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The “Good Deal Exemption” for Financial Advisors is No Joke

The “Rules”

[By Rick Kahler CFP®]

In the business of selling financial products, the “good deal exemption” may be one of the most widely used “rules” most people have never heard of. You can’t find it in any rule book or statute. Even Google has never heard of it. Yet it is used on a daily basis.

The rules and laws surrounding the sale of financial products are complex and voluminous. Even with the best of intentions, it isn’t hard to run afoul of a rule.

Under the good deal exemption, however, a licensee can violate any rule or statute as long as the investment sold to the customer turns out to be a “good deal.” This is a tongue-in-cheek way of saying you can violate any rule you want as long as the customer doesn’t file a complaint or sue you. Which they will rarely do if the deal turns out to make them loads of money.

It’s when investments go bad that customers often complain or sue, not because they were aware of any securities violations, but because they lost money. It’s the ensuing investigation by the regulating body and the customer’s attorney that uncovers any violations.

Example:

Recently, I came across a perfect example of the good deal exemption. A married couple I knew, Arnie and Audrey, invested with Bernie (not his real name) 30 years ago as they neared retirement. He put their entire savings of about $310,000 into mutual funds that invested in common stocks. Because of a pension and Social Security, they didn’t need any income from their investments.

At the same time, Arnie put his investments into a revocable living trust, naming Audrey as the trustee and beneficiary. Eleven years later, when Audrey was 80, Arnie died.

Losing her husband’s pension income and one Social Security check, Audrey needed to start drawing $2,000 a month from the portfolio. While most advisors would have recommended reducing the risk and volatility of the portfolio by investing less in stocks and more in bonds, Bernie kept Audrey invested 100% in stocks. This is aggressive for any 80-year-old needing income from a portfolio. He made no changes as the years went by.

At 85, Audrey started showing signs of dementia. Bernie rightly suggested appointing someone other than herself as trustee. But rather than naming one of her three children (who didn’t trust Bernie and may have transferred the accounts), he convinced her to appoint his wife, who also worked in his office, as trustee. In any broker’s books, this was a serious ethics violation.

In the great recession of 2008-2009, when Audrey was 89, her portfolio lost just under half of its value, falling from $832,507 to $478,820. Had Bernie reallocated the portfolio before the crash to a mix of 50% stocks and 50% bonds, the loss would have been cut in half. To his credit, Bernie told her to stay the course and not sell out.

Recently, at age 99, Audrey died. Her account had done phenomenally well, being 100% invested in US stocks, which for the last 10 years was the best investment class on the planet. Her $478,820 had grown to $1,300,000, providing her a $2000 monthly income and a substantial estate that she left to her children.

Assessment

Despite the inappropriately risky investments and the ethics violations, Bernie and his wife are probably protected by the good deal exemption. Given their substantial inheritance, Audrey’s children are unlikely to sue.

This happy ending was due primarily to luck. Audrey lived long enough and at the right time so her portfolio recovered. However, if luck were a sound investment strategy, Las Vegas would be full of millionaires happily retired on their winnings.

Conclusion

Your thoughts are appreciated.

***

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

***

A ‘Flawed’ SEC Program [A Retrospective “April Fool’s Day” Analysis]

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SEC Failed to Rein in Investment Banks [April Fool’s Day – 2015]

By Ben Protess, ProPublica – October 1, 2008 5:01 pm EDT

Editor’s Note: This investigative report was first published ten years ago. And so, we ask you to consider – on this April Fool’s Day 2019 – how [if] things have changed since then?  

***

Flag MOney

***

The Securities and Exchange Commission [SEC] last week abolished the special regulatory program that it applied to Wall Street’s largest investment banks. Known as the “consolidated supervised entities” program, it relaxed the minimum capital requirements for firms that submitted to the commission’s oversight, and thus, in the view of some experts, helped create the current global financial crisis.

But, the SEC’s decision to ax the program currently affects no one, since three of the five firms that voluntarily joined the program previously collapsed and the other two reorganized.

The Decision – 18 Months Ago

The decision came last Friday, one day after the commission’s inspector general released a report [1] (PDF) detailing the program’s failed oversight of Bear Stearns before the firm collapsed in March. The commission’s chairman, Christopher Cox, a longtime opponent of industry regulation, said in a statement [2] that the report “validates and echoes the concerns” he had about the program, which had been voluntary for the five Wall Street titans since 2004.

The report found that the SEC division that oversees trading and markets was “not fulfilling its obligations. “These reports are another indictment of failed leadership,” said Sen. Charles Grassley (R-Iowa) who requested the inspector general’s investigation.

The SEC program, approved by the commission in 2004 under Cox’s predecessor, William Donaldson, allowed investment banks to increase their amount of leveraged debt. But, there was a tradeoff: Banks that participated allowed their broker-dealer operations and holding companies to be subject to SEC oversight. Previous to 2004, the SEC only had authority to oversee the banks’ broker dealers.

Longstanding SEC rules required the broker dealers to limit their debt-to-net-capital ratio and issue an early warning if they began to approach the limit. The limit was about 15-to-1, according to the inspector general report, meaning that for every $15 of debt, the banks were required to have $1 of equity.

