[Federal Register Volume 67, Number 124 (Thursday, June 27, 2002)]
[Notices]
[Pages 43364-43367]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-16257]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46097; File No. SR-NASD-2002-69]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Posting of Margin Disclosure and Day-Trading Risk Disclosure Statements 
on Web Sites

June 20, 2002.
    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 May 30, 2002, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its wholly owned subsidiary, 
NASD Regulation, Inc. (``NASD Regulation''), filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by NASD Regulation. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD Regulation is proposing to amend NASD Rules 2341 and 2361 to 
require the posting of certain investor disclosure statements on 
members' Web sites. Specifically, the proposed rule change would amend: 
(1) Rule 2341 (Margin Disclosure Statement) to require members that 
permit customers to open accounts on-line or to engage in transactions 
in securities on-line to post the margin disclosure statement on their 
Web sites; and (2) Rule 2361 (Day-Trading Risk Disclosure Statement) to 
require members that promote a day-trading strategy to post the day-
trading risk disclosure statement on their Web sites. Below is the text 
of the proposed rule change. Proposed new language is in italics; 
proposed deletions are in brackets.
2341. Margin Disclosure Statement
    (a) No member shall open a margin account, as specified in 
Regulation T of the Board of Governors of the Federal Reserve System, 
for or on behalf of a non-institutional customer, unless, prior to or 
at the time of opening the account, the member has furnished to the 
customer, individually, in writing or electronically, and in a separate 
document, the [following] margin disclosure statement[:] specified in 
this paragraph (a). In addition, any member that permits non-
institutional customers either to open accounts on-line or to engage in 
transactions in securities on-line must post such margin disclosure 
statement on the member's Web site in a clear and conspicuous manner.

Margin Disclosure Statement

    Your brokerage firm is furnishing this document to you to provide 
some basic facts about purchasing securities on margin, and to alert 
you to the risks involved with trading securities in a margin account. 
Before trading stocks in a margin account, you should carefully review 
the margin agreement provided by your firm. Consult your firm regarding 
any questions or concerns you may have with your margin accounts.
    When you purchase securities, you may pay for the securities in 
full or you may borrow part of the purchase price from your brokerage 
firm. If you choose to borrow funds from your firm, you will open a 
margin account with the firm. The securities purchased are the firm's 
collateral for the loan to you. If the securities in your account 
decline in value, so does the value of the collateral supporting your 
loan, and, as a result, the firm can take action, such as issue a 
margin call and/or sell securities or other assets in any of your 
accounts held with the member, in order to maintain the required equity 
in the account.
    It is important that you fully understand the risks involved in 
trading securities on margin. These risks include the following:
     You can lose more funds than you deposit in the margin 
account. A decline in the value of securities that are purchased on 
margin may require you to provide additional funds to the firm that has 
made the loan to avoid the forced sale of those securities or other 
securities or assets in your account(s).
     The firm can force the sale of securities or other assets 
in your account(s). If the equity in your account falls below the 
maintenance margin requirements, or the firm's higher ``house'' 
requirements, the firm can sell the securities or other assets in any 
of your account held at the firm to cover the margin deficiency. You 
also will be responsible for any short fall in the account after such a 
sale.
     The firm can sell your securities or other assets without 
contacting you. Some investors mistakenly believe that a firm must 
contact them for a margin call to be valid, and that the firm cannot 
liquidate securities or other assets in their accounts to meet the call 
unless the firm has contacted them first. This is not the case. Most 
firms will attempt to notify their customers of margin calls, but they 
are not required to do so. However, even if a firm has contacted a 
customer and provided a specific date by which the customer can meet a 
margin call, the firm can still take necessary steps to protect its 
financial interests, including immediately selling the securities 
without notice to the customer.
     You are not entitled to choose which securities or other 
assets in your account(s) are liquidated or sold to meet a margin call. 
Because the securities are

[[Page 43365]]

collateral for the margin loan, the firm has the right to decide which 
security to sell in order to protect its interests.
     The firm can increase its ``house'' maintenance margin 
requirements at any time and is not required to provide you advance 
written notice. These changes in firm policy often take effect 
immediately and may result in the issuance of a maintenance margin 
call. Your failure to satisfy the call may cause the member to 
liquidate or sell securities in your account(s).
     You are not entitled to an extension of time on a margin 
call. While an extension of time to meet margin requirements may be 
available to customers under certain conditions, a customer does not 
have a right to the extension.
* * * * *
    (c) In lieu of providing the disclosures specified in paragraphs 
(a) and (b), a member may provide to the customer and, to the extent 
required under paragraph (a) post on its Web site, an alternative 
disclosure statement, provided that the alternative disclosures shall 
be substantially similar to the disclosures specified in paragraphs (a) 
and (b).
* * * * *
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 each customer, 
individually, in writing or electronically, the [following] disclosure 
statement[:] specified in this paragraph (a). In addition, any member 
that is promoting a day-trading strategy, directly or indirectly, must 
post such disclosure statement on the member's Web site in a clear and 
conspicuous manner.

