GTT resources for proprietary trading firms:

Here is a good place to start for an education about proprietary trading firms.
Special Study: Report of Examinations of Day-Trading Broker-Dealers. Office of Compliance Inspections and Examinations. U.S. Securities and Exchange Commission. February 25, 2000. Click here for the full report. This SEC report covers both retail broker dealers who have customer accounts and proprietary trading firms without retail customers. We focus on prop trading firms on this page.

If you plan to join a prop trading firm or are in one already, hold up your firm to the requirements of this SEC report. Do they respect the rules, or are there many lapses? Ask to see audited reports, net capital requirements and compliance, censures from the SEC or stock exchanges, complaints filed against them, and policies to stay in compliance.

Keep in mind that overall, this early 2000 SEC report was negative on the state of the industry and that's a warning sign. The important question is, 'has the state of the prop trading industry improved or declined since early 2000?' Considering the bear market damage since early 2000, the WorldCo demise, and other firms going out of business, we suspect the state of the industry may actually have gotten worse. Rumors are that many firms are on the selling block and have lost many prop traders. Unfortunately, there is little new guidance from the SEC and we hope this above report is updated soon. In the meantime, take a look at our message board forum "Are some prop trading firms violating Reg T margin rules?". Click here.

Here are few important and also problem areas to focus on in the above SEC report. Pay particular attention to: margin lending issues (Reg T) and some abuses; lending rules including third party loans and the requirement for non-affiliation; "deposit" accounts being allowed for prop traders, contrary to what some argue are not allowed (see excerpt below - and message board link above); organizational structures and the allowed use of LLC models with new requirement for Series 7 licenses (see excerpt below); restrictions on advertising and abuses; suitability and appropriateness - did your firm truly vet your qualifications for risky day trading?;

Excerpt from above SEC report in connection with "deposit" accounts for prop traders.
"In addition to the costs and fees described above, many firms stated that they require prospective customers to have a minimum amount of money to open an account. A February 2000 review of seven large day-trading firms revealed that five firms required initial deposits ranging from $20,000 to $75,000. A few firms noted, however, that their initial deposit requirements may be relaxed in certain circumstances, depending on the experience of the prospective day trader. Two of the seven firms did not indicate any minimum capital requirement."

Excerpt from above SEC report in connection with Organizational Structures.
"Day-trading firms are typically organized in one of two ways: as traditional corporate entities or limited liability companies or partnerships ("LLC"). These organizational differences separate day-trading firms into two specific operating models with fundamentally different characteristics.

Most day-trading firms are organized as traditional customer-based corporate entities and are members of the NASD. Customer-based firms are required to comply with federal securities laws and regulations that are designed to further customer protection. Firms that conduct a retail customer business must comply with NASD membership requirements; customer reserve requirements;8 the Federal Reserve Board's initial margin9 and SRO maintenance margin requirements;10 and SRO suitability rules.11 The Staff estimates that there are more than 100 day-trading firms organized as retail brokerage firms.

The second model is the LLC partnership structure in which a firm operates a proprietary business. These firms represent that they do not have customers, but "members" who become part owners of the firm. Day traders at these firms, as part owners, contribute capital to the firm and in turn, trade the firm's capital. Most of these firms are members of the PHLX. There are approximately 13 day-trading firms that are members of the PHLX. To become a member of a day-trading firm structured as an LLC, individuals are required to sign operating agreements that designate the member's ownership rights including: profit sharing arrangements, restrictions on withdrawals, provisions limiting losses, and other provisions common to partnership agreements. Because these firms are exempt from registering with the NASD, they are not subject to the NASD Conduct Rules.12

Prior to a change in its rules, the PHLX allowed members of proprietary firms to trade proprietary accounts without being licensed representatives. Thus, proprietary day-trading firms were able to advertise day trading to the general public and accept members that were not licensed. The PHLX recently amended PHLX Rule 604 to require individuals trading off the floor of the exchange to pass the Series 7 licensing examination.13"

Read later in this SEC report that many of the prop trading firms that are members of the PHLX (Philadelphia Stock Exchange) have not filed their required audited reports. This raises a serious concern for us and we suggest you ask your firm for a copy of their audited reports. There are many specific rules about capital, keeping deposits separate from capital in some instances and minimum capital requirements. If your firm falls short of these rules, you could be in for trouble ahead.

Check out the July 2002 cover story on proprietary trading in Active Trader magazine. "Choosing sides: New traders are faced with numerous choices, but one of the first might be the most difficult. Deciding whether to trade through a proprietary firm or a retail brokerage is not easy — there are advantages and disadvantages to both and many issues to weigh. Read on to learn more about what to take into account before making a choice." The story was written by JEFF PONCZAK. To read the article, click here. Jeff refers to tax matters on proprietary trading written about by our Robert A. Green, CPA, in the Business of Trading section in Active Trader magazine. Click here for a list of those articles.

Be very careful with some proprietary trading firms. Since Jeff Ponczak wrote the above article in July 2002, several proprietary trading firms have faired poorly during the bear market times. For a cautionary tail, read Jeff Ponczak's February 2004 article in Active Trader magazine, "Out of business. Prop firm shuts down." Click here for pdf copy. Jeff interviewed our Robert A. Green, CPA as a source for the story about Woldco's demise. See Robert's several quotations in "What traders should know" in the later part of the story.

When it comes to prop trading firms, we hear lots of tall stories about capital, business practices and more, but the closer we look, the more trouble we see in some of them - including a few of the prominent ones. We only have alliances with firms that we think make the grade and don't with the ones we think may be trouble. One large firm was selling a hedge fund vehicle recently that was fraught with trouble and not duly registered. Some have Form K-1s that are prepared wrong. One implies and confuses its traders into deducting health insurance premiums, which is clearly not allowed, since their trader members don't have earned income - which is required to deduct health insurance premiums from adjusted gross income (AGI). After you hear the pitch and stories from management about all the glory of joining their firm and paying up a large amount of capital, which is then at their whim in LLC Operating Agreements stacked in their favor, its very wise to consult with our firm first. Our attorneys and CPAs can tell you if you are speaking with one of the known firms that we have problems with and we can advise you on how best to proceed. There are some very reputable proprietary trading firms and we can steer you in the right direction.

Testimonial from a trader who read this page and "saved himself" with this information. Click here.

For lot's of discussion about proprietary trading, K-1 treatment, Form 1099-Misc and much more, visit our message boards. Click here and then scroll down to the "proprietary Trading" forum.

Testimonial from a trader who read this page and "saved himself" with this information:

-----Original Message-----
From: Exxx@aol.com
Sent: Friday, August 16, 2002 2:39 AM
To: info@greencompany.com
Subject: Re: Joe on your website

I just wanted to say thanks for the example of Joe. You just saved me from making a huge mistake and I really appreciate that. Let me explain. A proprietary firm just made me an offer to work for them. They wanted $5k down and another $500 for the training. I accepted their offer partly because I would be getting a series 55 license and because of the prospect of making big money. Until I read your article, I didn't know that I would be responsible for the loses and that I would be sued by the firm if I didn't pay. I also didn't realize that I was required to maintain the $5k deposit. I am a divorcee with a child and could not survive financially if I created trading loses and got sued. You saved me from losing my shirt and I am forever grateful.
Sincerely,
Mxxx Pyyyy