But the 2004 “consolidated supervised entities” program revoked these limits. The new program also eliminated the requirement that firms keep a certain amount of capital as a cushion in case an asset defaults.

Bear Sterns

As a result, the oversight program created the conditions that helped cause the collapse of Bear Stearns. Bear had a gross debt ratio of about 33-to-1 prior to its demise, the inspector general found. The inspector general also found that Bear was fully compliant with the programs’ requirements when it collapsed, which raised “serious questions about whether the capital requirement amounts were adequate,” the report said.

The report quoted Lee Pickard, a former SEC official who helped write the original debt-limit requirements in 1975 and now argues the 2004 program is largely to blame for the current Wall Street crisis.

“The SEC gave up the very protections that caused these firms to go under,” Pickard said in an interview with ProPublica. “The SEC in 2004 thought it gained something in oversight, but in turn it gave up too much public protection. You don’t bargain in a way that causes you to give up serious protections.”

Pickard, now a senior partner at a Washington, D.C.-based law firm, estimated that prior to the 2004 program most firms never exceeded an 8-to-1 debt-to-net capital ratio.

The previous program “had an excellent track record in preserving the securities markets’ financial integrity and protecting customer assets,” Pickard wrote [3] in American Banker this August. The new program required “substantial SEC resources for complex oversight, which apparently are not always available.”

Asked if he believes the 2004 program was a direct cause of the current crisis, Pickard told ProPublica, “I’m afraid I do.”

The New York Times reported Saturday that the SEC created the program after “heavy lobbying” for the plan from the investment banks. The banks favored the SEC as their regulator, the Times reported, because that let them avoid regulation of their fast-growing European operations by the European Union, which has been threatening to impose its own rules since 2002.

SEC Spokesman

A SEC spokesman declined to comment for this article, referring inquires to Chairman Cox’s statement. In the statement, Cox admitted the program “was fundamentally flawed from the beginning.” But Cox, a former Republican congressman from California, offered mild support for the program as recently as July when he testified before the House Committee on Financial Services. The program, among other oversight efforts, Cox said, had “gone far to adapt the existing regulatory structure to today’s exigencies.” He added that legislative improvements were necessary as well, and has since told Congress that the program failed.

More Questions

So why did the commission not end the program sooner? Some say that the program’s flaws only recently became apparent. “As late as 2005, the program seemed to make a lot of sense,” said Charles Morris, a former banker who predicted the current financial crisis in his book written last year, The Trillion Dollar Meltdown [4]. The SEC “didn’t know it didn’t work until we had this stress.”

And leverage does not always spell trouble. In a strong economy, leverage can also be attractive because it can increase the profitability of banks through lending.

In his recent statement, Cox said the inspector general’s findings reflect a deeper problem: “the lack of specific legal authority for the SEC or any other agency to act as the regulator of these large investment bank holding companies.”

Secretary of the Treasury Henry Paulson has called for a refining of the regulatory structure to reflect the global and interconnected nature of today’s financial system. In any case, the program’s failure can be seen in the disappearance of the participating banks: Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs.

skeleton-jpeg1

***

Assessment

Merrill Lynch’s leverage ratio was possibly as high as 40-to-1 this year and Lehman Brothers faced a ratio of about 30-to-1, according to Bloomberg [5].

The Fed and Treasury Department forced Bear Stearns into a merger with JPMorgan Chase in March. And the last two months, Lehman Brothers went bankrupt and sold their core U.S. business to British bank Barclays PLC, and Merrill Lynch was acquired by Bank of America. Morgan Stanley and Goldman Sachs, the two remaining large independent investment banks, changed their corporate structures to become bank holding companies, which are regulated by the Federal Reserve.

As these banks have folded or reorganized over the last several months, the Federal Reserve has largely assumed the SEC’s oversight responsibilities, though the commission will still have the power to regulate broker dealers.

Original Essay: http://www.propublica.org/article/flawed-sec-program-failed-to-rein-in-investment-banks-101

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HOW THE “FIDUCIARY CONUNDRUM” DEFIES PHYSICS?

And … How We Can Fix It

By Dr. David Edward Marcinko MBA MEd CMP®

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The Rules As I Understand Them

Securities industry Regulations and Regulators recognize that (registered) investment advisors give advice, while stock brokers sell brokerage products. Thus, the Series 65 license is required to become a financial advisor, while Series 7 licensed stock-brokers are not (and cannot) be fiduciary advisors.

So, advice is subject to a fiduciary duty, while product sales (brokerage) activity is not. The ratio of fiduciary advice to brokerage sales is about 1:99. So, what does that tell you?

A Contentious and Complicated Issue

This issue is so contentious and complicated today that lawyers are needed to define each and every term, engagement, transaction, brokerage or advisory contract, etc. It is far too amazingly contorted and complicated for most; including me; and we have even discussed the industry machinations and political double-talk on this ME-P previously; from some vary sharp industry experts, too.

The Fiduciary Conundrum

The “work-around” for these rules is industry “dual-registration”. Simply put, just get licensed to do both; as I did. Charge a commission when selling stuff and charge a fee for advice. And ideally, do both at the same time; while getting paid for both sides.