Day-Trading Risk 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 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. Further, certain evidence indicates that an investment 
of less than $50,000 will significantly impair the ability of a day 
trader to make a profit. Of course, an investment of $50,000 or more 
will in no way guarantee success.
    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 will generate substantial commissions, even if the per 
trade cost is low. Day-trading involves aggressive trading, and 
generally you will pay commissions on each trade. The total daily 
commissions that you pay on your trades will add to your losses or 
significantly reduce your earnings. For instance, assuming that a trade 
costs $16 and an average of 29 transactions are conducted per day, an 
investor would need to generate an annual profit of $111,360 just to 
cover commission expenses.
    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.
    Potential Registration Requirements. Persons providing investment 
advice for others or managing securities accounts for others may need 
to register as either an ``Investment Advisor'' under the Investment 
Advisors Act of 1940 or as a ``Broker'' or ``Dealer'' under the 
Securities Exchange Act of 1934. Such activities may also trigger state 
registration requirements.
    (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, and post on its Web site, 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 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.
* * * * *

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

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

[[Page 43366]]

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

1. Purpose
Introduction
    Rules 2341 and 2361 were developed to provide investors with 
additional and specific risk disclosures concerning margin and day-
trading, respectively. Rule 2341, which was adopted in April 2001,\3\ 
is designed to provide investors with information concerning the 
operation and risks associated with margin trading. NASD Regulation 
believed that investors' misconceptions about margin requirements, 
particularly with respect to maintenance margin, could cause investors 
to underestimate the risks of margin trading and to misunderstand the 
operation of and reasons for margin calls. Accordingly, NASD Regulation 
adopted Rule 2341 requiring members to deliver to non-institutional 
customers a specified disclosure statement that discusses the operation 
of margin accounts and the risks associated with trading on margin. 
Each member is required to deliver the margin disclosure statement to 
the customer prior to or at the opening of a margin account. Rule 2341 
also requires that the margin disclosure statement, or an abbreviated 
version of the statement as set forth in the Rule, be provided to 
margin customers annually.
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    \3\ See Securities Exchange Act Release No. 44223 (April 26, 
2001), 66 FR 22274 (May 3, 2001).
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    Rule 2361, which was adopted in July 2000,\4\ is designed to 
provide investors with information concerning unique risks arising from 
day-trading activities. Rule 2361 requires firms promoting a day-
trading strategy to provide their non-institutional customers with a 
day-trading risk disclosure statement prior to opening an account. The 
day-trading risk disclosure statement discusses 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.
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    \4\ See Securities Exchange Act Release No. 43021 (July 10, 
2000), 65 FR 44408 (July 17, 2000).
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    Both Rules further permit member firms to develop an alternative 
disclosure statement substantially similar to the ones provided in the 
Rules. In the case of Rule 2361, the alternate day-trading risk 
disclosure statement must be filed with, and approved by, NASD 
Regulation's Advertising Department.
Posting of Disclosure Statements on Web Sites
    While Rules 2341 and 2361 currently require that the disclosure 
statements be delivered individually to each covered customer, either 
in writing or electronically, the Rules do not require firms to post 
the statements on their Web sites. Rather, in developing Rules 2341 and 
2361, NASD Regulation focused on ensuring that each individual investor 
received the required risk disclosure statements. NASD Regulation 
believed that mandating specific delivery of the risk disclosure 
statements would be the most effective means of ensuring that customers 
received the required disclosures.
    In 2001, following the adoption of Rule 2341 and Rule 2361, the 
General Accounting Office (``GAO'') issued a report that discusses, 
among other things, actions taken by securities industry regulators to 
address on-line trading issues.\5\ The 2001 GAO Report recognized that 
Rules 2341 and 2361 require broker/dealers to furnish investors with 
certain key investor protection disclosures. It also noted that the 
margin disclosure statement required under Rule 2341 provides 
substantial information that is very helpful to investors to understand 
the risks of trading on margin. The GAO expressed concern, however, 
that while customers covered by Rules 2341 and 2361 were receiving the 
margin and day-trading risk disclosure statements, additional benefits 
could be achieved if the disclosures also were provided on-line, noting 
that many investors who trade on-line may prefer to review information 
in that medium and that a Web site posing also would make the 
information available to other on-line investors who are thinking about 
engaging in the activities covered by the disclosure statements. In 
this regard, the 2001 GAO Report recommended that the SEC take steps to 
ensure broker/dealers disclose additional information on their Web 
sites regarding, among other things, margin requirements and trading 
risks.\6\
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    \5\ See On-Line Trading, Investor Protections Have Improved but 
Continued Attention is Needed, Report to Congressional Requesters, 
GAO, 01-858 (July 2001) (the ``2001 GAO Report''). The 2001 GAO 
Report is a follow-up to a GAO report issued in 2000 (On-Line 
Trading, Better Investor Protection Information Needed on Brokers' 
Web Sites, Report to Congressional Requesters, GAO, General 
Government Division, 00-43 (May 2000) (the ``2000 GAO Report'')) 
that examined how on-line broker/dealers addressed investor 
protection issues.
    \6\ Similarly, noting that the SEC has determined from customer 
complaints it has received that many investors who traded on-line 
did not understand margin requirements and may not understand the 
risks they are taking or the rules and procedures for trading, the 
2000 GAO Report also recommended that the SEC ensure that broker/
dealers with on-line trading systems include certain investor 
protection information on their Web sites.
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    While many firms currently post the margin and day-trading risk 
disclosure statements on their Web sites on a voluntary basis, NASD 
Regulation believes that the investing public could further benefit 
from the information contained in the statements if additional on-line 
and day-trading firms were to post them on their Web sites. 
Accordingly, NASD Regulation is proposing this rule change which will 
address the GAO's recommendations and enable a broader array of persons 
to review the information regarding margin requirements and day-trading 
risks contained in the mandated disclosure statements.
    Consistent with the general recommendations raised in the GAO 
Reports, the proposed rule change would amend: (1) Rule 2341 to require 
member firms that permit customers to open accounts on-line or to 
engage in transactions in securities on-line to post the margin 
disclosure statement on their Web sites; and (2) Rule 2361 to require 
member firms that promote a day-trading strategy, directly or 
indirectly, to post the day-trading risk disclosure statement on their 
Web sites. The firms would be required to post the statements specified 
in Rules 2341 or 2361, as applicable, or the alternate statements 
permitted by the Rules. Under the proposal, the disclosure statements 
must be displayed on the Web site in a ``clear and conspicuous 
manner,'' or in a clearly identified location that is readily 
accessible to investors. While compliance with the ``clear and 
conspicuous'' standard would be based on the facts and circumstances 
surrounding each member's Web site, NASD Regulation's primary concern 
is that firms not post the disclosure statements in a remote place on 
their Web sites, where investors or potential investors would be 
unlikely to locate them.
    Importantly, the proposed rule change does not affect a member 
firm's existing requirements under Rules 2341 and 2361 to deliver 
individually to each customer covered by the Rules, either in writing 
or electronically, the disclosure statements mandated under the Rules. 
In addition, while NASD Regulation is not at this time proposing to 
require on-line firms that do not promote a day-trading strategy as 
defined in Rule 2361 to post the day-trading risk disclosure statement 
in addition to the margin disclosure statement on their Web sites, NASD 
Regulation encourages all on-line

