \20\ As originally filed, the NYSE proposal would require the 
member organization to obtain from a customer seeking to open a new 
account a deposit in satisfaction of the Day Trading Minimum Equity 
Requirement if the firm ``knows or has a reasonable basis to 
believe'' that the customer will pattern day trade. Amendment No. 1 
to the NYSE rule proposal would expand the application of the 
``knows or has a reasonable basis to believe'' standard to customers 
who resume pattern day trading in an existing account.
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6. Proposed Day Trading Buying Power
    Under the proposed Rule 431 revisions, the accounts of Pattern Day 
Traders would be restricted based upon their ``Day Trading Buying 
Power.'' For equity securities, Day Trading Buying Power would be equal 
to the equity in the customer's account at the close of business of the 
previous day, less any maintenance margin, multiplied by four. For non-
equity securities, Day Trading Buying Power would be computed using 
applicable special maintenance margin requirements pursuant to other 
provisions of NYSE Rule 431.
7. Proposed Account Restrictions
    The NYSE's rule proposal also would restrict the accounts of 
Pattern Day Traders who trade in excess of their Day Trading Buying 
Power. If a customer exceeded his or her Day Trading Buying Power, he 
or she would generate a Day Trading margin call. Until the customer 
meet the margin call, the NYSE member organization would be required 
to: (1) Margin the account based on the cost of all day trades made 
during the day; and (2) limit the customer's day trading buying power 
to the equity in the customer's account at the close of business on the 
previous day, less any maintenance margin, multiplied by two. If the 
Day Trading Margin call were not met within 5 business days, the NYSE 
member organization would then be required to restrict the account to 
trading on a cash available basis only.
8. Proposed Non-Withdrawal Requirement
    The NYSE represented that, in order to provide greater financial 
stability to the accounts of Pattern Day Traders, its rule proposal 
would require that: (1) a day trading customer deposit into the day 
trading account a sufficient amount of money to meet the Day Trading 
Minimum Equity Requirement or a Day Trading Margin Requirement; and (2) 
such deposits not be withdrawn for at least two business days (``Non-
Withdrawal Requirement'').
9. Proposed Prohibition on Cross-Guarantees
    In addition, the NYSE's rule proposal would require the NYSE member 
organizations to prohibit Pattern Day Traders from using guarantees 
between customer accounts at the same broker-dealer (``Cross-
Guarantees'') to meet the Day Trading Minimum Equity Requirement or a 
Day Trading Margin Requirement. According to the NYSE, this change is 
designed to address those instances where maintenance margin calls for 
day trading accounts would be avoided by having guarantees from the 
accounts of other customers at the same broker-dealer. Under the NYSE 
proposal, each Pattern Day Trader account would be required to meet its 
applicable requirements independently by using funds on deposit in that 
account.
10. Proposed Implementation
    The NYSE proposal would become operational six months after 
Commission approval of the proposed rule change.\21\
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    \21\ Telephone conversation among Donald Van Weezel, Managing 
Director, Credit Regulation, NYSE; Albert Lucks, Director, Credit 
Regulation, NYSE; Mary Anne Furlong, Director, Rules and 
Interpretive Standards, NYSE; Olga Davis, Principal Specialist, 
Credit Regulation, NYSE; and Nancy Sanow, Assistant Director; Thomas 
McGowan, Assistant Director; Joseph Morra, Special Counsel; and 
Steven Johnson, Special Counsel, Division, Commission, January 23, 
2001 (``January 23, 2001 Call with NYSE Staff'') (confirming 
operative date of proposed rule change).
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C. NASD Proposal

    Although the NYSE and NASD proposals differ somewhat in their 
structure, they are fundamentally comparable in their substance. The 
NASD rule proposal would amend NASD Rule 2520, Margin Requirements, to 
impose stricter margin requirements for customers who are Pattern Day 
Traders. The NASD observed that the expansion of day trading activity 
has brought increased scrutiny of margin requirements by self-
regulatory organizations (``SROs''). The NASD asserted that its rule 
proposal would help to protect the safety and soundness of member firms 
and ensure the overall financial well being of the securities markets.
    The NASD's current rules on day trading are similar in substance to 
those of the NYSE.\22\ In its proposal, the NASD describes that initial 
margin requirements under Regulation T \23\ and certain standard 
maintenance margin requirements under the NYSE and NASD rules currently 
are calculated only at the end of each day. Therefore, a day trader 
with no outstanding positions, including losses, in his or her account 
at the end of the day currently does not incur either an initial margin 
or maintenance margin requirement.
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    \22\ See explanation of NYSE's current rules in Section II.B., 
supra.
    \23\ 12 CFR 220 et seq.
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    Although a day trader may end the day without any positions, the 
day trader and the member firm are nonetheless at risk during the day, 
if credit is extended. To address the risk, the NASD currently requires 
day traders to demonstrate that they have the ability to meet margin 
requirements for at least their open positions during the day. 
Specifically, a customer who meets the definition of ``day-trader'' 
\24\ under the current rules must deposit in his or her account the 
margin that would have been required had the customer not liquidated 
his or her open positions during the trading day (i.e., generally 50 
percent of the largest open position). Under current rules, if the 
customer day trades, but does not fit the definition of ``day trader,'' 
the customer is still required to deposit 25 percent of his or her open 
position during the day. The NASD proposed to amend its margin rules 
covering day trading because current rules are not adequate to address 
added risks in leveraged pattern day trading.\25\
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    \24\ Current NASD Rule 2520 defines a ``day-trader'' as ``any 
customer whose trading shows a pattern of day-trading.'' The rule 
defines ``day-trading'' as ``the purchasing and selling of the same 
security on the same day.'' NASD Rule 2520(f)(8)(b).
    \25\ NASD Response to Comments.
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1. Proposed Definition of Pattern Day Trader
    The NASD stated that its proposal would define Pattern Day Trader 
to cover ``true'' day traders only, not merely incidental or occasional 
day traders. According to the NASD, the current definition of a day 
trader is overly broad: it includes customers, such as institutions and 
other large individual accounts, that have a high volume of trading 
activity and that occasionally day trade not as a strategy, but in 
response to a specific investment decision or in response to particular 
events. Accordingly, the NASD's proposal, like the NYSE proposal, would 
define as Pattern Day Traders those customers who execute four or more 
day trades within five business days, unless the number of their day 
trades is six percent or less of their total trades for that period.