As a naïve luddite, I learned this little truism in financial planning school decades ago, and as a doctor and fiduciary for my patients at all times, almost vomited.

Of course, there were more sophisticated students in our classes who regurgitated the standard industry opinion: “We’ll give the client a financial plan for free IF we can sell commissioned products.”

Ideally this meant a fat and fully commissioned wrap account, whole-life insurance policy, LTCI policy; etc. Or, sell products and collect fat ongoing, and often unrecognizable AUM fees [fee-only], too!

From the stock broker-advisor’s POV, it was “Heads I win – tails you loose” for the client. Now, you know why I am a former or reformed certified financial planner.

The Physics Split

Know that as a pre-medical college student years earlier, I leaned about the Werner Heisenberg Uncertainty Principle, in physics class.

Of course,  true Advice – is not Sales …  and Sales is not Advice. Both should never be; simultaneously. So, let’s ditch dual registration and decide which to pursue … and then proceed accordingly. Both sales and advice have risks and benefits to client and producer; both have advantages and disadvantages to both; as well.

WHY? Just like the Werner Heisenberg Uncertainty Principle; it shouldn’t [shan’t] be both; at once.

NOTE: In quantum mechanics, the Heisenberg uncertainty principle is any of a variety of mathematical inequalities asserting a fundamental limit to the precision with which certain pairs of physical properties of a particle, known as complementary variables, such as position x and momentum p, can be known simultaneously.

So, in physics, I can tell you where you are -OR- how fast you are going; but not both. Thus, if it is product sales; it is not advice.

Today, since “dual registration” is still allowed, my suggestion to clients is to seek a fiduciary in all matters 24/7/354; get it in writing, and try  to avoid arbitration and “best interest” or BICE clauses! Run from [fee-based and fee-only] AUM fees, too.

PS: I am not against Series #7 representatives and product sales. Salesmen/women often provide a valuable service and should be appropriately compensated. I only object when fees, costs, charges and commissions are duplicative, excessive and/or not fully disclosed to the client. Since excessive is an arbitrary term; full disclosure is the key ingredient.

Assessment

So – How am I wrong, mistaken and/or what did I miss? Do tell! Should We – Can We – Ditch Dual Registration [DDR]?

Oh! In the future, I also hope that State fiduciary standards will potentially cover both non-ERISA and ERISA situations, and employee plan participants will have access to full discovery rights, the one thing the industry fears most.

But, that’s a discussion for another day and time.

Conclusion

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Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

https://www.crcpress.com/Comprehensive-Financial-Planning-Strategies-for-Doctors-and-Advisors-Best/Marcinko-Hetico/p/book/9781482240283

***

Form ADV Part II [The Essential Document]

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Lifting the “Veil of Secrecy” on Selecting Financial Advisors

[By Dr. David Edward Marcinko MBA CMP™]

DEM white  shirtBy law, financial advisors must provide you with a form ADV Part II or a brochure that covers the same information. Even if a brochure is provided, ask for the ADV. Today, it may even be online.

While it is acceptable, even desirable, for the brochure to be easier to read than the ADV, the ADV is what is filed with the appropriate state or SEC. If the brochure reads more like a slick sales brochure or the information in the brochure glosses over the items on the ADV to a high degree, one should consider eliminating the advisor from consideration.

Types of Advisors

Registering with a state or SEC gives an advisor a fiduciary duty to the client. This is a high standard under the law. There are several types of advisors who are exempt from registering and filing an ADV.

First, there are registered representatives (brokers).  Brokers have a fiduciary responsibility to their firms regardless of whether they are statutory employees or independent contractors.

Second are attorneys and accountants whose advice is “incidental” to their legal or accounting practices. But, why would one hire someone whose advice is “incidental” to his primary profession?

A top-notch advisor is a full-time professional and should be registered.  One should insist that their advisor be registered.

***

Lifting veil of secrecy

[The Author in Chicago Seeking Fiduciary Transparency]

***

The ADV will describe the advisor’s background and employment history, including any prior disciplinary issues. It will describe the ownership of the firm and outline how the firm and advisor are compensated. Any referral arrangements will be described. If an advisor has an interest in any of the investments to be recommended, it must be listed as well as the fee schedule. There is also a description of the types of investments recommended and the types of research information that is used.

Assessment

A review of the ADV should result in an alignment of what the advisor said during the interview and what is filed with the regulators. If there is a clear discrepancy, choose another advisor. If it is unclear, discuss the issue with the advisor.

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Conclusion

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Fiduciary Financial Advisor versus Non-Fiduciary FAs

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Understanding the Difference

Dr. DEMBy Dr. David Edward Marcinko MBA CMP™

GOAL: To understand the difference between fiduciaries and non-fiduciaries, examine the SEC conduct rules.

Stock-Brokers (non-fiduciaries) are subject to FINRA Conduct Rule 2310(a) which reads:

In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his security holdings and as to his financial situation and needs.

