The Securities and Exchange Commission could consider a wide range of new regulations to help prevent future volatility and small staggering pressures like those of GameStop and AMC Entertainment that captivated Wall Street last week.
The agency that oversees US markets could follow a litany of rules, ranging from a limit on the level of uncovered interest on a specific security to aggressive taxes on short-term trading, according to Bank of America Merrill Lynch .
“The brokerage platforms are already creating restrictions on margins, options and trading certain securities with unusual activity,” wrote BofA analyst Michael Carrier in a note to clients.
Carrier has drawn up a list of rules that the SEC is likely to follow if it is serious about preventing the dramatic swings that marked the last week of January.
In addition to the short-term interest limit and short-term tax bets, Carrier said the commission could move on to reviewing payment for order flows, as well as increasing its supervision on social media to avoid market manipulation.
It is not yet clear when Gary Gensler, President Joe Biden’s choice to chair the SEC, will be confirmed for his post, given the Senate’s focus on confirming cabinet-level nominations and former President Donald Trump’s impeachment trial.
A SEC representative declined to comment on this story, but referred CNBC to a statement issued on Friday. Although the regulator did not mention any parties by name, he promised to protect individual traders and to examine charges of unfair trade restrictions that brokers may have imposed.
Still, Bank of America was not the only Wall Street research firm curious as to whether the SEC could ultimately take decisive action after a few chaotic days in a handful of heavily shorted stocks.
Last week’s wildcat poster boy, GameStop rose 399.9% from its closing price on January 22 to closing on January 29. Its stock spike, unexpected due to a fundamentally bleak outlook for the mainstream video game business, took most of Wall Street by surprise.
As the week progressed, it became clear that the hike was largely the result of a coordinated group of retail traders taking advantage of an extraordinary level of short selling of GameStop shares. The group, which appears to have originated from Reddit, was also targeting AMC and headphone maker Koss.
Short selling is a strategy in which investors borrow shares of a stock at a certain price in the expectation that the market value will fall below that level when it comes time to pay for the borrowed shares.
When the price of these shares goes up instead of falling, short sellers are often forced to repurchase the shares they borrowed to avoid future losses. When this happens en masse, it can lead to the so-called short squeeze and even more gain in the stock price.
But the explosive moves and subsequent actions by brokers to curb trade have drawn anger from both sides of the political corridor. Senator Elizabeth Warren, a staunch supporter of financial supervision, criticized the SEC on Thursday for the regulator’s failure to act.
“We need a SEC that has clear rules on market manipulation and then has the backbone to get in and enforce those rules,” said Warren at the time. “To have a healthy stock market, you need to have a police officer on the streets.”
Echoing Bank of America’s analysis, Jefferies shared his own thoughts on how the SEC can try to prevent future short pressures of the same magnitude.
“With Gary Gensler set to be confirmed as the SEC’s new president, the issue of market structure and retail investor participation has come to the forefront,” wrote analyst Daniel Fannon in a note published on Friday.
The analyst said he believed that the regulator could consider further investor education around derivatives and risk management and increase the costs of certain products or services, such as leverage and derivatives. He echoed Carrier’s thoughts that the SEC could end up more closely controlling hedge funds’ short positions and tighter payment supervision for order flow.
“Limiting access, increasing margin requirements and restricting inventories creates a temporary stopgap, giving the new SEC president a long-term problem to solve,” wrote Fannon. “Historically, changes in market structure, even in small sizes, take time and often involve audiences, pilot programs along with comments / feedback from market participants.”
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