[[Page 13611]]

    The NASD's proposed rule change would also require a firm that 
knows or has a reasonable basis to believe that a customer is a Pattern 
Day Trader to designate the customer as a Pattern Day Trader 
immediately. Under the NASD proposal, a firm would have a reasonable 
basis for believing that a customer is a Pattern Day Trader if, for 
example, the firm provided training to the customer on day trading in 
anticipation of the customer opening an account. Amendment No. 1 to the 
NASD Proposal deleted the provision that would have required a Pattern 
Day Trader to cease trading for 90 days before he or she would be free 
of that designation. According to NASD Regulation, the provision 
originally proposed is unnecessary because, even without the provision, 
a Pattern Day Trader could, under the proposed rules, shed the Pattern 
Day Trader designation by informing his or her broker-dealer that he or 
she would not day trade. This amendment also clarified that if a 
Pattern Day Trader claimed he or she was no longer a day trader, but 
then resumed day trading, he or she could be designated as a Pattern 
Day Trader based on the firm's knowledge or reasonable belief that the 
customer fit the proposed definition of a Pattern Day Trader.\26\
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    \26\ Amendment No. 1 to the NASD Proposal. Telephone 
conversation between Stephanie Dumont, Counsel, NASD Regulation, and 
Steven Johnston, Special Counsel, Division, Commission, January 31, 
2001 (clarifying the purpose of Amendment No. 1).
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2. Proposed Day Trading Minimum Equity Requirement
    The NASD's proposed rule change also would establish a Day Trading 
Minimum Equity Requirement that is identical to that proposed by the 
NYSE. The NASD represents that the current minimum equity requirement 
of $2,000 may not be large enough to prevent day traders from 
continuing to generate losses, without any additional deposit of funds 
into their accounts. Under the NASD proposal, a Pattern Day Trader, in 
order to meet the Day Trading Minimum Equity Requirement, would be 
required to maintain $25,000 in his or her account on any day in which 
he or she day trades. The NASD represents that the Day Trading Minimum 
Equity Requirement more appropriately addresses the additional risks 
inherent in leveraged day trading activities and ensures that customers 
cover losses incurred in their accounts from the previous day before 
continuing to day trade.
3. Proposed Day Trading Buying Power
    Like the NYSE proposal, the NASD proposal would permit the use of 
Day trading Buying Power at a level up to four times the difference 
between the equity in a customer's account at the close of business on 
the previous day and any maintenance margin required. The NASD 
represents that this limitation on a customer's Day Trading Buying 
Power, along with the Day Trading Minimum Equity Requirement, more 
appropriately addresses the intra-day risks created by customer day 
trading. At the firm's option, the Day Trading Margin Requirement could 
be calculated based on either the largest open position at any time 
during the day (if the customer's firm maintains ``time and tick'' 
records) or the aggregate total of the customer's day trades during the 
day.
4. Proposed Account Restrictions
    In addition, the NASD proposed rule change would impose a Day 
Trading Margin call if a customer exceeded his or her Day Trading 
Buying Power. Customers would have five business days to deposit funds 
to meet Day Trading Margin calls. Until the customer met the Day 
Trading Margin call, his or her Day Trading Buying Power would be 
limited to the equity in his or her account at the close of business on 
the previous day, less any maintenance margin, multiplied by two for 
equity securities. The Day Trading Margin Requirement would be 
calculated based on the aggregate cost of the customer's total day 
trades in a day. If the customer did not meet the Day Trading Margin 
call by the fifth business day, the account would be further restricted 
to trading on a cash available basis for 90 days or until the margin 
call was met.
5. Proposed Non-Withdrawal Requirement
    A deposit made to meet the Day Trading Minimum Equity Requirement 
or a Day Trading Margin Requirement would have to remain in a 
customer's account for two business days following the close of 
business on any day when the deposit is required. Amendment No. 1 to 
the NASD proposal clarified that the non-Withdrawal Requirement would 
apply only to the accounts of Pattern Day Traders and not to the 
accounts of all day traders.\27\
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    \27\ Amendment No. 1 to the NASD Proposal.
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6. Proposed Prohibition on Cross-Guarantees
    Under the NASD proposal, Cross-Guarantees could not be used when 
calculating the Day Trading Minimum Equity Requirement or the Day 
Trading Margin requirement. Each day trading account would be required 
to satisfy independently the proposed rule's requirements, based solely 
on the financial resources available in the account.
7. Proposed Change to Definition of ``Day Trade''
    Finally, the NASD rule proposal would amend provisions of NASD Rule 
2520, which currently requires that the sale and repurchase on the same 
day of a position held from the previous day be treated as a day trade. 
Under the NASD proposal, the sale of an existing position would be 
treated as liquidation, and a subsequent repurchase would be viewed as 
the establishment of a new position. Therefore, the sale of an existing 
position and subsequent repurchase would not be subject to NASD rules 
affecting day trades. Similarly, if a short position were carried 
overnight, the purchase to close the short position and the subsequent 
new sale would not be considered a day trade under the NASD's proposal.
8. Proposed Implementation Date
    Amendment No. 1 to the NASD Proposal would change the proposed 
operational date of the proposal from 30 days after the date the NASD 
issues a notice to NASD members announcing that the proposal has been 
approved by the Commission to six months from the date of such notice.

III. Summary of Comments

    The Commission received 214 letters commenting on the NYSE proposal 
and 49 letters commenting on the NASD proposal.\28\ Comment letters 
expressed various degrees of opposition or support to the approach 
taken by the proposed rule changes, although most commenters opposed 
the proposals. The commenters generally addressed issues

[[Page 13612]]

falling into one or more of the categories discussed below. In 
addition, the NYSE and NASD submitted responses \29\ to the comments 
received by the Commission regarding the proposed rule changes. These 
responses are also incorporated below.
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    \28\ The public files for the NYSE and NASD rule proposals are 
located at the Commission's Public Reference Room, 450 Fifth Street, 
N.W., Washington, D.C. 20549-0609. The public files for both rule 
proposals contain: (1) All comment letters on the proposals, 
including a list of all commenters on the proposals, which was 
prepared by Commission staff; (2) ``Report of Examinations of Day-
Trader Broker-Dealers,'' Office of Compliance Inspections and 
Examinations, Commission (``OCIE Report'') dated February 25, 2000; 
and (3) ``Securities Operations: Day Trading Requires Continued 
Oversight,'' the U.S. General Accounting Office, dated February 24, 
2000. The public file for the NYSE rule proposal also contains: (1) 
The original NYSE Proposal; (2) Amendment No. 1 to the NYSE 
Proposal; and (3) NYSE Response to Comments. The public file for the 
NASD rule proposal also contains: (1) The original NASD proposal; 
(2) Amendment No. 1 to the NASD Proposal; and (3) NASD Response to 
Comments.
    \29\ NYSE Response to Comments; NASD Response to Comments.
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A. Definition of Pattern Day Trader

