SEC Statement On Trading

Steer Clear of Investment Scams

SEC's Tips For On-line Investing

Washington, D.C., January 27, 1999

Chairman Arthur Levitt today issued the following statement to investors:

The Internet and other new technologies are in many ways transforming how our capital markets operate. There are clear benefits to these changes including lower costs and faster access to the market for investors. I believe that investors need to remember the investment basics, and not allow the ease and speed with which they can trade to lull them either into a false sense of security or encourage them to trade too quickly or too often.

Over the last two years, particularly in recent months, the SEC has been hearing concerns about retail, on-line (Internet) investing. In fact, the number of complaints concerning on-line investing has increased 330 percent in the last year. Some of the issues raised specifically relate to on-line trading, others are generic to all investing. The majority of them can be addressed through better education and investors ensuring that they have done their homework.

Every day, more and more Americans are investing in the stock market, and many of them are doing so through the Internet. On-line brokerage accounts account for approximately 25 percent of all retail stock trades. And, the number of on-line brokerage accounts is expected to exceed 10 million by the end of the year.

While the manner in which orders are executed may be changing, the time-honored principles of evaluating a stock have not. An investor's consideration of the fundamentals of a company - net earnings, P/E ratios, the products or services offered by the company - should never lose their underlying importance.

Investing in the stock market - however you do it and however easy it may be - will always entail risk. I would be very concerned if investors allow the ease with which they can make trades to shortcut or bypass the three golden rules for all investors: (1) Know what you are buying; (2) Know the ground rules under which you buy and sell a stock or bond; and (3) Know the level of risk you are undertaking. On-line investors should remember that it is just as easy, if not more, to lose money through the click of a button as it is to make it.

In recent months, we have begun to identify a number of issues every on-line investor should be aware of.

First, investors must understand the issues and limitations of on-line investing. You may occasionally experience delays on these new systems. Demand has grown so quickly that many firms are racing to keep pace with it. In the meantime, you may have trouble getting on-line or receiving timely confirmations of trade executions.

You should not always expect "instantaneous" execution and reporting. There can and will be delays in electronic systems. You should investigate and understand options and alternatives to executing and confirming your orders if you encounter on-line problems.

Second, investors may sometimes be surprised at how quickly stock prices actually move. For example, many technology stocks have recently had dramatic and rapid price movements. When many investors attempt to purchase (or sell) the same stock at the same time, the price can move very quickly. Just because you see a price on your computer screen doesn't mean that you will always be able to get that price in a rapidly changing market. You should take precautions to ensure that you do not end up paying much more for a stock than you intended or can afford.

One way to do this is to use limit orders rather than market orders when submitting a trade in a "hot" stock. The result for investors that do not limit their risk can be quite surprising. Say an investor wanted to buy a stock in an IPO that was trading earlier at $9.00 and failed to specify the maximum they were willing to pay using a limit order. That investor could end up paying whatever price the stock has moved to at the time his order reaches the market - $60, $90 or even more. If, on the other hand, the investor submitted a limit order to buy the stock at $11.00 or less, the order would only be executed if the market price had not moved past that level. Investors should understand the risk associated with trading in a rapidly moving market and make sure that they take all possible actions to control their risk.

Third, I am concerned that investors buying securities on margin may not fully understand the risks involved. In volatile markets, investors who have put up an initial margin payment for a stock may find themselves being required to provide additional cash (maintenance margin) if the price of the stock subsequently falls. If the funds are not paid in a timely manner, the brokerage firm has the right to sell the securities and charge any loss to the investor. When you buy stock on margin, you are borrowing money. And as the stock price changes, you may be required to increase the cash investment. Simply put, you should make sure that you do not over-extend.

Fourth, while new technology available to retail investors may resemble that of professional traders, retail investors should exercise caution before imitating the style of trading and risks undertaken by market professionals. For most individuals, the stock market should be used for investment not trading. Strategies such as day trading can be highly risky, and retail investors engaging in such activities should do so with funds they can afford to lose. I am very concerned when I hear of stories of student loan money, second mortgages or retirement funds being used to engage in this type of activity. Investment should be for the long-run, not for minutes or hours.

Millions of new investors have taken advantage of the unprecedented access and individual control the Internet provides. But, new opportunities present all of us with new responsibilities, challenges and risks. The SEC will do everything it can to protect and inform investors during this time of great innovation and change. But, investor protection - at its most basic and effective level - starts with the investor. I say to all investors - whether you invest on-line, on the phone, or in-person - know what you are buying, what the ground rules are, and what level of risk you are assuming.

The Securities and Exchange Commission warns that investment frauds usually fit one of the following categories:

* The Pyramid: Some on-line promoters claim you can do the impossible, like 'turn $5 into $60,000 in just three to six weeks.' Savvy investors know you can't. These offers are just electronic versions of the classic 'pyramid' scheme in which participants attempt to make money solely by recruiting new participants into the program. This SEC said this type of fraud is well-suited for the world of on- line computing because a con artist can easily send messages to a thousand people with the touch of a button. These 'investment opportunities' collapse when no new 'investors' can be found.

* The Risk-Free Fraud: 'Exciting, Low-Risk Investment Opportunities' to participate in exotic- sounding investments, including wireless cable projects, prime bank securities and eel farms, have been offered on-line. The SEC said one promoter attempted to get people to invest in a fictitious coconut plantation in Costa Rica, claiming the investment was 'similar to a CD, with a better interest rate.' Promoters misrepresent the risk by comparing their offer to something safe, like bank certificates of deposit. They aren't; in many cases, the 'investment product' doesn't even exist. It's just a scam.

