GameStop Frenzy is a tough call for transparency-focused regulators

Except for the evidence that people are trying to manipulate the market, regulators may not have much to do. One of the basic principles of US market regulation is transparency – provide investors with information and let them decide. The GameStop drama was nothing but transparent.

“You can sell garbage to the public as long as you tell the public,“ This is garbage and you would be an idiot to buy it, but would you like to buy it? “Said Harvey Pitt, former president of the SEC.

What seems to have happened in recent weeks is that a massive wave of retail investors has answered “Yes” to this question, say current and former decision makers. Fueled by social media platforms like Reddit and smartphone brokerage apps like Robinhood, traders bid the GameStop price at $ 483 per share from less than $ 18 per share three weeks earlier. The video game retailer closed at $ 63.77 on Friday, down 87% from its January 28 intraday peak.

“I think there are a lot of people who take a lot of risks that they don’t fully understand,” said Jim Himes (D., Conn.), A former Goldman Sachs banker who serves on the House Financial Services Committee. . . “Unfortunately, the most effective remedy for this type of work is to touch a hot stove.”

One of the reasons regulators can be prevented is the lack of political will to limit trading by small investors. When Robinhood temporarily blocked its customers from trading GameStop shares during the frenzy, there was a shout-out about market access. The large losses that these little boys caused to hedge funds by bidding for the shares were seen as a democratization of the market. Any derailment effort that could be criticized as protection for Wall Street.

“Most people believe that middle-class people, workers, should be able to take risks in the stock market,” he said in a rep interview. Maxine Waters (D., California), who chairs the House Financial Services Committee. .

So far, the consensus among regulators is that the episode did not expose major issues related to market plumbing. The Treasury Department said on Thursday that regulators believe that “the basic infrastructure of the market has been resilient”. The department said the SEC is considering “whether business practices are consistent with investor protection and fair and efficient markets” and expects to release a report on the factors that influenced it.

The SEC intervened earlier when it identified weaknesses. After the “rapid collapse” of 2010, when trading in some stocks fell, the regulator worked with stock exchanges to implement new shock absorbers for the market, including switches for individual stocks that interrupt trading in periods 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 have stimulated the financial crisis. The end of the dot-com boom in the late 1990s removed $ 6.05 billion from US household stocks between the first quarter of 2000 and the third quarter of 2002, according to Federal Reserve data. The sale stimulated a recession, but was relatively easy.

Regulators and lawmakers are likely to focus on two areas of control: the system that allows investors to trade shares and gamel-free applications for free, and the social networking sites that attract people to trade.

“The fact that our capital markets have this casino infection is something we have to fight against,” said Rep. Brad Sherman (D., California), who is the chair of a subcommittee of the Chamber for the Protection of Investors and Capital Markets. He wants to put regulatory hurdles in the way of the kind of “psychic rewards” offered by the Robinhood app, such as a confetti graphic that celebrates some trades.

The financial industry regulator, an industry self-regulator overseen by the SEC, said this year it intends to examine brokers offering “high-end” investment experiences. In a letter to brokerage firms about its review plans, Finra said it will look at how brokers using such tools disclose investment risks to clients and how they approve these clients for trading options. , which is thought to have exacerbated GameStop changes.

Ms Waters said she intends to use a Feb. 18 hearing to examine payment for order flow, the arrangement by which market makers, such as Citadel Securities, pay Robinhood to manage its customers’ transactions. Critics of the practice say it distorts brokers’ incentives and encourages them to maximize their revenue to the detriment of clients. Brokers say that it results in better prices for investors.

President Biden’s election to lead the SEC, Gary Gensler, could try to put his stamp on the market by examining the Robinhood business and its payment transactions for the flow of orders. Mr Gensler recently gave lectures on financial technology innovation at the Massachusetts Institute of Technology, which could shape how it handles the growth of low-cost, easy-to-use brokerage applications.

The SEC has repeatedly blessed payments for order flow as good for investors. Congress has examined the practice before, but few have come out of oversight.

Citadel Securities, one of the model’s main corporate beneficiaries, has also become a major force in politics. 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 Responsible Policies.

Senator Pat Toomey (R., Pa.), A top Republican on the Senate Banking Committee, praised the system that allows free trading to be “amazing” for small investors.

“If anyone is considering a better model for how we get better execution at lower costs and maintain liquidity, well, we’re all on our toes,” Mr. Toomey said in an interview. “But, boy, it would be hard to think, given how well the markets are working now.”

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