A fiduciary follows a higher standard of conduct: 

A fiduciary duty is an obligation to act in the best interest of another party. A fiduciary obligation exists whenever the relationship with the client involves a special trust, confidence and reliance on the fiduciary to exercise his discretion or expertise in acting for a client. A person acting in a fiduciary capacity is held to a high standard of honesty and full disclosure in regard to the client and must not obtain a personal benefit at the expense of the client.

Five primary responsibilities as a fiduciary to clients are:

  • To always put clients’ interest first
  • To act with utmost good faith
  • To provide full and fair disclosure of all material facts
  • Not to mislead clients, and
  • To expose all conflicts of interest and all compensation to clients.

More:

Assessment

Conclusion

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Understanding NYSE / NASD Minimum Credit Requirements

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A Primer for Physician Investors and Medical Professionals

By: Dr. David Edward Marcinko; MBA, CMP™

[Editor-in-Chief]

[PART 8 OF 8]

NOTE: This is an eight part ME-P series based on a weekend lecture I gave more than a decade ago to an interested group of graduate, business and medical school students. The material is a bit dated and some facts and specifics may have changed since then. But, the overall thought-leadership information of the essay remains interesting and informative. We trust you will enjoy it.

Introduction

We have seen that there are rules which stipulate that no brokerage firm may arrange for any credit to any client whose margin account does not have an equity of at least $2,000. The principal application of this rule is to initial transactions in newly opened margin accounts, however, it does apply at all times. 

Example: A doctor buys 100 shares, at $15, in a new margin account. His margin call is $1,500.

Rationale: $2,000 would be too much to require as it exceeds the total purchase price. However, a loan to the doctor isn’t allowed to be extended until, and unless, the account has equity of $2,000. The trade is simply paid in full -100% of the purchase price is the margin call. 

Example: A doctor buys 200 shares, at $15, in a new margin account (assume Regulation T = 60%).

His margin call is $2,000 

Rational: Regulation T 60% would be $1,800 (60% x $3,000). Since this would be $200 shy of the minimum equity level of $2,000, the call is the $2,000 minimum equity. 

Example: A doctor buys 300 shares, at $15, in a new margin account. (assume Regulation T = 60%) His margin call is $2, 700. 

Rationale: The account will have equity of $2, 700 (60% x $4,500), which is more than the $2,000 minimum. Therefore, the Regulation T initial requirement prevails.

The important points to remember about minimum credit requirements are:

1. You are not called upon to pay more than the purchase price.

2. You cannot be granted a loan until the account has an equity of at least $2,000.

3. If a decline in the market value of an existing account puts the equity below $2,000, there is no requirement to bring the equity back up to $2,000.

4. You may not withdraw money or securities from the account, if in doing so, you either:

  1. bring the equity below $ 2,000, or
  2. bring the equity below the maintenance level

These are the only times SMA may not be withdrawn from an account

The Short Sale

Selling short is engaged in by medical professionals who anticipate a market decline. By selling borrowed property (shares of stock) at the current market value, the doctor expects to return the borrowed property (shares of the same issuer bought in the marketplace) to the lender, normally the investor’s brokerage firm, when the market price is lower, thus profiting from the drop in price.

Essentially this is the buy low, and sell high philosophy. However, when executing a short sale one is selling high initially, then buying low later to “cover”, or close out the deal by buying low and selling high in the reverse order .

Bear in mind that the short seller is borrowing property, not money. However, due to the high degree of risk inherent in short selling, it is permitted only in a margin account. A Regulation T call is required as a show of good faith, a way the client demonstrates the financial wherewithal to buy back the property. Let’s look at a short sale transaction and the subsequent effects of market fluctuations on equity, as we did previously with buying on margin (long margin).

Credit Balance and Equity

A doctor shorts (sells short) 100 shares at $100 per share with Regulation T at 60%. The margin account would be credited with the proceeds of the sale, though the doctor has no access to these monies at this point in the deal. The account should also be credited with the doctor’s required Regulation T margin call. Therefore, the credit balance in a doctor’s margin account is the sum of the  proceeds of the short sale, plus the Regulation T margin call. This number will not change, regardless of future market fluctuations. The credit balance in a short margin account is a constant.

What does change with market fluctuations?

  1. the cost of buying back the borrowed property to cover the short sale.
  2. the equity in the account.

Equity in a short margin account is computed as follows:

Credit of  $ 16,000 – CMV  $10,000 equals $ 6,000 equity.

Now, let’s evaluate the effect of appreciation in the market price

If the stock rises to $120 per share, then the credit of $16,000 – CMV $ 2, 000, equals $ 4,000 equity.

Remember, the credit balance does not change when CMV fluctuates. The equity in this account is no longer Regulation T.

Let’s determine the amount by which the account is restricted (remember, any margin account with equity below Regulation T is restricted). Or, 60% X $12,000 = $ 7,200 – $ 4,000 = $ 3,200

Also, it should be clear, the equity percentage of this account is less than 60%, by the formula:

Equity / CMV = $ 4,000/$ 12,000 = 33.33%

This is the basic principle of the short sale; as the market price of the shorted stock increases, the equity decreases. The reverse is also true; as the price declines, the equity rises. Remember, short sellers are anticipating a market decline. Also, when buying long, or selling short, any change in market value causes a dollar for dollar change in equity.