    The proposed rule changes would define as Pattern Day Traders 
customers who execute four or more day trades \30\ within five business 
days, unless the number of day trades is six percent or less of the 
total day trades for that five-day period. The NYSE stated that this 
definition is directed toward active Pattern Day Traders and the risk 
surrounding their activities.\31\ A relatively small number of 
individuals raised specific objections to this definition. These 
individuals, along with a broker-dealer \32\ and the Industry Day-
Trading Advisory Task Force (``Task Force''),\33\ expressed concern 
that the proposed definition could encourage customers to hold 
positions overnight that they might otherwise have liquidated, thus 
giving rise to additional risk of financial loss.\34\
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    \30\ Under the proposed rules, a day trade is, generally, the 
purchase and sale or the sale and purchase of the same security on 
the same day.
    \31\ NYSE Response to Comments.
    \32\ Letter from Cornerstone Securities Corporation 
(``Cornerstone Letter'').
    \33\ The Task Force is comprised of representatives from 15 
firms: Advanced Clearing, Inc.; All-Tech Direct, Inc.; Ameritrade, 
Inc.; Charles Schwab & Co., Inc.; EDGETRADE.com, Inc.; E-Trade 
Group, Inc.; iClearing Corporation; Momentum Securities; NextTrend, 
Inc.; On-Line Investments Services, Inc.; Southwest Securities, 
Inc.; Spear, Leedst & Kellog; Terra Nova Trading LLC; Tradescape 
LLC; and US Clearing (Division Fleet Securities). Letter from the 
Task Force (``Task Force Letter'').
    \34\ See, e.g., E-mail from Steven Petrizzi, E-mail from M. 
Spetman; Cornerstone Letter; Task Force Letter.
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    In addition, a broker-dealer, the Task Force, and the Discount 
Brokerage Committee (``Brokerage Committee'') and Ad Hoc Committee on 
Technology and Regulation (``Technology Committee'') of the Securities 
Industry Association (``SIA'') \35\ (collectively, the ``SIA Brokerage 
and Technology Committees'') indicated concern over the impact that the 
proposed definition could have upon professional or institutional 
investors. These commenters stated that the definition lacks adequate 
exclusions for those types of investors.\36\ Broker-dealers also 
opposed the definition of Pattern Day Trader because it would encompass 
so-called ``incidental'' or ``inadvertent'' day traders.\37\ In this 
regard, a few firms proposed exceptions for customers who, as a result 
of ``inadvertent'' or ``non-willful'' error, temporarily met the 
proposed definition of Pattern Day Trader.\38\ The SIA Brokerage and 
Technology Committees and SIA Office of General Counsel recommended 
that the proposed definition be revised to explicity exempt specific 
types of trading activity, such as the exercise of a profitable options 
position.\39\ A law firm commenting on the proposed rule changes 
recommended exceptions to the proposed definition of Pattern Day Trader 
for certain institutional investors, arguing that sophisticated 
investors with large accounts do not need to be protected by the 
proposed rule changes.\40\ The NASD responded to this comment by 
reasserting its belief that the proposed six percent exception 
adequately addresses institutional trading. The NASD argued that this 
exception was not intended to exempt all institutions that frequently 
day trade, but only those whose day trading represented a small 
proportion of their overall trading activity.\41\
---------------------------------------------------------------------------

    \35\ According to the SIA, the organization ``brings together 
the shared interests of more than 740 securities firms to accomplish 
common goals.'' Letter from SIA Brokerage and Technology Committees 
(``SIA Brokerage and Technology Committees Letter'').
    \36\ Letter from Momentum Securities, LLC (``Momentum Letter''); 
Task Force Letter; SIA Brokerage and Technology Committees Letter.
    \37\ See, e.g., Momentum Letter.
    \38\ See, e.g., Letter from Empire Programs.
    \39\ SIA Brokerage and Technology Committees Letter; Letter from 
the SIA Office of General Counsel (``SIA General Counsel Letter''). 
The SIA Brokerage and Technology Committees and SIA General Counsel 
recommended adding the following exceptions to the proposed 
definition of day trading: (1) Exercising a profitable option 
position; (2) reopening a long option position that had been closed 
out earlier the same day; (3) reopening a short option position that 
had been closed out earlier the same day; and (4) the purchase of a 
security by a customer and the sale of the same security by the 
customer in a repurchase or other financing transaction.
    \40\ Letter from Brunelle and Hadjikow.
    \41\ NASD Response to Comments.
---------------------------------------------------------------------------

    Finally, the Task Force opposed the definition because it is based 
on transactional activity instead of the amount of available leverage. 
The Task Force asserted, for example, that a customer that completed 
five day trades within a ``week'' \42\ would meet the definition of 
Pattern Day Trader ``even though the customer ha[d] not taken on any 
greater level of financial risk or leverage.'' \43\
---------------------------------------------------------------------------

    \42\ Status as a Pattern Day Trader is determined on a rolling 
five-business-day basis. Telephone conversation among Donald Van 
Weezel, Managing Director, Regulatory Affairs, NYSE; Albert Lucks, 
Director, Credit Regulation, NYSE; and Nancy Sanow, Assistant 
Director; Thomas McGowan, Assistant Director; Joseph Morra, Senior 
Special Counsel; and Melinda Diller, Attorney; Division, Commission, 
January 7, 2000.
    \43\ Task Force Letter.
---------------------------------------------------------------------------

B. ``Knows or Has a Reasonable Basis to Believe'' Standard

    Several securities industry commenters opposed the requirement to 
treat as Pattern Day Traders current or new customers whom a trading 
firm ``knows or has a reasonable basis to believe'' will engage in 
pattern day trading.\44\ One securities firm opposed the ``knows or has 
a reasonable basis to believe'' standard because it calls for a firm to 
``subjectively consider the manner of trading a new customer might 
pursue.'' \45\
---------------------------------------------------------------------------

    \44\ See, e.g., Momentum Letter.
    \45\ Momentum Letter.
---------------------------------------------------------------------------

    The NYSE responded to these criticisms by explaining that a firm 
could have a reasonable basis to believe that a customer would engage 
in Pattern Day Trading if this were indicated by information obtained 
from a customer's representations or by prior trading patterns of the 
customer at the firm.\46\ The NASD responded that the proposed standard 
is based on a firm's knowledge or reasonable belief only, and would not 
require a firm to anticipate a new customer's activity unless the firm 
had knowledge or a reasonable belief that the customer would engage in 
pattern day trading. The NASD stated that if, for example, a firm 
provided a customer with training on day trading in anticipation of 
that customer opening an account with that firm, then the firm would 
have a reasonable basis to believe that customer would pattern day 
trade in his or her account.\47\
---------------------------------------------------------------------------

    \46\ NYSE Response to Comments.
    \47\ NASD Response to Comments.
---------------------------------------------------------------------------

    This standard was supported by comments from the North American 
Securities Administrators Association (``NASAA''). NASAA contended that 
brokerage firms have an affirmative duty to assess a prospective 
client's suitability to trade, and therefore firms should determine 
whether the client fits the definition of Pattern Day Trader. According 
to NASAA, this assessment should not be overly burdensome to make. 
NASAA noted as an example that where a firm trains a customer in day 
trading techniques, that firm would be presumed to know or have a 
reasonable basis to believe that such a customer would engage in 
pattern day trading.\48\
---------------------------------------------------------------------------

    \48\ NASAA is a voluntary association of state, provincial, and 
territorial securities administrators in the 50 states, the District 
of Columbia, Puerto Rico, Canada, and Mexico. Letter from NASAA 
(``NASAA Letter''). See also Section II., Description of the 
Proposed Rule Changes, supra, for further discussion of ``knows or 
has a reasonable basis to believe'' standard.

---------------------------------------------------------------------------

[[Page 13613]]

C. Day Trading Minimum Equity Requirement

    The majority of comments the Commission received on the proposals' 
Day Trading Minimum Equity Requirement were from individuals, many of 
whom identified themselves as day traders. Nearly all of these 
individuals characterized the Day Trading Minimum Equity Requirement as 
unfair to small investors.\49\ Individual commenters asserted that the 
Day Trading Minimum Equity Requirement would act as a barrier to 
persons seeking to enter the day trading market.\50\ Individual 
commenters also asserted that the requirement was designed to exclude 
small investors from a type of trading traditionally dominated by 
professional traders.\51\ A securities firm, as well as a significant 
number of individual commenters, argued that the proposed Day Trading 
Minimum Equity Requirement would be ``paternalistic.'' These commenters 
asserted that the risks of day trading are widely known; therefore, it 
is unnecessary for the NYSE or NASD to protect investors from those 
risks.\52\ The SIA Brokerage and Technology Committees stated, however, 
that they had no objection to the proposed dollar amount of the Day 
Trading Minimum Equity Requirement (i.e., $25,000).\53\
---------------------------------------------------------------------------