[[Page 43367]]

firms to do so. NASD Regulation believes that on-line traders may 
benefit from the information provided in the day-trading risk 
disclosure statement regardless of whether the on-line firm whose Web 
site the trader is visiting or using promotes a day-trading strategy.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act, which 
requires, among other things, that the Association's rules must be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. NASD Regulation believes 
that the proposed rule change requiring certain member firms to post 
the margin disclosure and day-trading risk disclosure statements on 
their Web sites will help protect investors and the public interest in 
a trading environment where increasing numbers of investors are trading 
on-line or accessing broker/dealers through Web sites.

B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed rule change 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

    Written comments were neither solicited nor received.

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

    The proposed rule change has been filed by the Association as a 
``non-controversial'' rule change under Section 19(b)(3)(A) of the 
Act,\7\ and Rule 19b-4(f)(6) thereunder.\8\ Because the foregoing 
proposed rule change: (1) Does not significantly affect the protection 
of investors or the public interest; (2) does not impose any 
significant burden on competition; and (3) does not become operative 
for 30 days after the date of filing, or such shorter time as the 
Commission may designate if consistent with the protection of investors 
and the public interest, provided that NASD Regulation has given the 
Commission written notice of its intent to file the proposed rule 
change, along with a brief description and text of the proposed rule 
change, at least five business days prior to the date of filing of the 
proposed rule change, or such shorter time as designated by the 
Commission, the proposed rule change has become effective pursuant to 
Section 19(b)(3)(A) of the Act \9\ thereunder.\10\
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    \7\ 15 U.S.C. 78s(b)(3)(A).
    \8\ 17 CFR 240.19b-4(f)(6).
    \9\ 15 U.S.C. 78(b)(3)(A).
    \10\ 17 CFR 240.19b-4(f)(6).
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    A proposed rule change filed under Rule 19b-4(f)(6) \11\ requires 
that a self-regulatory organization give the Commission written notice 
of its intent to file the proposed rule change, along with a brief 
description and text of the proposed rule change, at least five 
business days prior to the date of filing the proposed rule change. 
However, Rule 19b-4(f)(6)(iii) \12\ permits the Commission to designate 
a shorter time. NASD Regulation seeks to have the five-business-day 
pre-filing requirement waived with respect to the proposed rule change. 
The Commission has determined to waive the five-business-day pre-filing 
requirement. The Commission notes that NASD proposes to make the 
proposed rule change operative on July 1, 2002.
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    \11\ 17 CFR 240.19b-4(f)(6).
    \12\ 17 CFR 240.19b-4(f)(6)(iii).
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    At any time within 60 days of this filing, the Commission may 
summarily abrogate this proposal if it appears to the Commission that 
such action is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
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-2002-69 and 
should be submitted by July 18, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-16257 Filed 6-26-02; 8:45 am]
BILLING CODE 8010-01-P