Minimum Maintenance Requirements (Short) 

If the market continues to appreciate to $160 per share, the equity drops to zero.

Suppose that the market price rose to its theoretical maximum, or infinity? The doctor’s loss would be infinite. Remember, the maximum potential loss on a short sale is unlimited!

To protect against such an occurrence, industry Self Regulatory Organizations (SROs) developed regarding the minimum equity that must be maintained in a margin account. The minimum maintenance in a short account is equity of 30% of CMV. Note that this is higher than the 25 % figure for long margin accounts due to the nature of extreme risk of loss in the short sale.

Given that the CMV has risen to $160 per share ($16,000 total CMV), the minimum equity required to be maintained under SRO rules is 30% x CMV or  $4,800 equity. The doctor would receive a $4,800 maintenance call to bring his equity from -0- to the $4,800 minimum.

Remember, as in (cash) long accounts, there is no requirement to bring a margin account up to Regulation T equity. The maintenance equity is the percentage up to which the account must be brought when and if equity drops below the 25% or 30% levels.

Excess Equity (SMA) and Buying Power

We have seen what market appreciation does to a short seller. Let’s evaluate the effects of market depreciation in value. If the declines to $85, per share, then $ 16,000 credit – CMV $ 8,500 = $ 7,500 equity. Again, market fluctuations don’t affect credit balance. The equity in the account is now higher than Regulation T, and SMA (excess equity) has just been created.

And, as before, excess equity (SMA) can be used to buy more securities. Couldn’t it also be used as the Regulation T down payment on another sale? Yes, this is another use of SMA that is called shorting power or “selling power”. The formula for buying power as well as shorting power is exactly the same: Remember, it’s SMA / RT to use buying power.

In this case, $2,400 / 60% = $4,000 of buying (shorting) power after the decline to $85, the doctor could buy long or sell short another $4,000 worth of stock and use his SMA to meet his 60% ($2,400) Regulation T Margin call. Recall, the margin call for a short sale is the same as for a long purchase.

Cheap Stock Rule

The SROs created a set of special maintenance rules in short margin accounts to protect against unreasonable risk in low-priced issues. These rules are appropriately labeled the “cheap stock” rules.

At all times, a doctor must maintain equity in a short margin account of the greater of the following:

  1. 30% of the CMV (SRO Minimum Maintenance Requirement)
  2. $2,000 (SRO Minimum Credit Requirement)

3.   Equity as required under the rules  below

The cheap stock rules are as follows:

Stock Price                                     Minimum Maintained Equity

0 – $2.50 per share             $ 2.50 per share

$2.50 – $5.00 per share      100% of per share price

$5.00 per share and up       $ 5.00 per share

Example: A doctor shorts 1,000 shares of a $1.50 per share stock. How much must he deposit initially and how much must be maintained in the account?

First, since Regulation T won’t come into play until equity hits $2,000, the SRO minimum credit requirement of $2,000 should come into play. However, since this is a cheap stock, we determine if the requirements of those special rules require more than $2,000. They do, and require a minimum be maintained in this short margin account of at least $2.50 per share sold short (1,000 shares at $2.50 each = $2,500 minimum that needs to be in this account at all times to comply with SRO rules).

Furthermore, if the market begins to rise, the cheap stock rules would require that at all times the amount of money in the account be at least 100% of the price per share until the stock hits $5. For example, if the stock rose to $4 per share, the doctor would have to have $4,000 in the account to carry the position (1,000 shares times 100% of CMV, $4 per share in this case).

Day Trading and the Internet

Internet day trading has become something of an, investment bubble of late, suggesting that something lighter than air can pop and disappear in an instant. This has occurred despite the fact that most lay and healthcare professionals who engage in such activities, do not appreciated even the basic rules of margin and debt, as reviewed review. History is filled with examples: from the tulip mania of 1630 Holland and the British South Sea Bubble of the 1700’s; to the Florida land boom of the roaring twenties and the Great Crash of 1929; and to $ 875 an ounce gold in the eighties and to the collapse of Japans stock and real estate market in  early 1990’s. To this list, one might now add day Internet trading

The cost of compulsive gambling, arising from internet day trading activities, may be high for the physician, his family and society at large. Compulsive gamblers, in the desperation phase of their gambling, exhibit high suicide ideation, as in the case of Mark O Barton’s the murderous day-trader in Atlanta. His idea actually became a final act of desperation. Less dramatically is a marked increase in subtle illegal activity. These acts include fraud, embezzlement, CPT up-coding, medical over utilization, excessive full risk HMO contracting, and other “alleged white collar crimes.”  Higher healthcare and social costs in police, judiciary (civil and criminal) and corrections result because of compulsive gambling. The impact on family members is devastating. Compulsive gamblers cause havoc and pain to all family members. The spouses and other family members also go through progressive deterioration in their lives. In this desperation phase, dysfunctional families are left with a legacy of anger, resentment, isolation and in many instances, outright hate.

