Suitability and Whisper Numbers under Attack

New Proposals for a New Millennium – Suitability and Whisper Numbers

 Mark J. Astarita

The end of the millennium has further demonstrated the changes that are in store for the brokerage industry in the start of the new millennium. Last month I took a look forward, but since writing that column in November, two significant events have occurred.

The first was the release on November 22, 1999 by SEC Commissioner Laura S. Unger of a 95 page report summarizing the findings from a series of on-line investing round tables conducted during 1999. The second was a speech given by SEC Chairman Arthur Levitt at The Economic Club of New York, New York City, the text of which was publicly available in December. Both the Unger report and the Levitt speech give clear details of what is in store for the financial markets, and thus the brokerage community in the coming months and years.

The Unger report raises a number of issues, but one of the most significant is the concept of a suitability requirement for discount and online brokers, who do not offer investment advice. Until now, the only true suitability requirement has been placed upon brokers who provide investment advice, and a requirement that brokers know their customer. Discussions regarding a requirement for a suitability determination by every brokerage firm in the area of day trading have been proposed, and are moving towards approval. The expanded use of margin by customers who are not relying upon a broker for advice is also causing concern, and suitability regulations are being proposed, for all brokerage firms which permit their customers to day-trade, or using margin. It appears that there are far too many people day trading, and losing money at the discount brokers, and an apparently significant number of people using margin who do not have a clue as to the importance of the downside of a leveraged transaction.

The significance of these proposals are clear – the Commission is not going to continue to let the country’s financial institutions turn a blind eye to the 65 year old widow who has decided that now is a good time to day trade the hottest Internet stock on margin The question of whether the government should be stopping people from making stupid mistakes because of the lure of day trading, enhanced by margin leverage and a $7.00 commission, is better left to another column, and some will surely suggest that such individuals are fools who deserve what they get. However, a more practical view is that the vast rise in the markets, our 14 years of a bull market, and $7.00 commissions have lulled inexperienced investors into the belief that day trading, margin trading, and speculation as a whole are easy money items, that can make anyone rich.

The Unger Report also raised question of the impact of technology on the on-line firms’ performance and evaluation of their best execution obligations; the impact of investor demand for market information impacted the pricing of real-time data; the hardware and software demands resulting from online trading; education of online investors; real time chat forums where securities are discussed, and pumped, in real time, across the world, and even compensation of Internet portals who are directing investors to the online firms. The report recommends that the full Commission look into placing some type of suitability requirement upon online brokerage firms; enhancing the obligation of broker/dealers to obtain the best execution for their customers, and to educate consumers regarding best execution obligations; as well as other aspects of online executions and orders, including system capacity, delivery of market data, chat rooms, and investor education.

Chairman Levitt’s speech provides further insight into the problems in the markets as viewed by the Commission, and the proposals for change that are being considered. Chairman Levitt stressed the quality of the markets, and with a broad brush took aim at varied aspects of the financial markets, and varied participants in those markets, including issuers, broker-dealers, investors, and, in something of a surprise, analysts.

A significant point raised by the Chairman is the quality and integrity of financial reporting. All market participants rely upon the integrity of the information reported to the SEC by issuers, as the financial information is the basis upon which most valuations are, or should, be performed. Chairman Levitt is raising the concern for the integrity of that reporting in recent months, and, in his words, the “gradual, but perceptible, erosion in the quality of financial reporting.

The motivation to satisfy Wall Street earnings expectations was beginning to override long established precepts of financial reporting and ethical restraint. A culture of gamesmanship over the numbers was not only emerging, but weaving itself into the fabric of accepted conduct.” While Chairman Levitt was chastising issuers for reporting for the analysts, he took an equal, if not more critical mark on the analysts themselves.

One does not have to be a broker or serious investor to understand the issues being raised regarding analysts, earnings projections and whisper numbers. Aren’t whisper numbers just another form of inside information? Where did that whisper number come from, if not from an insider of the company? Or, when a company misses its quarterly earning projections by a penny, why is it that the stock pummels percentage points in a matter of minutes? Or, why does it do so when it meets the projections?

According to Chairman Levitt the answers to these questions are in the relationship between analysts and issuers, and how they interact with each other. While not directly suggesting new rules and regulations, he hints that new regulations may be in the works, and he urged financial professionals to recommit themselves to integrity and quality, and promised increased oversight in the area of the quality of information. Coupled with Commissioner Unger’s report, we can expect a very interesting 2000.


Securities Attorney at Sallah Astarita & Cox | 212-509-6544 | | Website | + posts

Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.

He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page -, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.