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[Fair Use: For Educational/Research Purposes Only] Day Trading: A Study in Temptation

By Ianthe Jeanne Dugan Washington Post Staff Writer

"I finally feel like I have control over my future," 30-year-old day trader Scott Webb wrote in a letter to his mother last year, a few months before he was killed in a shooting spree in Atlanta by fellow day trader Mark O. Barton.

Although he had failed as a stockbroker, Webb was passionate about stocks and had found his outlet executing rapid-fire buys and sells for his own account at Atlanta-based Momentum Securities Inc., becoming one of the thousands of people drawn to what has become known as day trading.

The rapid rise of this new kind of stock market speculation has yielded big profits for firms that cater to day traders and has also significantly increased trading volume, according to a report that will be released next week by the Senate Permanent Subcommittee on Investigations, which is holding two days of hearings starting today. Unlike the day-trading firms, though, most practitioners have lost money in their frenzy, the subcommittee concluded.

Webb borrowed tens of thousands of dollars to fund his unprofitable trading. He began to make money only when he started running classes for people who wanted to learn day-trading techniques.

By the time of the shooting that took his life, Webb had lost more than $40,000. His mother has filed a wrongful-death suit against Barton's estate and Momentum.

The Senate subcommittee began its investigation into day trading after the Barton shooting, and its report--a draft of which was obtained by The Washington Post--is the most detailed to date on the breadth and scope of day trading. It found that 15 of the largest firms in the field pulled in revenue last year of $541.5 million--276 percent more than in 1997. Profits spiraled to more than $66 million. Last year, those firms alone opened more than 12,000 new accounts.

The 4,000 to 5,000 most active traders are borrowing huge sums and losing money, the draft report said. On average, day traders pay commissions of $16 per trade and make 29 trades a day. That means the average day trader would need to pull in more than $111,000 a year in stock market gains just to break even.

"Day trading can be compared with certain types of gambling," said Sen. Susan Collins (R-Maine), chairman of the subcommittee.

The subcommittee's conclusions amplify those made in a less comprehensive report last August by the North American Securities Administrators Association, which represents state securities regulators. The investigation by Collins's team found cases of illegal activity, such as forgery and unauthorized trading, but the most dramatic problems stem from legal business practices. Rarely do firms disclose the risks of day trading, the subcommittee report argues. Many firms accept customers with no money and no experience and they encourage customers to lend one another money to meet margin calls, the demands for more cash to secure loans used to buy stocks, it added.

Momentum, which is one of the nation's largest and most reputable day-trading firms, is one of three case studies presented in the subcommittee draft report, which argues the nation needs tighter rules for the day-trading business. Regulators at the states, as well as the New York Stock Exchange and National Association of Securities Dealers, have also called for placing more restrictions on day-trading firms.

Jim Lee, Momentum's president, declined to comment publicly before testifying Friday. Harvey Houtkin, who founded All-Tech Direct Inc., another firm that's the subject of a case study, said that investigators are likely to focus on what he said were routine loans between his customers, and will also accuse him of lax reviews and misleading advertising.

Houtkin said day-trading firms are being unfairly targeted because they do not have the lobbying muscle of major Wall Street firms whose profits are being threatened by the software that lets day traders trawl for the best deal.

"Are colleges defrauding Americans by telling them if they come they'll be more successful?" Houtkin asked. "Not everyone comes out of college a success. If they fail, is it a scam?"

On Tuesday, the Securities and Exchange Commission sued All-Tech and seven associates for violating federal margin rules that allow traders to borrow 50 percent of the value of their stock purchases. The SEC alleges that throughout 1998, the firm made 103 unsecured loans to customers to meet margin calls totaling more than $3.6 million.

The margin loans, according to the Collins investigation, are pervasive. The loans are mainly extended to meet intra-day margin calls, even if traders' accounts are flat the next morning. The report argues that day-trading firms, motivated to get the trading dollars, often link borrowers to people with money to encourage them to keep trading.

"While there is nothing inherently improper with customers lending money to one another to satisfy margin calls, it is problematic for day-trading firms to encourage such lending when their revenue stream depends heavily on sustained customer trading," the draft report said.

While Momentum is "commended" for fair advertising, the investigators said that its customers routinely lent each other money. Of 2,128 customers, 103 last year had lent money to another customer to meet margin calls. Momentum, the draft report says, made a "concerted effort" in early 1999 to improve its standards and compliance program. But it maintains the firm has poor supervision in some branch offices--until recently they did not have branch manuals outlining company policy--that exposed customers such as Scott Webb to greater risk.

"How Scott Webb became a day trader at Momentum is a telling case study about the importance of determining the suitability of customers for this highly risky practice," Collins said.

Although Webb had not held a job in six months and had lost all his money day-trading at another firm, he claimed on a Momentum application in July 1998 that his annual income was $50,000. He left blank the boxes for net worth and "initial deposit." There is no evidence, the investigators said, that Webb followed Momentum's policy of having customers read and sign a disclosure form detailing the risks of day trading.

Momentum opened the accounts for Webb with $60,000 of borrowed money. Justin Hoehn, Webb's friend and fellow day trader, told investigators that Webb borrowed $30,000 from his father, Roy Webb, assuring him it would be used for a conservative trading strategy. Webb borrowed another $30,000 from a Momentum customer, Gerald Simpson, promising to return it with 18 percent interest.

Webb usually traded more than 60,000 shares and 100 tickets per day and was consistently getting margin calls. Documents show that Webb borrowed continually from Simpson--more than $100,000 sometimes--to meet the margin calls.

On the afternoon of July 29, Webb was sitting at a desk, training a new customer when Barton walked in and mumbled something about the market. Barton pulled out a gun and shot Webb dead.

End.

) 2000 The Washington Post Company

-- Zdude (zdude777@hotmail.com), February 24, 2000

Answers

For many of the day traders, it is merely a form of gambling...to which they become addicted.

-- Mad Monk (madmonk@hawaiian.net), February 24, 2000.

agreed. i think for the average citizen, it is gambling. only the stakes are unbelievably high. i can't believe how intrinsicly evil the financial/banking system is. i was listening to cliff on the International Intelligence Briefing last night as he explained Alan Greenspan, the Fed, banking, etc. so unbelievable how they control our country, economy, our daily lives, and they make money no matter which way it goes.

-- tt (cuddluppy@aol.com), February 25, 2000.

If you are going to gamble, racehorse handicapping is a lot more interesting. (Yes,I'm prejudiced! I raise thoroughbreds.)

-- morgan (bitbybit@eoni.com), February 25, 2000.