    \49\ See, e.g., E-mail from Susie Brown (``Brown Letter'').
    \50\ See, e.g., Letter from Serg Palanov.
    \51\ See, e.g., E-mail from Brent Aston.
    \52\ Datek Online Holdings Corporation Letter (``Datek 
Letter''); See also May letter.
    \53\ The SIA Brokerage and Technology Committees are opposed, 
however, to imposing the Day Trading Minimum Equity Requirement when 
a firm ``knows or has a reasonable basis to believe'' a customer 
will in engage in pattern day trading. SIA Brokerage and Technology 
Committees Letter.
---------------------------------------------------------------------------

    Most securities firms commenting on the proposed rule changes 
opposed the Day Trading Minimum Equity Requirement wholly or 
partially.\54\ For example, one firm challenged the premise that there 
is a relationship between the size of a customer's account and his or 
her investment success. The same firm argued that the imposition of a 
higher equity requirement could encourage investors to put more of 
their capital at risk than they would absent the proposed rules.\55\ 
Securities firms also took the position that imposing the Day Trading 
Minimum Equity Requirement on Pattern Day Traders would fail to protect 
either member firms or the securities markets.\56\ One of the firms 
argued that the health of the securities markets is not threatened by 
accounts that have only small equity balances, and there is no data to 
suggest that a higher equity requirement for day trading would reduce 
the risk to securities firms.\57\ As an alternative, one securities 
firm recommended applying a $25,000 minimum equity requirement to 
customers who seek and receive approval to trade at a 4:1 margin ratio, 
but not to customers who trade at a 2:1 ratio.\58\
---------------------------------------------------------------------------

    \54\ See, e.g., Cornerstone Letter.
    \55\ Datek Letter.
    \56\ See, e.g., Momentum Letter.
    \57\ Datek Letter.
    \58\ Momentum Letter. The Task Force also recommended that the 
day trading rules differentiate between customers who trade at a 4:1 
ratio and those who trade at a 2:1 ratio. Task Force Letter.
---------------------------------------------------------------------------

    In response to this alternative, the NASD stated that it believes 
an objective standard based on the level of day trading activity, which 
can be applied uniformly to all customers, is an important component to 
regulation in this area. In this regard, the frequency of day trading 
is a relevant indicator of intra-day risk, which in turn is important 
in determining whether additional requirements, such as the Day Trading 
Minimum Equity Requirement, are necessary. The NASD further stated that 
it believed requiring minimum equity of $25,000 would provide a 
significant ``cushion'' to prevent day traders from continuing to 
generate losses in their accounts and, at the same time, avoid 
imposition of excessive restrictions on day traders with limited 
capital.\59\
---------------------------------------------------------------------------

    \59\ NASD Response to Comments.
---------------------------------------------------------------------------

    In response to comment letters objecting to the proposed imposition 
of the Day Trading Minimum Equity Requirement,\60\ the NYSE stated that 
the current equity requirement of $2,000 does not sufficiently address 
the speculative nature and potential volatility of pattern day trading. 
Further, the NYSE stated that the amount of the proposed minimum Day 
Trading Minimum Equity Requirement appropriately addresses the 
financial exposure of firms and the potential for significant monetary 
losses by customers. In the NYSE's view, the Day Trading Minimum Equity 
Requirement should provide some ``staying power'' to day traders (i.e., 
enable them to continue day trading) should they incur trading 
losses.\61\ The NASD added that the current equity requirement of 
$2,000 does not adequately address day trading risks.\62\ The NASD 
represents that given the speculative nature of day trading the 
proposed Day Trading Minimum Equity Requirement would provide a better 
``cushion'' in case of financial losses by customers.\63\
---------------------------------------------------------------------------

    \60\ See, e.g., Brown Letter.
    \61\ NYSE Response to Comments.
    \62\ NASD Response to Comments.
    \63\ NASD Response to Comments.
---------------------------------------------------------------------------

    NASAA and the U.S. Senate Permanent Subcommittee on Investigations 
(``Senate Subcommittee'') supported substantial increases in the size 
of the equity requirement for day trading.\64\ Following increased 
public and private sector concern over the risks associated with day 
trading, the Senate Subcommittee conducted an eight-month investigation 
of the day trading industry. Based on the investigation, the Senate 
Subcommittee found that ``[securities] industry leaders agreed that a 
day trader's chance of success is directly and proportionally related 
to the amount of capital with which a person starts trading.'' \65\ 
NASAA stated that the Day Trading Minimum Equity Requirement should 
reduce the frequency of margin calls, increase the chances that day 
traders will be able to independently meet margin calls, and provide a 
``cushion'' when market corrections occur.\66\
---------------------------------------------------------------------------

    \64\ NASAA Letter; Senate Subcommittee Letter.
    \65\ Senate Subcommittee Letter.
    \66\ NASAA Letter.
---------------------------------------------------------------------------

    Finally, the Senate Subcommittee submitted detailed alternative 
proposals regarding, among other things, the required level of equity 
and suggested restrictions on accounts that do not meet the equity 
requirement. For example, the Senate Subcommittee proposed that day 
trading rules establish a rebuttable presumption ``such that a firm 
must initially presume that a day trading customer who does not have 
$50,000 with which to open an account in inappropriate for day 
trading.'' The presumption could be overcome if a firm concluded that 
other factors outweighed the fact that the customer did not have 
$50,000 with which to open an account. Under the Senate Subcommittee's 
proposal, a firm would be required, among other things, to state its 
reasons for concluding that a day trading strategy was appropriate for 
such a customer.\67\
---------------------------------------------------------------------------

    \67\ Senate Subcommittee Letter.
---------------------------------------------------------------------------

    In response to recommendations by the Senate Subcommittee that the 
equity requirement for Pattern Day Traders be increased to $50,000,\68\ 
the NYSE stated that it believes $25,000 is a sufficient level of 
equity, given the fact that firms may further increase equity 
requirements based on their own policies and procedures, known as 
``house requirements.'' \69\ The NASD stated that the proposed Day 
Trading Minimum Equity Requirement should

[[Page 13614]]

provide protection against continued losses in day trading accounts 
while refraining from excessive restrictions on day traders with 
limited capital. The NASD also observed that firms have the option of 
increasing equity requirements on day traders by imposing house 
requirements.\70\
---------------------------------------------------------------------------

    \68\ Id.
    \69\ NYSE Response to Comments.
    \70\ NASD Response to Comments.
---------------------------------------------------------------------------

    In addition, the Senate Subcommittee recommended that customers who 
fail to maintain sufficient funds in their accounts be restricted to 
trading on a cash basis only.\71\ In response to this suggestion, the 
NASD stated that if a customer continued to day trade in his or her 
account without maintaining the proposed Day Trading Minimum Equity 
Requirement, the NASD would expect that the customer's firm would 
restrict that account to trading on a cash available basis.\72\
---------------------------------------------------------------------------

    \71\ Senate Subcommittee Letter.
    \72\ NASD Response to Comments.
---------------------------------------------------------------------------

D. Margin Ratio

    A small number of individual commenters expressed opposition to 
increasing to a 4:1 ration the amount of leverage available to 
customers who satisfy the Day Trading Minimum Equity Requirement.\73\ 
These individual commenters, as well as the Senate Subcommittee, 
expressed concern that increasing the margin ratio would multiply any 
losses of, and increase speculation by, those persons who trade at the 
higher ratio.\74\ On the other hand, securities firms generally did not 
object to allowing customers to trade at a 4:1 ratio.\75\
---------------------------------------------------------------------------