Recent Updates

Since most people, including medical professions,  initially loose at day trading, they give up and decide not to do it anymore. As there is a minimum amount of money, about $ 25,000-50,000 of trading capital needed to start, this loss is a powerful de-motivator. Still, scared by the Barton incident, the NASD and NYSE have recently proposed new rules for those who engage in questionable day trading activities.  One proposal would provide that a minimum equity of $ 25,000 be maintained at all times, versus the current $ 2,000 for other margin accounts. If the amount of a pattern day trader fell below the new threshold, no further trading would be permitted until the threshold was maintained.

Options Trading

Stock options are contracts that obligate medical investors to either buy or sell a stock at a specific price, by a specific date. For example, a put option is a bet on falling prices. Let’s suppose Dr. Jane Smith holds a put option on XYZ stock, with a $ 50 exercise price, and the stock falls to $ 45. The value of the put rises in the options market because it lets her sell a $ 50 share, which is above the market price. A call option, on the other hand, is a bet on rising prices. Again, Dr. Smith holds a call option on XYZ stock, with an exercise price of $ 50. If the share rises to $ 55, the value of the option increase since she may buy for $ 50, a stock now worth $ 55.

In 1999, Charles Schwab, the biggest on-line brokerage executed more than 30 million option trades. Due to this demand, Schwab launched other complex services, such as the on-line simultaneous buying and selling of options. Also crowding the options field, are new upstart on-line brokerages, such as: Interactive Brokers, Preferred Capital Markets Technology and CyberCorp. They provide powerful software which will allow options in the future to trade as effortlessly and efficiently as stocks.

In  mid-2000 the Reuters Group PLC Instinet Corporation, the electronic network most widely used by institutional investors, opened an Internet brokerage aimed at consumers, including healthcare practitioners. Instinet will let retail clients place orders alongside institutions, and will offer access to charts, news and research. Thus, artificially empowering the individual investor, as well as again tempting the compulsive prone addict.

Acknowledgements

The assistance Mr. James Nash, of the Investment Training Institute, in Tucker, GA is acknowledged in the preparation of this ME-P.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Web Sites of Interest

http://www.tradehard.com

The ultimate super site for investment bankers and traders. Started by a group of well known stockbrokers, day traders, and money managers. This site offers advice about how to work the market to your advantage.

http://www.internetinvesting.com

This is an investor’s guide to on-line brokers, discount brokers, day trading and after hours investing. The site offers stock quotes, financial news, investment banking strategies, a book list and daily commentary about the market. This is a serious text heavy resource.

References and Readings

  • Atkinson,  W., and Crawford, AJ.:  On-line investing raises questions about suitability. Wall Street Journal, November, 28, 1999.
  • Farrell, C.: Day Trade On-line. John Wiley & Sons, New York, 1999.
  • Friedfertig, M.: Electronic Day Trader’s Secretes. McGraw-Hill, New York, 1999.
  • Gibowicz, Peter: Registered Representative (Study Program ,Volume II). Edward Fleur Financial Education Corporation, New York, 1998.
  • Gibowicz, Peter: Quick Seven. Edward Fleur Financial Education Corporation, New York, 1998.
  • Gibowicz, Peter: Registered Representative (Study Program, Volume I). Edward Fleur Financial Education Corporation, New York, 1998.
  • Kadlec, CW.: Dow 100,000: Fact or Fiction. New York Institute of Finance, New York, 1999
  • Nash, J: Securities Markets. In, Nash, J: (International Training Institute Manual). Atlanta, 1999.
  • Nassar, DS: How to Get Started in Electronic Day Trading. McGraw-Hill, New York,
  • 1999.
  • Schmuckler, E:  The Addictive Personality. In, Marcinko, DE (2001 Financial Planning for Medical Professionals. Harcourt Professional Publishing, New York, 2000. 

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About Securities “Shelf Registration”

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A Primer for Physician Investors and Medical Professionals

By: Dr. David Edward Marcinko; MBA, CMP™ http://www.CertifiedMedicalPlanner.org

[Editor-in-Chief]

[PART 5 OF 8]

Dr. Marcinko with ME-P Fans

NOTE: This is an eight part ME-P series based on a weekend lecture I gave more than a decade ago to an interested group of graduate, business and medical school students. The material is a bit dated and some facts and specifics may have changed since then. But, the overall thought-leadership information of the essay remains interesting and informative. We trust you will enjoy it.

Introduction

A relatively new method of registration under the Act of ’33 is known as shelf registration. Under this rule, an issuer may register any amount of securities that, at the time the registration statement becomes effective, is reasonably expected to be offered and sold within two years of the initial effective date of the registration. Once registered, the securities may be sold continuously or periodically within 2 years without any waiting period for a registration to clear issuers generally like shelf registration because of the flexibility it gives them to take advantage of changing market conditions.

In addition, the legal, accounting, and printing costs involved in issuance are reduced, since a single registration statement suffices for multiple offerings within the 2 year period. In effect, what the issuer does is register securities that will meet its financing needs for the next 2  years. It issues what it needs at the current time, and puts the balance on the shelf” to be taken off the shelf as needed.

