GameStop Frenzy is a tough call for transparency-focused regulators

Unless there is evidence that people were trying to manipulate the market, regulators may not have much to do. One of the fundamental principles of market regulation in the United States is transparency: give information to investors and let them decide. The GameStop drama was nothing if not transparent.

“You can sell garbage to the public as long as you tell the public, ‘It’s garbage and you would be a fool to buy it, but would you like to buy it? Said Harvey Pitt, former chairman of the SEC.

What appears to have happened in recent weeks is that a massive wave of retail investors have answered “Yes” to this question, say current and former policymakers. Fueled by social media platforms like Reddit and smartphone brokerage apps like Robinhood, traders pushed GameStop’s price up to $ 483 per share from less than $ 18 per share three weeks earlier. The struggling video game retailer closed at $ 63.77 on Friday, down 87% from its intraday high on Jan.28.

“I think a lot of people take a lot of risks that they don’t fully understand,” said Rep. Jim Himes (D., Connecticut), a former Goldman Sachs banker who sits on the House financial services committee. . “Unfortunately, the most effective remedy for this sort of thing is to touch a hot stove.”

One of the reasons regulators can be stuck is the lack of political will to limit trading by small investors. When Robinhood temporarily prevented its customers from trading GameStop shares during the frenzy, a cry arose from the market entrance. The big losses these little guys inflicted on some hedge funds by driving up the stock were seen as a democratization of the market. Any effort to derail that could be criticized as a protection for Wall Street.

“Most people think that middle class people, working people, should be able to try their luck in the stock market,” said Representative Maxine Waters (D., Calif.), Who chairs the Financial Services Committee of the Room, in an interview. .

The consensus among regulators so far is that the episode did not reveal any major issues with the plumbing in the market. The Treasury Department said Thursday that regulators believe “the basic market infrastructure is resilient.” The ministry said the SEC was examining “whether business practices are consistent with investor protection and fair and efficient markets,” and is expected to issue a report on the factors that have influenced it.

The SEC intervened earlier when it identified weaknesses. After the 2010 ‘crash flash’, when trading in some stocks went haywire, the regulator worked with the exchanges to implement new market buffers, including circuit breakers for individual stocks that interrupt trading during episodes of extreme volatility.

Regulators also know that while the stock market affects the economy, it does not have the same impact as the debt markets, which triggered the financial crisis. The end of the Internet boom of the late 1990s wiped out $ 6.05 trillion from US household inventories between the first quarter of 2000 and the third quarter of 2002, according to data from the Federal Reserve. The selling triggered a recession, but it was relatively subdued.

Regulators and lawmakers are likely to focus on two areas for review: the system that allows investors to trade stocks for free, and game-like apps and social media sites that get people to trade.

“The fact that our financial markets have this casino infection is something to fight,” said Rep. Brad Sherman (D., Calif.), Who is chairman of a House sub-committee on investor protection and financial markets. He wants to put in place regulatory barriers to the kind of “psychic rewards” that the Robinhood app offers, like a confetti graphic that celebrates certain trades.

The Financial Sector Regulatory Authority, an industry self-regulatory body overseen by the SEC, said this year that it intends to review brokers who offer “gamelike-style” investment experiences. In a letter to brokerage firms about its review plans, Finra said it will review how brokers who use such tools disclose investment risks to clients and how they approve those clients for options. negotiation, which would have exacerbated the fluctuations of GameStop.

Ms Waters said she plans to use a hearing on Feb. 18 to examine the payment flow for orders, the deal by which market makers such as Citadel Securities pay Robinhood to handle its clients’ transactions. Critics of the practice say it distorts the motivations of brokers and encourages them to maximize their income at the expense of clients. Brokers say this translates to better prices for investors.

President Biden’s pick to lead the SEC, Gary Gensler, could try to put his stamp on the market by looking at Robinhood’s business and its order flow payment arrangements. Mr. Gensler recently lectured on financial technology innovation at the Massachusetts Institute of Technology, which may shape how he deals with the rise of low-cost, easy-to-use brokerage applications.

The SEC has repeatedly acknowledged that pay-as-you-go is good for investors. Congress has also looked at the practice before, but little has come from oversight.

Citadel Securities, one of the main beneficiary companies of the model, has also become a major political force. Its owner, billionaire Kenneth Griffin, was the third-largest donor to Republican political campaigns in the 2020 election cycle, according to data compiled by the Center for Responsive Politics.

Senator Pat Toomey (R., Pa.), The senior Republican on the Senate Banking Committee, hailed the system that allows free trade as “amazing” for small investors.

“If anyone has a better model in mind for getting better execution at a lower cost and maintaining liquidity, well, I’m all for it,” Mr. Toomey said in an interview. “But, boy, that would be a hard thing to find given the good functioning of the markets now.”

Write to Paul Kiernan at [email protected] and Dave Michaels at [email protected]