    \73\ See, e.g., Letter from Jay Marting (``Marting Letter'').
    \74\ See, e.g., Marting Letter; Senate Subcommittee Letter.
    \75\ See, e.g., Momentum Letter.
---------------------------------------------------------------------------

    In response to concerns about increasing the amount of leverage 
available to Pattern Day Traders,\76\ the NYSE and NASD represented 
that permitting the use of leverage at a 4:1 ratio is appropriate when 
considered in conjunction with other provisions of the proposed rule 
changes.\77\ The NYSE stated that as a whole, its proposal would 
encourage customers to avoid margin calls by trading only within their 
Day Trading Buying Power. The NYSE and NASD also indicated that 
allowing pattern Day Traders to trade at the 4:1 ratio would bring day 
trading accounts into parity with ordinary margin accounts, where the 
standard maintenance margin is also 25 percent.\78\
---------------------------------------------------------------------------

    \76\ See, e.g., Letter from Matthew Panza (``Panza Letter''); 
Letter from EDGETRADE.com (``EDGETRADE Letter'').
    \77\ NYSE Response to Comments; NASD Response to Comments.
    \78\ NYSE Response to Comments; NASD Response to Comments.
---------------------------------------------------------------------------

E. Method of Computing Margin Calls

    A substantial number of individuals and securities firms commenting 
on the rule proposals were opposed to the proposed method of computing 
the Day Trading Margin call.\79\ Some of these commenters objected to 
calculating the margin call based on all day trades during a day, once 
a Pattern Day Trader had exceeded his or her Day Trading Buying 
Power.\80\ Individual commenters asserted that using this method would 
result in customers receiving margin calls many times larger than the 
amount of equity in the customer's account. A few of these comments 
apparently believed that a customer with no outstanding Day Trading 
margin calls who exceeded his or her Day Trading Buying Power would, 
under the proposed rules, face a Day Trading Margin call equal to 50 
percent of the total cost of all day trades executed on the day in 
which the customer exceeded his or her Day Trading Buying Power.\81\ 
The NYSE has clarified that if a Pattern Day Trader had no outstanding 
Day Trading Margin calls, his or her Day Trading Margin Requirement 
would equal 25 percent of either (1) the customer's highest open 
position during the day,\82\ or (2) 25 percent of the total cost of the 
customer's day trades during the day.\83\ Many of the individual and 
industry commenters lodging concerns regarding the calculation of Day 
Trading Margin calls stated that such margin calls would be unfairly 
punitive to day traders.\84\
---------------------------------------------------------------------------

    \79\ See, e.g., Panza Letter; EDGETRADE Letter.
    \80\ See e.g., Panza Letter; Letter from Ed Naylor (``Naylor 
Letter'').
    \81\ See e.g., Naylor Letter.
    \82\ For the Day Trading Margin Requirement to be based on a 
customer's highest open position, the customer's firm must maintain 
``time and tick'' records documenting the sequence in which each day 
trade was completed.
    \83\ NYSE Response to Comments. January 23, 2001 Call with NYSE 
Staff (clarifying that this formula applies solely to Pattern Day 
Traders who have no outstanding day trading margin calls).
    \84\ See e.g., Ray Letter; Momentum Letter.
---------------------------------------------------------------------------

    The NYSE and NASD explained the calculation of Day Trading Margin 
calls as follow.\85\ In accounts not subject to restrictions under the 
proposed rules, Day Trading Margin calls would be calculated based on a 
customer's highest open position in a day.\86\ For example, assume that 
a customer who is a Pattern Day Trader had $30,000 cash equity and no 
security positions in his or her account at the close of business on 
Day 0. The customer's Day Trading Buying Power for Day 1 would be 
$120,000 (four times the equity in the customer's account at the close 
of business on Day 0).\87\ Also assume that the customer executed two 
day trades on Day 1--a $50,000 purchase and sale, followed by a 
$200,000 purchase and sale.\88\ Under these conditions, the customer's 
highest open position on Day 1 is $200,000.\89\ Since the customer's 
highest open position exceeds her or her Day Trading Buying Power, the 
customer incurs a Day Trading Margin call of $20,000, calculated as 
followings:
---------------------------------------------------------------------------

    \85\ January 23, 2001 Call with NYSE Staff (clarifying operation 
of NYSE proposed rules). Telephone conversation between Susan 
Demando, Director, of Finance/Operations, Member Regulation, NASD 
and Thomas McGowan, Assistant Director, Division, Commission, 
January 24, 2001 (``January 24, 2001 Call with NASD Staff'') 
(clarifying operation of NASD proposed rules).
    \86\ For a customer's Day Trading Margin Requirement to be based 
on his or her highest open position, the customer's firm must 
maintain ``time and tick'' records of the customer's transactions; 
otherwise, the customer's Day Trading Margin Requirement must be 
calculated based on the total cost of a customer's day trades during 
the day.
    \87\ The proposed rules would define Day Trading Buying Power 
for equity securities as the equity available in a customer's 
account as of the close of business on the previous day less any 
maintenance margin requirement, multiplied by four. Because, in this 
example, the customer has no open positions in his or her margin 
account, the customer has no maintenance margin requirement.
    \88\ The example assumes that the customer closes one position 
before opening the next. This would be the case, for example, if the 
customer: (1) Purchased ``Security A'' for $50,000 at 10:00 a.m.; 
(2) sold ``Security A'' for $50,000 at 11:00 a.m.; (3) purchased 
``Security B'' for $200,000 at 1:00 p.m.; and (4) sold ``Security 
B'' for $200,000 at 3:30 p.m.
    \89\ Had the customer not closed the position in ``Security A'' 
before purchasing ``Security B,'' the customer's highest open 
position would have been $250,000, the sum of positions open 
simultaneously.

  $200,000  (largest open position on Day 1)
  -120,000  (Day Trading Buying Power)
-----------
    80,000
  x    .25  (Day Trading Margin)
-----------
   $20,000  (Day Trading Margin call)
 

    In addition to incurring a Day Trading Margin call on Day 1, the 
customer's account is restricted until the margin call is met. On Day 
2, for example, the customer's Day Trading Buying Power is restricted 
to $60,000 (two times the assumed equity \90\ in the customer's account 
at the close of business on Day 1). Further, the customer's account is 
margined based on the total cost of all day trades executed on Day 2. 
For example, assume that on Day 2 the customer executes two day 
trades--a $40,000 purchase and sale and $30,000

[[Page 13615]]

purchase and sale. Since the total cost of the customer's day trades 
($70,000) exceeds his or her Day Trading Buying Power ($60,000), the 
customer incurs a second Day Trading Margin call of $5,000, calculated 
as follows:
---------------------------------------------------------------------------

    \90\ The example assumes that there are no profits or losses in 
the account, no commission or interest charges, and no other items 
that would affect the account balance. Therefore, the amount of 
equity in the account at the end of Day 0.