SECURITIES MARKETS 

The purchase of common stock in an IPO (initial public offering) is facilitated through of the members an investment bank underwriting syndicate or selling group. This is known as the primary market and the proceeds of sale go directly to the issuing company. Six months later however, if a doctor wants to sell his shares, this would be accomplished in the secondary market. The term secondary market refers to trading in outstanding issues as the proceeds do not go to the issuer, but to the current owner of the securities, such as the physician investor.

Therefore, the secondary market provides liquidity to doctors who acquired securities in the primary market. After a doctor has acquired securities in the primary market, he wants to be able to sell the securities at some point in the future in order to acquire other securities, buy a house, or go on a vacation. Such a sale takes place in the secondary market. The medical investor’s ability to convert the asset (securities) into cash is heavily dependent upon the secondary market. All investors would be hesitant to acquire new securities if they felt they would not subsequently have the ability to sell the securities quickly at a fair price in the secondary market.

Securities Act of 1934

Every trade of stocks and bonds that is not a purchase of a new issue is a trade that takes place in the secondary market. The market place for secondary trading is the stock exchanges and the over-the-counter (OTC) market, and is governed by the Securities Act of 1934, which actually created the Securities and Exchange Commission (SEC) and outlines the powers of the SEC to interpret, supervise, and enforce the securities laws of the United States. The Act of 34 is very broad and governs the sales of securities, including the regulation of securities markets exchanges, OTC markets, broker/dealers, their employees, the conduct of secondary markets, the extension of credit in the purchase and sale of securities, and the conduct of corporate insiders (officers and directors and holders of more than 10% of the outstanding stock). The Act also prohibits fraud and manipulative and deceptive activities in securities transactions

The Stock Exchanges

A stock exchange is a private association of brokers. The main purpose of an exchange is to provide a central meeting place for its member-brokers. This central meeting place is called the floor. It is on the floor that the members trade in securities. It is important to remember that a stock exchange itself does not own any of the securities that are traded on its floor. Nor does it buy or sell any of the securities traded on the exchange. Instead, the securities are owned by member firms, customers, or perhaps, by the exchange member firm itself.

It is also important to remember that a stock exchange does not establish or fix the price at which any security is traded on the exchange. The price is determined in a free and open auction type of trading. It depends on the supply and  demand relationship of that security at a particular time. In other words, if sellers of a stock are offering to sell more shares of that stock than buyers want to buy, the price of that stock will tend to go down. On the other hand, if buyers want to buy more shares of a stock than the sellers are offering to sell, the price of that stock will tend to go higher because of the strong demand.

Any discussion of stock exchanges has to focus on the NYSE, which is by far the largest and most important of the exchanges. There are two exchanges referred to as national stock exchanges, the NYSE and the American Stock Exchange (AMEX). In addition to these two national exchanges, there are several regional stock exchanges including the Philadelphia Exchange, the Chicago Exchange (formerly Midwest), the Pacific Exchange, the Boston Exchange, and the Cincinnati Exchange. Stocks that are traded on an exchange are referred to as listed stocks. The term “listed on an exchange” means that the issue is eligible for trading on the floor of the exchange.

How does a stock become listed? The issuing company, having decided that they wish the prestige and broad visibility of being listed on the NYSE, applies to the exchange for listing. A critical condition for listing is that the issuer agrees to solicit proxies from those common stock shareholders unable to attend shareholder meetings. Once the securities have been accepted for listing (trading) on an exchange, the issuer must continue to meet certain requirements which are not quite as stringent as the original listing requirements, and may be de-listed if the firm ceases to solicit proxies on its existing voting stock, or meet other minimal requirements.

Physically, the exchange brings together buyers and sellers on a trading floor. The NYSE floor is larger than several football fields and is divided into 19 trading posts. Eighteen of the posts are horseshoe or U-shaped stations 100 square feet in area. The nineteenth post (post number 30) is in the northwest corer and really isn’t a post at all; it’s just an area where the inactive stocks trade.

The Specialist

Specialists are experts in trading one or more specific stocks at their particular post on the exchange floor. Their activity is vital to the maintenance of a free and continuous market in the specific issues they represent. They are responsible for conducting the auction at the post. Everyone interested in buying the stock calls out a price and the shares go to the highest bidder. The buyers compete, but there is only one seller. Unlike the usual auction market, the auction on the floor of the exchange is a two way auction with some brokers seeking to buy at the lowest possible price for their doctor clients and other brokers trying to sell at the highest possible price for their doctor clients. When two brokers, one representing a buyer and one a seller, agree on a price, a sale is made. The specialist functions in a dual capacity as a dealer and as a broker. As a dealer or principal, he buys and sells for his own account and risk to maintain a fair and orderly market in the stocks in which he specializes.

For example, if a commission broker approaches the specialist at the post with a buy or sell order, and there are no other brokers in the crowd, that is currently interested in buying or selling the stock, the specialist will buy the stock from that commission broker (if it’s a sell order) for his own account or sell the stock from his inventory (if it’s a buy order). Perhaps, he may even be able to fill the order from his specialist’s book?

