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New margin rules likely
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November 19, 1999: 4:09 p.m. ET
NYSE changes affect day traders; other markets expected to follow
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - New margin rules may be on their way early next year that will make it easier for day traders to borrow against the money they have in their accounts.
But the rules make other, stricter stipulations about trading on margin, the process of trading securities on borrowed money, in an effort to curb any excesses by day traders and stop them from hurting themselves by trading too aggressively.
The board of the New York Stock Exchange approved more-liberal margin account rules for day traders Nov. 4. If approved by the Securities and Exchange Commission, the changes will increase the ratio that day traders use to borrow against the money they have in their account from 2:1 to 4:1.
In other words, if day traders have $100,000 in their account, they will be able to buy and trade securities worth up to $400,000. Currently, the most they would be able to day trade is $200,000 worth of stock.
The National Association of Securities Dealers, parent of the Nasdaq stock market, is expected to follow suit in establishing new, clearer margin rules in the near future.
"We have been working with the NASD on this for a number of months," said Ray Pellecchia, an NYSE spokesman. The exchange has not set a date for forwarding the proposed rules to the SEC but that will happen "soon," he said.
All the self-regulatory organizations that govern the various U.S. stock markets, such as those at the regional exchanges, are likely to file new margin rules with the SEC by year-end. After the SEC gets a rule proposal, it opens it for public comment, normally a period of 60 or 90 days. The SEC would then recommend any changes and decide whether to approve the new rules.
"We have been looking at this for some time," NASD spokeswoman Nancy Condon confirmed, adding that she could not go into detail until NASD's rule proposal was adopted by the NASD board.
The NYSE's new margin rules come in light of regulatory concern that day trading firms violate or circumvent margin rules. In particular, regulators fear day-trading companies allow and even encourage customers to lend money to each other if they run the risk of a "margin call," a request for them to sell stock or put more money in their account in order to meet credit demands.
In August, a state regulators' report found that such loans are common and "highly questionable," particularly when day trading firms are encouraging customers to trade beyond their means. But the legal framework for prosecuting such practices was far from clear, normally revolving around the idea that by arranging loans, the day-trading company is acting as an investment advisor of sorts.
Though the NYSE's proposed rules do not rule out such loans between customers, they would clarify what customers can and can't do. They would also require the loans to be held for at least two days. Most such loans are made overnight, so the rules would stop customers from circumventing margin policies that way.
Though the NYSE's proposal increases the amount of leverage a day trader can get during the day, it also imposes penalties on traders who violates the rules. Traders pushing the margin envelope will face a margin call on the value of all their positions during the day rather than their biggest position, as is normally the case now.
The NYSE has realized that holding a stock intraday is not as risky as taking overnight or long-term positions in a stock, said David Whitcomb, president and CEO of Automated Trading Desk Inc., a company that uses computer programs to day trade but does not have retail traders. The 4:1 margin limit is a return to days before the NYSE adopted its current rule in 1987 and makes sense to Whitcomb.
"The feeling is that day trading is not as high-risk an activity as taking a position and holding it for weeks, months or years," Whitcomb said. "The distance that a stock can move in one day is nowhere near as great."
Whitcomb admitted the timing of the new rules is peculiar, coming on the heels of the temporary closing of Harbor Securities, a New York-based day trading company, after it faced a margin call brought on by a rogue trader and customers who lent money to the trader. Harbor is a member of the Philadelphia Stock Exchange and covered by their margin rules.
But Whitcomb welcomes attempts to clarify margin rules that were originally written before the advent of retail day trading. Given computer technology, it is also easier to track margin positions in real time that were once tallied only at the end of the day.
If a trader is able to demonstrate the time and sale of positions, they will be able to use that to tally their margin position intraday. Otherwise they will be required to aggregate all their positions throughout the day, as if they still owned them all even if they have sold out of many, and will be limited to the 2:1 margin they have now.
The NYSE's rules also will set guidelines to clarify who is considered a day trader. The new rules, as they now stand, also will require day traders to keep a minimum balance of $25,000 in their account. That's an increase from a $2,000 minimum today.
If a day trader's equity drops below $25,000 at the end of the day, when the Federal Reserve requires them to settle any losses, they will have five business days to repay the deficit. Otherwise the day-trading company has to take the deficit as a loss. Any money a trader pays into their account to meet margin requirements will also have to stay in their account for the next two business days.
