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The end of the millennium has further demonstrated the changes
that are in store for the brokerage industry in the start
of the new millennium. Last month I took a look forward, but
since writing that column in November, two significant events
have occurred.
The first was the release on November 22, 1999 by SEC Commissioner
Laura S. Unger of a 95 page report summarizing the findings
from a series of on-line investing roundtables conducted during
1999. The second was a speech given by SEC Chairman Arthur
Levitt at The Economic Club of New York, New York City, the
text of which was publicly available in December. Both the
Unger report and the Levitt speech give clear details of what
is in store for the financial markets, and thus the brokerage
community in the coming months and years.
The Unger report raises a number of issues, but one of the
most significant is the concept of a suitability requirement
for discount and online brokers, who do not offer investment
advice. Until now, the only true suitability requirement has
been placed upon brokers who provide investment advice, and
a requirement that brokers know their customer. Discussions
regarding a requirement for a suitability determination by
every brokerage firm in the area of day trading have been
proposed, and are moving towards approval. The expanded use
of margin by customers who are not relying upon a broker for
advice is also causing concern, and suitability regulations
are being proposed, for all brokerage firms which permit their
customers to day-trade, or using margin. It appears that there
are far too many people day trading, and losing money at the
discount brokers, and an apparently significant number of
people using margin who do not have a clue as to the importance
of the downside of a leveraged transaction.
The significance of these proposals are clear – the Commission
is not going to continue to let the country's financial institutions
turn a blind eye to the 65 year old widow who has decided
that now is a good time to day trade the hottest Internet
stock on margin The question of whether the government should
be stopping people from making stupid mistakes because of
the lure of day trading, enhanced by margin leverage and a
$7.00 commission, is better left to another column, and some
will surely suggest that such individuals are fools who deserve
what they get. However, a more practical view is that the
vast rise in the markets, our 14 years of a bull market, and
$7.00 commissions have lulled inexperienced investors into
the belief that day trading, margin trading, and speculation
as a whole are easy money items, that can make anyone rich.
The Unger Report also raised question of the impact of technology
on the on-line firms' performance and evaluation of their
best execution obligations; the impact of investor demand
for market information impacted the pricing of real-time data;
the hardware and software demands resulting from online trading;
education of online investors; real time chat forums where
securities are discussed, and pumped, in real time, across
the world, and even compensation of Internet portals who are
directing investors to the online firms. The report recommends
that the full Commission look into placing some type of suitability
requirement upon online brokerage firms; enhancing the obligation
of broker/dealers to obtain the best execution for their customers,
and to educate consumers regarding best execution obligations;
as well as other aspects of online executions and orders,
including system capacity, delivery of market data, chat rooms,
and investor education.
Chairman Levitt's speech provides further insight into the
problems in the markets as viewed by the Commission, and the
proposals for change that are being considered. Chairman Levitt
stressed the quality of the markets, and with a broad brush
took aim at varied aspects of the financial markets, and varied
participants in those markets, including issuers, broker-dealers,
investors, and, in something of a surprise, analysts.
A significant point raised by the Chairman is the quality
and integrity of financial reporting. All market participants
rely upon the integrity of the information reported to the
SEC by issuers, as the financial information is the basis
upon which most valuations are, or should, be performed. Chairman
Levitt is raising the concern for the integrity of that reporting
in recent months, and, in his words, the "gradual, but perceptible,
erosion in the quality of financial reporting.
The motivation to satisfy Wall Street earnings expectations
was beginning to override long established precepts of financial
reporting and ethical restraint. A culture of gamesmanship
over the numbers was not only emerging, but weaving itself
into the fabric of accepted conduct." While Chairman Levitt
was chastising issuers for reporting for the analysts, he
took an equal, if not more critical mark on the analysts themselves.
One does not have to be a broker or serious investor to understand
the issues being raised regarding analysts, earnings projections
and whisper numbers. Aren't whisper numbers just another form
of inside information? Where did that whisper number come
from, if not from an insider of the company? Or, when a company
misses its quarterly earning projections by a penny, why is
it that the stock pummels percentage points in a matter of
minutes? Or, why does it do so when it meets the projections?
According to Chairman Levitt the answers to these questions
are in the relationship between analysts and issuers, and
how they interact with each other. While not directly suggesting
new rules and regulations, he hints that new regulations may
be in the works, and he urged financial professionals to recommit
themselves to integrity and quality, and promised increased
oversight in the area of the quality of information. Coupled
with Commissioner Unger's report, we can expect a very interesting
2000.
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Mark J. Astarita is a securities attorney and partner in
the law firm of Beam & Astarita, LLC, representing financial
professionals in litigation and regulatory matters. He is
the founder of The Securities Law Home Page (www.seclaw.com)
and can be reached at astarita@seclaw.com
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