  $70,000  (cost of all day trades on Day 2)
  -60,000  (Day Trading Buying Power)
----------
   10,000
 x  \91\.  .............................................................
        50
----------
   $5,000  (Day Trading Margin call)
 

F. Time Allowed to Meet Margin Call

    Some \91\ commenters stated that they were opposed to the 
requirement that, once a customer receives a Day Trading Margin call, 
he or she must meet the margin call within five business days.\92\ One 
commenter, for example, protested that along with other provisions of 
the proposed rule changes, this requirement would force customers to 
liquidate positions based on non-market considerations.\93\ In response 
to objections to reducing the time to meet a margin call from seven to 
five business days, the NYSE stated that this change was made to 
conform its proposed rule revisions to the time frame included in 
Regulation T for standard margin accounts.\94\
---------------------------------------------------------------------------

    \91\ The Day Trading Margin rises to 50 percent because the 
customer has an outstanding Day Trading Margin call. January 23, 
2001 Call with NYSE Staff; January 24, 2001 Call with NASD Staff 
(both clarifying use of 50 percent margin under proposed rules).
    \92\ See, e.g., Letter from Terry Laughlin (``Laughlin 
Letter'').
    \93\ Laughlin Letter.
    \94\ NYSE Response to Comments; 12 CFR 220.2; 12 CFR 
220.4(c)(3)(i).
---------------------------------------------------------------------------

G. Actions Required When Day Trading Buying Power Is Exceeded

    A significant number of comment letters from individuals, and 
roughly half of the letters from securities industry commenters, 
addressed the subject of the actions to be taken if a customer exceeds 
his or her Day Trading Buying Power.\95\ For example, individual 
commenters objected to the provisions restricting use of leverage to a 
2:1 ratio once a Pattern Day Trader has incurred a Day Trading Margin 
call.\96\ A securities firm and the SIA Brokerage and Technology 
Committees criticized provisions that would reduce the degree of 
leverage available to customer who has received a Day Trading Margin 
call because, they argued, it departs from the approach used in 
Regulation T.\97\ This firm and the SIA Brokerage and Technology 
Committees were opposed to the imposition of immediate restrictions on 
the accounts of individuals who exceeded their Day Trading Buying 
Power, and the SIA Brokerage and Technology Committees favored imposing 
as few restrictions as possible during the five-business-day period for 
meeting a Day Trading Margin call.\98\ Finally, the Task Force proposed 
that no restrictions be imposed on the account of a Pattern Day Trader 
during the five business days specified for meeting a Day Trading 
Margin call.\99\
---------------------------------------------------------------------------

    \95\ See, e.g., Naylor Letter; Cornerstone Letter (addressing 
imposition of 2:1 ratio).
    \96\ See, e.g., E-mail from Jeff Landau.
    \97\ Cornerstone Letter; SIA Brokerage and Technology Committees 
Letter. 12 CFR 220 et seq.
    \98\ SIA Brokerage and Technology Committees Letter; Cornerstone 
Letter.
    \99\ Task Force Letter.
---------------------------------------------------------------------------

    In response, the NYSE stated that the proposed actions are 
appropriate and will help to minimize financial risk to securities 
firms and markets.\100\ In response to concerns that the companion 
actions required may ``penalize'' customers,\101\ the NASD represented 
that immediate consequences are necessary to discourage customers from 
exceeding their Day Trading Buying Power.\102\
---------------------------------------------------------------------------

    \100\ NYSE Response to Comments
    \101\ See, e.g., Letter from Brent Johnson.
    \102\ NASD Response to Comments.
---------------------------------------------------------------------------

    The Senate Subcommittee supported the proposed restrictions on 
Pattern Day Traders who exceed their Day Trading Buying Power.\103\ 
NASAA also supported the Day Trading Margin call provisions and other 
restrictions imposed by the proposed rule changes. NASAA described the 
proposed measures as the placement of regulatory ``speed bumps'' to 
ensure compliance with reasonable margin risk levels and to enforce 
penalties for day trading in accounts with little or no equity.\104\
---------------------------------------------------------------------------

    \103\ Senate subcommittee Letter.
    \104\ NASAA Letter
---------------------------------------------------------------------------

H. Non-Withdrawal Requirement

    Most securities firms, and The Rules and Regulations Committee of 
the SIA's Credit Division (``SIA Rules and Regulations Committee''), 
opposed the requirement that funds deposited into a customer's account 
to satisfy the Day Trading Margin Requirement or Day Trading Minimum 
Equity Requirement of the proposed rule changes must remain in the 
account for two business days.\105\ One trading firm, for example, 
stated that the Non-Withdrawal Requirement is unnecessary because 
positions are not held overnight and, therefore, funds are not at risk. 
The firm also contrasted the proposed Non-Withdrawal Requirement with 
the treatment of deposits made to satisfy Regulation T \106\ margin 
calls. The firm observed that customers are permitted to withdraw those 
deposits the day after the deposits have been made.\107\
---------------------------------------------------------------------------

    \105\ See, e.g., Cornerstone Letter. Letter from SIA Rules and 
Regulations Committee (``SIA Rules and Regulations Committee 
Letter'').
    \106\ 12 CFR 220 et seq.
    \107\ Cornerstone Letter.
---------------------------------------------------------------------------

    The SIA Rules and Regulations Committee argued that the Non-
Withdrawal Requirement is overly restrictive, and that customers should 
be able to use funds available in their accounts, absent a pattern of 
activity demonstrating that they lack sufficient financial resources to 
engage in Pattern Day trading.\108\ The NYSE, however, represented that 
the effectiveness of other provisions of its proposed rule change could 
be limited if a customer were permitted to withdraw funds prior to 
trading on the day after that customer had been required by the 
proposal to deposit them. The NYSE explained that if a customer is 
permitted to withdraw such funds prior to the next day's trading, he or 
she could shield the funds from day trading losses through overnight 
borrowing. The NYSE observed that overnight borrowing to meet margin 
calls does not demonstrate a customer's fitness to engage in Pattern 
Day Trading.\109\
---------------------------------------------------------------------------

    \108\ SIA Rules and Regulations Committee Letter.
    \109\ NYSE Response to Comments.
---------------------------------------------------------------------------

    The NYSE and NASD stated that they believe the Non-Withdrawal 
Requirement would result in greater caution by entities lending funds 
to customers who must meet Day Trading Margin calls. In their view, 
this is because funds deposited to meet Day Trading Margin calls would 
be placed at risk of day trading losses.\110\ This, the NYSE argued, 
may encourage entities lending funds to more carefully evaluate the 
creditworthiness of Pattern Day Traders. The NYSE believed that this 
increased caution should provide a better foundation for reducing 
financial risk to the securities industry and to individual 
investors.\111\ The NASD believed that the Non-Withdrawal Requirement 
would also force Pattern Day Traders to more frequently rely upon their 
own funds and assets in meeting margin requirements and thereby 
decrease financial risk to securities firms.\112\
---------------------------------------------------------------------------

    \110\ NYSE Response to Comments; NASD Response to Comments.
    \111\ NYSE Response to Comments.
    \112\ NASD Response to Comments.
---------------------------------------------------------------------------

I. Cross-Guarantees

    Many individual commenters, as well as a significant number of 
firms, expressed opposition to the exclusion of Cross-Guarantees from 
the calculation of

[[Page 13616]]

the Day Trading Margin Requirement.\113\ In addition, one commenter 
proposed to exclude accounts trading at the 2:1 ratio from the 
application of the proposed provisions on Cross-Guarantees.\114\ The 
NYSE believes that the provision in its rule proposal on Cross-
Guarantees ``suitably addresses concerns of whether [a] customer has 
the financial resources to day trade, and allows for separate 
evaluation of customers' day trading risks.''\115\ The NASD also 
believes that its proposed provision on Cross-Guarantees is necessary 
to address those concerns.\116\
---------------------------------------------------------------------------