* The 'Pump And Dump' Scam: Be wary of messages posted on-line urging you to buy a stock quickly. The messages may say the stock is poised for rapid growth, or warn you should sell before it goes down. Often the writer claims to have 'inside' information about an impending development. In reality, the promoter may be an insider who stands to gain by selling shares after the stock price is pumped up by gullible investors, or a short-seller who stands to gain if the price goes down.

What You Need to Know About Trading
In Fast-Moving Markets

The price of some stocks, especially recent "hot" IPOs and high tech stocks, can soar and drop suddenly. In these fast markets when many investors want to trade at the same time and prices change quickly, delays can develop across the board. Executions and confirmations slow down, while reports of prices lag behind actual prices. In these markets, investors can suffer unexpected losses very quickly.

Investors trading over the Internet or online, who are used to instant access to their accounts and near instantaneous executions of their trades, especially need to understand how they can protect themselves in fast-moving markets.

You can limit your losses in fast-moving markets if you know what you are buying and the risks of your investment; and know how trading changes during fast markets and take additional steps to guard against the typical problems investors face in these markets.

With a click of mouse, you can buy and sell stocks from more than 100 online brokers offering executions as low as $5 per transaction. Although online trading saves investors time and money, it does not take the homework out of making investment decisions. You may be able to make a trade in a nanosecond, but making wise investment decisions takes time. Before you trade, know why you are buying or selling, and the risk of your investment.

To avoid buying or selling a stock at a price higher or lower than you wanted, you need to place a limit order rather than a market order. A limit order is an order to buy or sell a security at a specific price. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. When you place a market order, you can't control the price at which your order will be filled.

For example, if you want to buy the stock of a "hot" IPO that was initially offered at $9, but don't want to end up paying more than $20 for the stock, you can place a limit order to buy the stock at any price up to $20. By entering a limit order rather than a market order, you will not be caught buying the stock at $90 and then suffering immediate losses as the stock drops later in the day or the weeks ahead.

Remember that your limit order may never be executed because the market price may quickly surpass your limit before your order can be filled. But by using a limit order you also protect yourself from buying the stock at too high a price.

Investors may find that technological "choke points" can slow or prevent their orders from reaching an online firm. For example, problems can occur where:

- an investor's modem, computer, or Internet Service Provider is slow or faulty;

- a broker-dealer has inadequate hardware or its Internet Service Provider is slow or delayed; or

- traffic on the Internet is heavy, slowing down overall usage.

A capacity problem or limitation at any of these choke points can cause a delay or failure in an investor's attempt to access an online firm's automated trading system.

Most online trading firms offer alternatives for placing trades. These alternatives may include touch-tone telephone trades, faxing your order, or doing it the low-tech way--talking to a broker over the phone. Make sure you know whether using these different options may increase your costs. And remember, if you experience delays getting online, you may experience similar delays when you turn to one of these alternatives.

Some investors have mistakenly assumed that their orders have not been executed and place another order. They end up either owning twice as much stock as they could afford or wanted, or with sell orders, selling stock they do not own. Talk with your firm about how you should handle a situation where you are unsure if your original order was executed.

If you cancel an order, make sure the cancellation worked before placing another trade

When you cancel an online trade, it is important to make sure that your original transaction was not executed. Although you may receive an electronic receipt for the cancellation, don't assume that that means the trade was canceled. Orders can only be canceled if they have not been executed. Ask your firm about how you should check to see if a cancellation order actually worked.

In a cash account, you must pay for the purchase of a stock before you sell it. If you buy and sell a stock before paying for it, you are freeriding, which violates the credit extension provisions of the Federal Reserve Board. If you freeride, your broker must "freeze" your account for 90 days. You can still trade during the freeze, but you must fully pay for any purchase on the date you trade while the freeze is in effect.

You can avoid the freeze if you fully pay for the stock within five days from the date of the purchase with funds that do not come from the sale of the stock. You can always ask your broker for an extension or waiver, but you may not get it.

If you trade on margin, your broker can sell your securities without giving you a margin call

Now is the time to reread your margin agreement and pay attention to the fine print. If your account has fallen below the firm's maintenance margin requirement, your broker has the legal right to sell your securities at any time without consulting you first.

Some investors have been rudely surprised that "margin calls" are a courtesy, not a requirement. Brokers are not required to make margin calls to their customers.

Even when your broker offers you time to put more cash or securities into your account to meet a margin call, the broker can act without waiting for you to meet the call. In a rapidly declining market your broker can sell your entire margin account at a substantial loss to you, because the securities in the account have declined in value.

There are no Securities and Exchange Commission regulations that require a trade to be executed within a set period of time. But if firms advertise their speed of execution, they must not exaggerate or fail to tell investors about the possibility of significant delays.

For more information on online trading problems, read SEC Chairman Arthur Levitt's message to investors, and the National Association of Securities Dealers' Notice to Members 99-11, dealing with online trading.

Are you gambling? Or Investing? The Connecticut Council on Problem Gambling has a quiz you can take to help you decide if you have a problem, and suggests where you can go for help.

What To Do If You Have a Complaint

Act promptly. By law, you only have a limited time to take legal action. Follow these steps to solve your problem:

1. Talk to your broker or online firm and ask for an explanation. Take notes of the answers you receive.

2. If you are dissatisfied with the response and believe that you have been treated unfairly, ask to talk with the broker's branch manager. In the case of an online firm, go directly to step number three.

3. If you are still dissatisfied, write to the compliance department at the firm's main office. Explain your problem clearly, and tell the firm how you want it resolved. Ask the compliance office to respond to you in writing within 30 days.

4. If you're still dissatisfied, then send a letter of complaint to the National Association of Securities Dealers, your state securities administrator, or to the Office of Investor Education and Assistance at the SEC along with copies of the letters you've sent already to the firm.