GameStop Frenzy is difficult for regulators focused on transparency

Unless there is evidence that people were trying to manipulate the market, regulators may not have much to do. One of the basic principles of market regulation in the United States is transparency – provide investors with information and let them decide. The GameStop drama was transparent.

“You can sell trash to the public, as long as you tell the public, ‘This is trash and you would be an idiot if you bought it, but would you like to buy it?'” Said Harvey Pitt, former SEC chairman.

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

“I think there are a lot of people taking 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 of Representatives’ Financial Services Committee. “Unfortunately, the most effective remedy for this type of thing is to touch a hot stove.”

One of the reasons why regulators may be blocked is the lack of political will to limit the trades of retail investors. When Robinhood temporarily blocked his clients from trading GameStop shares during the frenzy, there was a cry about market access. The huge losses that these little ones inflicted on some hedge funds by increasing their shares were seen as a democratization of the market. Any effort to derail that could be criticized as protection for Wall Street.

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

The consensus among regulators so far is that the episode has not exposed major problems with the market’s plumbing. The Treasury Department said on Thursday that regulators believe the “core market infrastructure is resilient”. The department said the SEC is looking into “whether trading practices are consistent with investor protection and fair and efficient markets” and is expected to release a report on the factors that influenced it.

The SEC has intervened before in identifying weaknesses. After the 2010 flash crash, when some stock trading went crazy, the regulator worked with the stock exchanges to implement new buffers for the market, including breakers for individual stocks that interrupt trading during episodes of extreme volatility.

Regulators also know that, although the stock market affects the economy, it does not have the same impact as the debt markets, which drove the financial crisis. The end of the dot-com boom in the late 1990s wiped out $ 6.05 trillion from American household stocks between the first quarter of 2000 and the third quarter of 2002, according to Federal Reserve data. The liquidation caused a recession, but it was relatively mild.

Regulators and legislators are likely to focus on two areas of scrutiny: the system that allows investors to trade shares for free and the gaming applications and social media sites that attract people to trade.

“The fact that our capital markets have this casino infection is something we must fight against,” said Representative Brad Sherman (D., California), who is chairman of a House subcommittee on investor protection and capital markets. . He wants to put regulatory hurdles on the type of “psychic reward” that the Robinhood app offers, like a confetti graphic that celebrates some negotiations.

The Financial Industry Regulatory Authority, a sector self-regulator overseen by the SEC, said this year that it plans to examine brokers who offer “gaming-like” investment experiences. In a letter sent to brokers about his examination plans, Finra said he would look at how brokers using such tools disclose investment risks to clients and how they approve those clients for trading options, which are believed to have exacerbated GameStop’s swings .

Waters said he plans to use a hearing on February 18 to examine the pay-per-order flow, the arrangement by which market makers like Citadel Securities pay Robinhood to handle their clients’ trades. Critics of the practice say it distorts brokers’ incentives and encourages them to maximize their revenue at the expense of clients. Brokers say that this results in better prices for investors.

President Biden’s choice to head the SEC, Gary Gensler, could attempt to put his brand on the market by examining Robinhood’s business and its order flow business. Mr. Gensler recently gave a talk on innovation in financial technology at the Massachusetts Institute of Technology, which could shape how he addresses the rise of low-cost, easy-to-use brokerage applications.

The SEC has repeatedly considered the pay-per-order flow to be good for investors. Congress has also examined the practice before, but little has come from oversight.

Citadel Securities, one of the main beneficiaries of the model, 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 Responsive Politics.

Senator Pat Toomey (R., Pa.), The leading Republican on the Senate Banking Committee, praised the system that allows free trade to be “incredible” for small investors.

“If someone has a better model in mind to get better execution at lower costs and maintain liquidity, well, I’m all ears,” said Toomey in an interview. “But, man, that would be a difficult thing to invent, given how well the markets work now.”

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