NASD NOTICE TO
MEMBERS 99-11:
VOLATILITY AND ONLINE TRADING
The honeymoon between online BDs and their clients is over. The
dangerous combination of record trading volume and increased price volatility, especially
with Internet issuers, has resulted in large order imbalances, systems queues, and
backlogs. During such extreme market conditions, firms often implement procedures designed
to ensure the continuous execution of customers' orders while also lessening the exposure
of the firm to extraordinary market risk. Some Market Makers temporarily discontinued
normal automatic order executions, handled orders manually, and reduced their size
guarantees on individual stocks or groups of stocks (i.e., stocks of Internet issuers).
Unfortunately such practices may have resulted in delays in order executions and
executions at prices significantly away from the market price quoted at the time of order
entry. These executions led to market losses caused by executions at prices higher or
lower than customers expected, especially with respect to orders placed over the Internet.
In an effort to pointedly warn online firms of their obligations to properly service their
accounts, NASD Regulation (NASDR) issued Notice to Members 99-11 (NTM).
Disclosure
DELAYS:high volumes of trading may cause delays
in execution and executions at prices significantly away from the market price quoted or
displayed at the time the order was entered.
| EXPLAIN TO CUSTOMERShow order executions are handled by Market Makers
that Market Makers may execute orders manually or reduce their size guarantees
during periods of volatility, resulting in possible delays in order execution and losses
|
TYPES OF ORDERS:Customers unfamiliar with the
relative benefits and risks of market and limit orders fail to enter orders better suited
for volatile markets.
EXPLAIN TO CUSTOMERSthat market orders are fully and promptly executed without regard to
price and that the fill may be at a price significantly different from the current quoted
price
that limit orders will be executed only at a specified price or better and
that, while the customer receives price protection, there is the possibility that the
order will not be executed
that market orders (in distinction to limit orders) for initial
public offering securities trading in the secondary market, particularly "hot
stocks," increases the risk of receiving an execution substantially away from the
quoted market price
|
ACCESS: online customers experience incur losses
when they are unable to access their accounts. During periods of volatility, all customers
may experience delays or system outages preventing telephone access to an account
representative.
EXPLAIN TO CUSTOMERSthe difficulties they may experience, either online or through telephone,
accessing their accounts or their representative
what circumstances will likely increase such difficulties
- the firm's procedures for responding to these access problems
|
THE
WARNING!!! You cannot simply respond to online or market pressures with
ill-conceived measures. NASDR specifically cautions that the disclosure of procedures that
are unfair, inconsistent, or unreasonable would not be deemed appropriate.
THE THREAT? Seems pretty clear: enforcement
action against non-compliant members.
Communications With The Public
The NTM cautions firms against using advertisements or sales literature
that exaggerate the member's capabilities or which omit the risks of trading and the
possibilities of delayed executions. Members are warned about the necessity to have the
systems capacity to support any claims they make about their trading services.
AND OUT THERE IN THE REAL WORLD
The NTM provides several examples of measures undertaken at
member firms in response to volatile markets. Under the circumstances, readers should take
careful note of the policies and procedures described, and consider implementing them
where appropriate.
Hot IPOs And Hot Stocks
Practice: A number of Market Makers discontinue their normal automatic
execution of orders and began handling orders manually. Firms also reduced their size
guarantees on individual stocks or groups of stocks.
Problem: This in turn led to delays in order executions, executions at
prices significantly away from the market quoted at the time the order was entered, and
delays in execution confirmations and cancellation reports.
| Order-Entry Firms' Responses:
Halt on-line trading of hot IPOs and stocks (usually
for short periods of time not greater than one day), requiring customers to purchase these
securities through a registered representative, either in person or via the telephone.
Decline to accept market orders for hot IPOs, requiring customers who wish to
buy these stocks to enter a limit order specifying the highest price they would pay for
these issues.
Decline to accept any orders for IPOs forecasted to be hot until secondary
trading begins.
Contact clients who have placed orders on IPOs that look to be volatile.
Alert customers to restrictions through Web site notices.
|
Margin
Some online firms raised the amount of equity
that must be maintained in margin accounts (maintenance margin) for long positions in
certain volatile stocks to between 40 percent and 100 percent. This increase is from the
25 percent maintenance margin required by NASD and stock exchange rules or the 30 percent
to 35 percent maintenance margin required by many firms. This practice attempts to ensure
that the equity in a customer's margin account is sufficient to cover large changes in the
price of a stock.
Some particularly volatile securities have been designated as "not marginable,"requiring customers to purchase
the securities with 100 percent initial margin, allowing payment to be made within three
days of settlement. Firms also have designated certain securities as "cash
on hand," requiring customers to have 100 percent of the purchase price of
the security in the account before the transaction can be executed.
Investor Education
The concept of "investor education" is practiced to educate
the investor and to protect the firm against subsequent customer complaints based upon
"ignorance." Such information is often presented through an online dictionary of terms or a glossary,
where focus is given to issues related to market volatility. "Helpful
hints",particularly those addressing the best uses of different orders
and margin, are becoming more common. Finally, many firms have customer help desks and support agents,
both of which provide answers to customer questions.
| WARNING!!!
Be careful that the support services you offer are reasonably available. Recent press
reports disclosed widespread online client dissatisfaction over their inability to
reasonably reach customer service telephone numbers, especially when coupled with online
outages or periods of delayed inaccessibility. |
Pop-up Or Splash Screens
Certain firms have added a page that a customer must view when
entering the customer account pages. These gateways or checkpoints are best used to
display warnings of increased margin requirements, delays in trade reporting, limits on
the use of market orders, advisories on the use of limit orders, and advisories as to the
reliability of so-called "real time" quotes.
The practice of a mandatory viewing of volatility notices is particularly well
suited during volatile markets for warning customers that entering a cancel order and a
separate replacement order may result in the customer being responsible for the
execution of duplicate orders, if the cancellation order cannot be processed in a timely
fashion. Firms should advise customers to place limit orders to reduce the risk of placing
a duplicate order and ensure that the price received is within acceptable limits. One firm
created a category of order called "cancel and replace": the firm will execute
the second or "replace order" only if it can confirm that the initial order was
in fact canceled.
Remember your obligations under Securities and Exchange Commission (SEC) Staff Legal Bulletin No. 8 (September 8, 1998) about the need for broker/dealers to maintain enough internal systems capacity to operate properly when trading volume is high.
|
