Regulators Suspect Some Firms of Shuffling Cash to Skirt Rules
What’s the worst-case scenario in day trading? It’s not a customer losing all the money in his or her account. It’s losing even more than that.
State securities regulators believe that some day-trading firms have concocted elaborate--and potentially illegal--maneuvers to dramatically boost how much stock their traders can buy. That greatly magnifies gains, but can trigger huge losses when bets go wrong.
“While certain of this activity may technically be within the letter of the law, it is not within the spirit” of the law, National Assn. of Securities Dealers Chairman Frank Zarb wrote in a letter to brokerage firms this month.
Specifically, regulators are concerned that some firms encourage traders to pool their money with other traders or with the firms themselves. Some of these arrangements are an apparent attempt to circumvent federal regulations limiting what’s known as “margin,” or the amount of stock that can be bought with borrowed money.
Normal leverage allows a trader to buy $1 of stock with 50 cents down and 50 cents borrowed.
In a lawsuit against one day-trading firm, Massachusetts regulators said a customer’s account was worth roughly $32,000, yet somehow generated more than $99 million worth of trades in a four-month period.
In the most egregious cases, regulators believe, money is shuffled around so that traders cover each other’s debts at the end of the day. That can mask improper activity from regulators who examine day-trading firms’ books.
In cases where traders blend their money with the firm’s, the traders may form so-called limited liability corporations. Legally, they’re no longer considered customers of the firm. Instead, they become partners.
Through arrangements the firms have with clearinghouses--separate companies that handle stock-trading paperwork--the traders then can gain access to enormous leverage.
How extensive these practices are at day-trading firms isn’t known. The NASD so far has merely issued warnings that it will be scrutinizing brokerages more carefully for possible abuses.
