Securities Operations:

Day Trading Requires Continued Oversight

GGD-00-61: Published: Feb 24, 2000. Publicly Released: Feb 24, 2000.

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Pursuant to a congressional request, GAO reviewed day trading, focusing on: (1) the nature and extent of day trading; (2) regulatory actions taken to address the day trading risks; and (3) the actions day trading firms have taken to address regulatory concerns.

GAO noted that: (1) day trading among less experienced investors is an evolving segment of the securities industry; (2) day traders, who represent less than one-tenth of 1 percent of all individuals who bought or sold securities, accounted for a growing part of trading on Nasdaq, estimated by industry officials to be about 10 to 15 percent of Nasdaq volume; (3) these traders all did their trading at specialized day trading firms, but the firms employed various structures and operating strategies that affected the risks the traders faced; (4) some firms encouraged any individual who wanted to be a day trader, and had the capital to begin trading, to use the firm's systems and facilities to trade, risking the trader's own capital; (5) others emphasized that they wanted only people who were qualified and able to be professional traders to trade, risking the firms' capital; (6) these traders could be fired if they suffered significant loss, but they do not lose their own capital; (7) some firms employed a combination or variations of these strategies; (8) the effects of day trading on both individuals who engage in it and the markets as a whole are uncertain; (9) federal regulators have taken some actions to address the risks of day trading; (10) the regulatory arm of the National Association of Securities Dealers (NASD), called NASD Regulation (NASDR), and the Securities and Exchange Commission (SEC) have made a special effort to target their examination resources during the last 2 years on day trading firms, performing 67 examinations of day trading firms and their branches; (11) the rule violations found most frequently in their examinations of firms related to supervisory procedures, net capital computations, and advertising; (12) they also found violations involving margin and lending issues; (13) NASDR has recently submitted proposed rule changes to SEC that require day trading firms to assess the appropriateness of day trading for each potential customer and to fully disclose the risks of day trading; (14) NASDR and the New York Stock Exchange have also submitted proposed rule changes to SEC to tighten margin requirements; (15) some of the day trading firms GAO visited recognized these regulatory concerns and told GAO that they have already taken steps to provide better disclosure, screen prospective traders, and restrict certain activities, such as customer-to-customer lending; and (16) determining the adequacy and extent of oral disclosures, screening, and planned restrictions presents a difficult challenge because neither the regulators nor GAO could directly observe the interactions between the firms and traders or potential traders.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: In March 2004, SEC issued a wide-ranging proposal on market structure issues that could result in significant changes to the functioning of the markets, including changes to tick sizes, order routing rules, ECN access fees, etc. Any changes SEC makes in these areas could affect the impact of day traders on the markets. However, SEC officials said that the number of day traders has significantly declined and they had no plans to conduct a study.

    Recommendation: Because the effects of day trading in an environment that depends less on the Small Order Executive System and more on electronic communications networks (ECN) are uncertain, the Chairman, SEC, in conjunction with NASD, should evaluate the implications of the growing use of ECNs by day traders on the integrity of the markets. GAO recognizes that major changes are occurring in the structure of securities markets, especially the change to decimal trading, and recommends that the evaluation of day trading begin after decimal trading is implemented.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: SEC and NASD have continued to examine day trading firms. Specifically, they followed up on the previous exam findings and completed examinations for the other identified firms that had not been examined. SEC will continue to do cause examinations as necessary, and NASD will continue to examine day trading firms on a routine basis.

    Recommendation: Day trading is risky for individual investors, represents a large and growing portion of the Nasdaq trading volume, and is an evolving part of the securities industry. Therefore, the Chairman, SEC, should do at least one more cycle of targeted examinations of day trading firms to ensure that firms take the corrective actions they propose in response to previous examination findings.

    Agency Affected: United States Securities and Exchange Commission

 

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