Stock_Market

Specialist’s Book

This is done by using the specialist’s book of buy orders (bids), marked on the left hand page, or sell orders (offers) on the right. There is a book for each stock in which the specialist specializes. The pages are ruled and are usually printed with fractional stock points at regular intervals to permit easy insertion of orders. The orders are entered in the book by the specialist according to price and in the sequence in which they are received at the post. He notes the number of shares, putting down 1 for 100 shares, 2 for 200 shares, etc. He also notes the name of the member firm placing the order and if the order is Good Till Cancelled (GTC), or not. When orders are executed, they are executed in the same order recorded in the book at that particular price.

The specialist’s book also keeps track of all orders “away from the market ” (limit orders and stop orders) in his book. The book is organized with all buy orders on the left hand side of the page and all sell orders on the right hand side. In the absence of bids and offers from the “trading crowd” on the floor, the specialist can quote the best available market for the security by announcing the highest bid and the lowest offer (ask). The best bid is always the highest buy limit order on his book and the best offer (ask) is always the lowest sell limit on his book. In addition to quoting the best price, he will also give the “size of the market ” which is determined by the number of shares being bid for and offered at the respective best bid and best ask prices. The quote is price and size. When asked to quote the market for a security, the specialist disregards any stop orders on his book since those orders do not become activated until triggered by another trade. One thing to remember is that since most doctors place stop orders to hedge (protect) against a price movement adverse to their interests, most stop orders are entered with the fervent wish that they never be executed.

On stop and limit orders placed below the market, the specialist is required to reduce the price of those orders on the ex-dividend (ex-split, ex-rights) date. The two critical things to remember are: what types of orders are reduced and by how much? The specialist will reduce all GTC (open) buy limit and sell stop orders on an ex-date. You may remember this with the acronym BLISS where the BL equals buy limit and the SS equals sell stop. The only time either of these orders will not be reduced is if the medical client turned in DNR (do not reduce) instructions.

The price of the order is then reduced by enough to equal or exceed the amount of the dividend.

If we go back to the example approaching the specialist to buy or sell stock and there is no one in the “crowd”, the specialist will first give the commission broker a quote from his book. That quote will be the highest bid price (the highest priced limit order to buy on his books) and the best asked price {the lowest priced sell limit on his books). If the commission broker is willing to buy at the lowest ask or offering price on the specialist’s book, then a trade will take place; if the commission broker is looking to sell and is willing to accept the highest bid price on the specialist’s book then, again, a trade will take place. It is the responsibility of the specialist to maintain an orderly market and to keep the spread between the bid and asked prices as narrow as possible. If the spread between bid and asked is too wide to generate market activity, the specialist will act on his own account.

If the specialist is presented with sell orders at the post and he has no buyers, he must bid at least 1/8 of a point higher than the best bid on his books. If he has buyers and no sellers, then he must offer stock from his inventory at a price at least, 1/8 of a point below the lowest offer on his book.

Why? It’s because the specialist cannot “compete” with public orders and if his bid matched a customer’s bid or his offer matched a customer’s offering or ask price, he would be considered to be ” competing”.  Since the specialist is required to bid higher and ask lower than the best public orders on his book, the spread is narrowed. That is why it is said that the specialist acts in a dual capacity, as a dealer and as a broker. When buying and selling for his own account, he is acting as a dealer. The specialist acts as a broker when he executes limit orders left with him by commission brokers. When these limit orders are executed out of the specialist’s book (the doctor’s limit price is reached), the specialist uses a priority, parity, and precedence system, as to which order is executed first. These rules, like most others, are designed to give preference to the general public, not to members of the exchange, on a first come first served basis.

Walking Through a Trade

To see how the transactions are actually handled on the floor of an exchange, let us assume that an order to buy 100 shares of General Electric has been given by a doctor customer to the registered representative (stock broker), of a member firm in Atlanta. The order is a market order (an order to buy at the lowest possible price at the time the order reaches the floor of the exchange). This order is telephoned by direct wire, or computer, to the New York office of the member firm, which in turn telephones its order to its clerk on the floor of the exchange.

Each member firm has at least one member of the exchange representing them making trades on the floor. Each one of these members is assigned a number for identification. When the floor clerk receives the order to purchase the General Electric, he causes his member’s call number to appear on 3 large boards situated so that one is always in view. These boards are constantly watched brokers so that they will know when wanted at the phone, since there’s too much noise on the floor to use a paging system. Seeing his number on the board, the broker hurries to his telephone station or cell phone and receives the order to buy 100 shares of G.E. “at the market”. Acting as a commission broker, he immediately goes to the post where G.E. is traded and asks “how’s G.E”, of the specialist?

Part 4: Underwriting US Government Securities Issues

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Link: http://feeds.feedburner.com/HealthcareFinancialsthePostForcxos

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

LEXICONS: http://www.springerpub.com/Search/marcinko

PHYSICIANS: www.MedicalBusinessAdvisors.com

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HOSPITALS: http://www.crcpress.com/product/isbn/9781466558731

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ADVISORS: www.CertifiedMedicalPlanner.org

BLOG: www.MedicalExecutivePost.com

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