GameStop Frenzy is a tough call for regulators focusing on transparency

Excluding evidence that people are trying to manipulate the market, regulators may not have much to do. One of the core principles of market regulation in the US is transparency – giving investors information and letting them decide. The GameStop drama was nothing, if not transparent.

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

What has apparently happened over the past few weeks is that a large wave of retail investors have answered ‘Yes’ to the question, say current and former policymakers. Powered by social media platforms like Reddit and smartphone brokerage apps like Robinhood, traders are offering the price of GameStop up to $ 483 per share from less than $ 18 per share three weeks in advance. The struggling video game retailer closed at $ 63.77 on Friday, 87% lower than its intraday peak on January 28.

“I do think a lot of people run the risk of not fully understanding,” Rep. Jim Himes (D., Conn.), A former Goldman Sachs banker who sits on the House Finance Committee, said. . “Unfortunately, touching a hot stove is the most effective remedy for such a thing.”

One reason regulators can be stimulated is the lack of political will to restrict trade by small investors. When Robinhood temporarily traded its customers of GameStop shares during the frenzy, a call went up about market access. The huge losses that little guys have inflicted on some hedge funds by offering the stock is seen as a democratization of the market. Any attempt to derail could be criticized as protecting Wall Street.

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

The consensus so far among regulators is that the episode did not expose major problems with the plumbing work of the market. The department of treasury said on Thursday that regulators believe the core infrastructure of the market is resilient. The department said the SEC is investigating ‘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 stepped in earlier when it identified weaknesses. After the ‘flash crash’ in 2010, when trading in some stocks expired, the regulator worked with stock exchanges to implement new shock absorbers for the market, including power outages for individual stocks that disrupt trading during extreme volatility.

Regulators also know that although the stock market is affecting the economy, it is not having the same impact as debt markets, which has fueled the financial crisis. According to the Federal Reserve, the end of the dot-com boom of the late 1990s wiped out $ 6.05 billion dollars from US equities’ households. The sell-off sparked a recession, but it was relatively mild.

Regulators and legislators are likely to focus on two areas: the system that allows investors to trade stocks for free, and the game apps and social media sites that entice people to trade.

“The fact that our capital markets have this casino infection is something to fight,” said Brad Bradman (D., California). He chairs a subcommittee of the House on investor protection and capital markets. He wants to set up regulatory barriers to the kind of ‘psychic rewards’ the Robinhood app offers, such as a confetti-graphic version celebrating some trades.

The Financial Industries Regulatory Authority, a self-regulator in the industry overseen by the SEC, said it plans to investigate brokers this year that offer a “gamely” investment experience. In a letter issued to brokerage firms about their investigation plans, Finra said they were going to look at how brokers using such instruments reveal investment risks to clients and how they approve clients for trading options, exacerbating GameStop’s swing.

Mrs. Waters said she plans to use a trial on Feb. 18 to investigate pay-for-order flows, the arrangement by which market makers like Citadel Securities pay Robinhood to handle their clients’ trading. Critics of the practice say it distorts the incentives of brokers and encourages them to maximize their income at the expense of clients. Brokers say it results in better prices for investors.

President Biden’s choice to run the SEC, Gary Gensler, could try to make his mark on the market by examining Robinhood’s business and the pay-for-order flow transactions. Mr. Gensler recently gave lectures on financial technology innovation at the Massachusetts Institute of Technology, which may shape how he handles the rise of cheap and easy brokerage programs.

The SEC has repeatedly blessed pay-for-order flows as good for investors. Congress has also examined the practice before, but supervision has come little.

Citadel Securities, one of the model’s most important 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 Responsive Politics.

Senate Pat Toomey (R., Pa.), The leading Republican on the Senate Banking Committee, praised the system that allows free trade as ‘great’ for small investors.

“If anyone has a better model in mind for how we can better export at lower cost and maintain liquidity, it’s my ears,” he said. Toomey said in an interview. “But young, it will be difficult to come up with given how well the markets are functioning now.”

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