    \113\ See, e.g., Momentum Letter.
    \114\ Momentum Letter. See also Task Force Letter.
    \115\ NYSE Response to comments.
    \116\ NASD Response to Comments.
---------------------------------------------------------------------------

    NASAA also expressed support for the proposed provisions on Cross-
Guarantees. NASAA suggested that Cross-Guarantees circumvent the 
purpose of margin requirements. In addition, NASAA expressed concern 
regarding the potential harm to investors if securities firms that are 
strongly recommending an investment or an investment strategy to a 
customer also take steps to arrange margin guarantees for that same 
customer.\117\ Similarly, the Senate Subcommittee stated that Cross-
Guarantees would ``undermine margin requirements'' and could ``evade 
the purpose'' of equity requirements as well.\118\
---------------------------------------------------------------------------

    \117\ NASAA Letter.
    \118\ Senate Subcommittee Letter.
---------------------------------------------------------------------------

J. Burdens on Firms

    Most securities industry commenters expressed concern over the 
implementation, administration, and enforcement burden that they 
believed would be placed upon securities firms by the proposed rule 
changes.\119\ The SIA Brokerage and Technology Committees argued, for 
example, that the system enhancements required to monitor such 
parameters as Day Trading Buying Power and to impose restrictions on 
accounts would be ``significant, complicated, and costly.'' The SIA 
Brokerage and Technology Committees asserted that such burdens should 
not be imposed on firms that do not promote day trading strategies. The 
committees also expressed particular concern regarding the burden of 
implementing provisions of the proposed rule changes that would exclude 
from the definition of Pattern Day Trader those customers whose day 
trades represent six percent or less of their total trades.\120\ In 
addition, the Task Force argued that the proposed rule changes would 
require firms to classify and monitor their entire customer base on a 
daily basis.\121\ As an alternative, one firm proposed that customers 
desiring to trade at a 4:1 ratio should be required to apply for 
approval to trade at that level, and that broker-dealers should only be 
required to monitor the accounts trading at a 4:1 ratio. The firm 
believed this would reduce a firm's burden of implementing day trading 
margin rules.\122\
---------------------------------------------------------------------------

    \119\ See, e.g., SIA General Counsel Letter.
    \120\ SIA Brokerage and Technology Committees Letter.
    \121\ Task Force Letter.
    \122\ Datek Letter (referring to Task Force recommendations).
---------------------------------------------------------------------------

    Responding to these concerns, the NYSE stated that the programming 
and monitoring of its proposed rule would not be unduly burdensome, and 
stated that it would delay the operative date by six months from the 
date of commission approval, in order to allow firms to implement its 
proposed rule.\123\ In response to specific concerns regarding the 
burden of implementing the proposed exclusion from the definition of 
Pattern Day Trader for customers whose day trades represent six percent 
or less of their total trades, the NYSE stated that the exclusion is 
not mandatory, i.e., members may choose not to exclude such investors 
from the operation of the NYSE's proposed rules.\124\ With regard to 
the same concern, the NASD responded that its staff consulted with 
members of the Rule 431 Committee who advised that programming and 
monitoring the exception would not be overly burdensome.\125\
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    \123\ NYSE Response to Comments. January 23, 2001 Call with NYSE 
Staff (confirming operative date of proposed rule change).
    \124\ NYSE Response to Comments.
    \125\ NASD Response to Comments.
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IV. Discussion of the NYSE and NASD Proposed Rule Changes

    Day trading generally refers to a kind of trading system involving 
frequent, rapid-fire purchase and sale transactions (or sale and 
purchase transactions) in securities in a single day. Day trading 
transactions are often effected by persons who typically have 
computerized links to market centers and who attempt to capture small 
differences in stock prices.\126\ As day trading activity increased, so 
did media attention and public concern over the risks inherent in day 
trading.\127\ Given the potential for significant losses to those 
persons who engage in day trading activities, legislators and 
regulators have scrutinized the practice and have taken steps to 
protect investors and limit financial risks to investors, broker-
dealers, and securities markets.
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    \126\ 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.'' Senate Subcommittee Letter (Citing 
definition in proposed NASD Rule 2360(e)).
    \127\ See, e.g., ``State Securities Regulators Investigate 
Practices of Securities Firms as Part of a Broad-Based Inquiry Into 
Day Trading,'' The Wall Street Journal, Sec. C., pp. 1, col. 6, 
August 25, 1999; ``Critical Report by North American Securities 
Administrators Association,'' The Wall Street Journal, Sec. A, pp. 
26, col. 1; ``Senators Lambaste Actions by Day Traders,'' USA Today, 
Sec. B, pp. 2, February 25, 2000; ``Day Trading: A Study in 
Temptation; Senate Panel to Investigate Risk Disclosure,'' The 
Washington Post, February 24, 2000, Sec. E., pp. 1.
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    For example, from October 1998 through September 1999, the 
Commission's Office of Compliance Inspections Examinations (``OCIE'') 
examined 47 registered broker-dealers that were providing day trading 
facilities to the general public. In February 2000, OCIE issues a 
report of its findings and recommendations, addressing risk disclosure, 
net capital compliance, lending arrangements, supervisory 
infrastructure, and other issues associated with day trading.\128\
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    \128\ OCIE Report.
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    In addition, the Senate Subcommittee held hearings on day trading 
that focused on investor suitability, the use of margin, advertising, 
and profitability.\129\ Moreover, various SROs filed, and the 
Commission approved, other rule proposals regulating day trading 
practices.\130\ The NYSE and NASD rule proposals relating to margin 
requirements for day traders represent further regulatory responses to 
issues raised by day trading.
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    \129\ Day Trading: An Overview: Hearing Before the Permanent 
Subcommittee on Investigations of the Committee on Governmental 
Affairs, 106th Cong., 1st Sess. 106-285 (1999). The Senate 
Subcommittee also reviewed and provided recommendations concerning 
the NYSE and NASD rule proposals on the use of margin. Senate 
Subcommittee Letter.
    \130\ See e.g., Securities Exchange Act Release No. 43021 (July 
10, 2000), 65 FR 44082 (July 17, 2000) (File No. SR-NASD-99-41) 
(approving new rules pertaining to the opening of day trading 
accounts and delivery of a risk disclosure statement).
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    The rule proposals submitted by the NYSE and NASD were the result 
of collaborative efforts by these SROs, through the Rule 431 
Committee--comprised of NYSE and NASD staff, attorneys from the NYSE's 
outside counsel, staff of the Board of Governors of the Federal 
Reserve, and representatives from several broker-dealers and clearing 
firms--to develop special margin rules that better reflect the risks 
inherent in day trading. Because initial margin requirements under 
Regulation T and standard maintenance margin requirements under current 
NYSE and NASD rules are calculated only at the end of the day incurred, 
a day trader with no