While a trader is under a margin call from NYSE rules, he or she will revert to having 2:1 buying power and will not be able to use "real time" -- or so-called "time and tick" -- accounting. Instead, the trader would have to tally all their positions throughout the day and calculate margin requirements from that.
If the day trader can't meet the margin call within five days, he or she will be limited to trading only with the cash they have in their account and will not have access to margin at all.
The NYSE's proposed rules define a day trader as a trader who has made four intraday trades within the last 12 months, up from three at the moment. Anyone who has made four intraday trades within the last five trading days would also be considered a day trader unless less than 6 percent of the trades were made on margin.
The intent of that definition is to capture both active, professional day traders and the growing number of sporadic active traders, who day trade a few times a month from home.
The NYSE also plans to stop day traders from using "cross-guarantee provisions" that allow them to aggregate the value of different accounts in meeting margin requirements. The $25,000 minimum and various margin rules would apply to each account that a day trader opens.
And overnight positions will also not be covered by the new rules on margin. They will continue to be governed by the Federal Reserve's policies on margin at the end of the day. That may hamper certain kinds of momentum traders who follow a stock's direction and like to buy a rising stock near the end of the day, hoping to hold it overnight and sell it at the opening of the next day's trading.
The overall intent of the rule changes is to clarify margin policies that have been confusing since the NYSE adopted new margin rules in 1987, day traders suggested. Some industry insiders commend attempts to ensure margin rules for different stock markets are the same.
Though the NASD adopted similar margin rules as the NYSE in April 1993, it did not adopt all the same interpretations of the rules. Many of the margin rules had been developed through interpretation, which the NYSE publishes for its members in an interpretation handbook.
"Very simply, the NASD and the NYSE are supposed to have identical rules. They don't," said Saul Cohen, chief counsel for the day trading trade group, the Electronic Traders Association.
Whitcomb said his company interpreted the NASD rules "very conservatively. We assume our customers only have 2:1 margin." But that has not been the case with all broker-dealers, he said.
Some NASD members that clear their own trades allowed customers to trade with 4:1 margin, interpreting the rules more liberally. In December the NASD tried to clarify the rule with a notice to members that ran over some gray areas in how to oversee the use of margin. But these new rules, if also proposed by the NASD and accepted by the SEC, should standardize margin policies.
The Federal Reserve Board is the ultimate arbiter of margin rules nationwide. The Fed stipulates that investors can only buy stock on borrowed, margin money equal to the equity they put up, a margin ratio of 2:1. But the Fed only requires margin investors to calculate their positions at the end of the trading day, meaning those rules are of little concern to day traders.
Broker-dealer companies also answer to the margin rules of the stock market at which they are a member, particularly when it comes to governing day traders. If a customer's broker-dealer is a member of Nasdaq, for instance, the customer will be governed by NASD rules.
Both day traders and regulators agree the margin laws have been confusing and need clarification, said Steven Levine, chief of credit regulation and national credit officer for Southwest Securities, which processes trades for day-trading companies, and special credit counsel to the ETA.
"Many of the so-called problems out there, there's no violation of existing margin rules," he said. For instance, a day trader with $100,000 could gain 4:1 leverage by margining the original sum to $200,000, then borrowing $100,000 from another customer and using that in a margin account, too.
Levine, who was assistant chief of credit regulation at the NYSE and helped write the NYSE's original margin rules in 1987, said the new rules will clarify how margin, a vital tool for day traders, can be used.
He has some reservations about the new rules - he thinks increasing the number of trades that classifies an investor as a day trader from three to four is unnecessary and may encourage unsuitable trading.
He also feels several of the policies discriminate against day traders. For instance, if they put cash in their accounts to meet margin calls, he doesn't see why it would have to stay in the account for the next two business days. Overnight margin positions are also allowed in options trading, he said, so he does not see why day traders who like to use that strategy would be limited in their access to margin.
But the rules are "not set in concrete," he pointed out, and will be revised in the SEC's comment period.
There are around 5,000 traders who go into the offices of day trading companies around the United States and trade professionally, according to the industry's trade group, the Electronic Traders Association.
They aim to make quick profits trading large blocks of shares for small, rapid gains, holding stock for a matter of minutes and profiting off small moves in the price. In theory they close "flat" at the end of the day, meaning they don't hold stock for longer than the trading day.
Because day traders buy large blocks of stock, almost all use margin to increase their buying power. But using margin proves a risky strategy if and when stocks start to move against traders, when they find their exposure increased. 
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