[[Page 13617]]

outstanding positions, including losses, in his or her account at the 
end of the day currently incurs neither an initial margin nor a 
maintenance margin requirement. Although current NYSE and NASD special 
maintenance margin requirements apply to day traders, those 
requirements do not adequately address the potential financial risks 
posed by day trading, and may have encouraged practices, such as the 
use of Cross-Guarantees, that do not require customers to demonstrate 
actual financial ability to engage in day trading.
    The Commission has reviewed the NYSE and NASD proposed rule 
changes, and has considered carefully the comment letters submitted in 
response to these proposals, as well as the NYSE and NASD responses to 
the comment letters, and finds that the proposed rule changes are 
consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities exchange and 
national securities association, respectively. The Commission finds 
that the NYSE proposal is consistent with section 6(b)(5) of Act,\131\ 
which requires the rules of a national securities exchange to be 
designed to prevent fraudulent and manipulative act and practices, to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. Section 15A(b)(6) of the 
Act\132\ imposes the same requirement on a national securities 
association. The Commission also finds that the NASD proposal is 
consistent with section 15A(b)(6) of the Act.
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    \131\ 15 U.S.C. 78f(b)(5).
    \132\ 15 U.S.C. 78o-3(b)(6).
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    In addition, the Act specifically grants to SROs the authority to 
establish and enforce standards of financial responsibility among their 
members. Section 6(c)(3)(A) of the Act\133\ provides, among other 
things, for a national securities exchange to deny or condition 
membership privileges on compliance with the exchange's own financial 
responsibility rules. Section 15A(g)(3)(A) of the Act\134\ grants the 
same authority to national securities association. Pursuant to this 
authority, the SROs are authorized to promulgate rules governing the 
financial responsibility requirements of their members. The Commission 
finds that the NYSE proposal is consistent with goals of section 
15a(g)(3)(A) of the Act and the NASD proposal is consistent with the 
goals of section 15A(g)(3)(A) of the Act.
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    \133\ 15 U.S.C. 78f(c)(3)(A).
    \134\ 15 U.S.C. 78o-3(g)(3)(A).
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    The Commission finds that the NYSE and NASD proposals are designed 
to protect Pattern Day Traders, the firms where those traders have 
their accounts, and the markets on which they trade. The intra-day risk 
of substantial losses to both the customer and the firm increases in 
day trading accounts that do not have sufficient equity capital. 
Moreover, customers' and firms' reliance on cross-guarantees among 
customer accounts to meet margin requirements exacerbate these risks. 
These potential losses can be magnified if a sudden and substantial 
adverse movement were to occur in the prices of securities popular 
among day traders or in the markets as a whole. In the Commission's 
view, the integrity of U.S. financial markets will be better protected 
through appropriate margin and similar requirements on customers who 
engage in day trading practices.
    The proposed NYSE and NASD rules are not designed to prevent day 
trading, but to reduce the risk of financial losses by Pattern Day 
Traders and their firms. For example, by increasing the minimum equity 
requirement for Pattern Day Trades, the proposed rule help ensure that 
day traders have an appropriate amount of equity for the potential 
losses that may be incurred through day trading. Finally, the 
Commission finds that overall market integrity is increased by rules, 
such as those here proposed by the NYSE and NASD, that are designed to 
reduce excessive and unnecessary risk of financial loss to market 
participants.
    The Commission finds that the proposed definition of Pattern Day 
Trader takes a reasonable approach to specifying the type of trading 
activity for which the use of margin should be further regulated. In 
particular, the definition focuses on day trading behavior, while 
providing an exception for accounts where the number of day trades 
executed represents only a small percentage of all trading activity. 
The Commission finds that it is reasonable for the NYSE and NASD to use 
objective standards to identify and regulate accounts that may be at 
greatest risk as a result of day trading.
    The Commission also finds that the proposed Day Trading Minimum 
Equity Requirements strikes a balance between, and responds to, the 
diverging concerns of the various commenters on this issue. While there 
was a range of views regarding the dollar amount of equity that should 
be required in connection with day trading, the Commission finds that 
the proposed rule changes are designed to accomplish the objective of 
assuring the financial well-being of broker-dealers, which in turn 
promotes the integrity of the securities markets.
    Regarding the imposition of Day Trading Margin calls on Pattern Day 
Traders, the Commission notes that the proposed rules would impose 
relatively larger margin calls for accounts that have already generated 
but not yet satisfied a Day Trading Margin call. In those accounts, Day 
Trading Buying Power would be limited to a 2:1 ratio for leverage and 
Day Trading Margin would be calculated based on the aggregate cost of 
all day trades that occurred in a single day. The Commission finds that 
provisions would reduce Day Trading Buying Power, and those that would 
produce relatively larger Day Trading Margin calls for accounts already 
under restrictions, are in keeping with the NYSE and NASD's stated 
objectives of reducing risk by encouraging Pattern Day Traders to 
assume increased financial responsibility for their trading 
activities.\135\
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    \135\ For further discussion of Cross-Guarantees, see, Section 
II, supra. Description of the Proposed Rule Charges.
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    The Commission also finds that the proposed rule changes take 
reasonable steps to require investors who day trade to assume a greater 
obligation for the intra-day financial risks associated with Pattern 
Day Trading. The Commission observes, for example, that the use of 
Cross-Guarantees in the calculation of Day Trading Margin calls could 
dilute the impact of proposed provisions designed to encourage greater 
independent financial responsibility. The Commission finds that this 
approach is consistent with Regulation T, which does not permit initial 
margin requirements to be met through the use of a guarantee for a 
customer's account.\136\
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    \136\ 12 CFR 220.3(d).
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    Finally, the Commission recognizes the concerns of commenters 
regarding the burden on securities firms of implementing the proposed 
rules. The Commission understands that practical implementation of the 
proposed rules may require systems changes by firms. However, the 
Commission finds that, by the NYSE and NASD delaying the operative 
dates of the proposed rule changes for six months, there should be 
sufficient time for securities firms to institute measures for 
monitoring and enforcing the new rules and to bring any interpretive 
issues to the attention of the NYSE or NASD.
    The Commission finds good cause for approving Amendment No. 1 to 
the NYSE proposal and Amendment No. 1 to the NASD proposal prior to the

[[Page 13618]]

thirtieth day after the date of publication of notice of filing thereof 
in the Federal Register. Amendment No. 1 to the NYSE proposal ensures 
that the NYSE and NASD approaches to the regulation of day trading 
margin rules are consistent so that they can be applied and interpreted 
uniformly. Amendment No. 1 to the NASD's rule proposal also ensures 
that the NASD's and NYSE's approaches to the regulation of day trading 
are consistent and provides for additional time for firms to implement 
its proposed rule change. For these reasons, the Commission finds good 
cause for accelerating approval of both amendments.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the Amendment No. 1 to each proposed rule change, 
including whether they are consistent with the Act. Persons making 
written submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule changes between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Section. Copies of 
Amendment No. 1 to the NYSE proposed rule change will also be available 
for inspection and copying at the principal office of the NYSE. Copies 
of Amendment No. 1 to NASD proposed rule change will also be available 
for inspection and copying at the principal office of the NASD. All 
submissions should refer to File Nos. SR-NYSE-99-47 or SR-NASD-00-03 
and should be submitted by March 27, 2001.

VI. Conclusion

    It is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\137\ that the proposals SR-NYSE-99-47 and SR-NASD-00-03 as 
amended, be and hereby are approved.\138\
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    \137\ 15 U.S.C. 78s(b)(2).
    \138\ In approving the proposals, the Commission has considered 
their impact on efficiency, competition, and capital formation.

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-5402 Filed 3-5-01; 8:45 am]
BILLING CODE 6717-01-M