One month after GameStop (GME) shares rose to record levels as a result of trading with Reddit, Wall Street, online brokerage Robinhood and Reddit face the Department of Justice (DOJ), the Commodity Futures Trading Commission (CFTC) and both rooms. of Congress.
During GameStop’s two-week meteoric rise, the S&P 500 dropped a whopping 5% from the top to the bottom. Wall Street feels the full squeeze of chaos. Hedge funds endured an extremely dangerous event comparable to the global financial crisis, as retail investors banded together to suppress institutional investors. Fortune was made and lost within hours as the now infamous hedge fund Melvin Capital Management became the poster child of Wall Street’s self-help machine.
Suffice it to say legislators and regulators are paying attention. The incident also caught the eye of Treasury Secretary Janet Yellen and the US Securities and Exchange Commission (SEC). Now what?
A House Financial Services Committee hearing on the GameStop trade rush scheduled for Feb. 18 will shed light on current secular trends that allow capital markets to become caricatures of themselves.
“We are still learning new things about what goes on every day … [T]the financial markets can move fast, “Andy Green, senior fellow for economic policy at American Progress and former SEC board, told Yahoo Finance Live. I think therefore it is very important for investors to be sensible, to seek the long run. term, to be aware of the basics of not borrowing margins and taking risks they cannot afford. ‘
Conflicting interests
Robinhood will have to ask tough questions. This will have to explain why it has temporarily banned investors from trading GameStop and other stocks. Robinhood will also need to disclose how it assesses whether customers are suitable to trade options (even if they are only call options with a defined risk). The exploding call option volume and the leverage contained in it are a big part of a recent rise in share prices. It can be very dangerous to hand out leverage to inexperienced traders.
Last year, Robinhood sharpened the educational section of his website – but only after a British university student committed suicide after misinterpreting his account statement and financial loss (a lawsuit filed by the student’s family against Robinhood is pending) . With the influx of new retailers opening new accounts, it will be helpful to re-examine how brokers generally assess clients’ risk and suitability – and whether or not brokers adhere to their written controls and procedures.
Green compares Robinhood’s no commission trading to the free services that Big Tech offers that are not really free. “The cost is hidden. And it is passed on to ordinary users of the big technology sites or other parts of society. So there are hidden costs for many of these platforms and free services that we are going to pay for, and we need to think more carefully.” he said.
Robinhood will also have to explain Citadel Securities’ margin calls. Like most retail brokers, Robinhood sells its users’ order flow to wholesale market makers like Citadel, which is how brokers make money.
This practice, called order flow payment (PFOF), is under scrutiny. Wall Street market makers, such as Citadel, paid brokers, such as Robinhood, $ 2.86 billion for client orders in stocks and stock options, according to Bloomberg data. The business model needs to be thoroughly researched to determine how small investors are indeed affected by it. There is a lot of money in it, so the stakes are high.
Robinhood and other brokers claim that they improve the fill-in price of client orders if it matches internally with companies such as Citadel, Susquehanna International Group and Virtu Financial. But last December, Robinhood paid a $ 65 million fine to the SEC, in part for providing “inferior trading prices” that cost customers $ 34.1 million. Assuming that Robinhood has cleared his action, he still needs to set out his order price improvement statistics in different classes of stocks – especially according to stock price and market capitalization.
Doug Cifu, CEO of Virtu Financial (the only public company that pays for order flows), recently defended the practice on a merit call. He said he had never seen any data confirming the allegation that PFOF was distorting the market.
Traders are concerned about PFOF because it reduces the overall transparency of the market (as well as all foreign exchange transactions) by definition, because the details of the transactions that are internally matched do not get into the public data feeders. In addition, there is a reason why these orders are so valuable, which should be sniffed out and placed in the record. Traders want businesses that buy customer orders to announce if they are trading before such orders or otherwise trying to take advantage of the data.
Finally, the structure of trading stocks is likely to be examined. The term pump-and-dump (whether fair or not) is likely to emerge during the congressional hearing. That is, questions will arise as to whether there was an actual attempt to artificially increase the prices of shares with the aim of selling them profitably.
Hedge funds pay billions of dollars annually for high-speed exchange data that is far more useful than the slower feed that small investors get. And it’s the slow, retail data entry called the National Best Bid and Offer, or NBBO, that is being used as a measure to determine whether customers are getting a better price at Citadel et. al.
If the NBBO were faster and not so archaic, retailers would probably fill up better. But that would affect the profitability of PFOF, and therein lies the garbage. The NBBO offers a de facto structural safe haven for brokers to deliver refills at lower prices at the expense of retailers.
A 2014 study compared the retail NBBO to direct feed buying hedge funds in search of price disruption. Its findings: “The price disruption between the NBBOs occurs several times per second in very active stocks and usually lasts one to two milliseconds. The short duration of disruptions reduces their costs for investors who rarely trade, while the “Frequency of disruptions makes it expensive. For regular traders. Higher security prices and days with high trading volume and volatility are related to disruptions.”
The high trading volume and volatility were features of the GameStop saga. It will therefore be useful to determine exactly what price shifts have taken place and how much it costs investors.
“I’m not going to propose … a comprehensive reform of the payment flow order, because you have to look at the whole market. But I do not think that conflicts of interest are good for investors. It is not good for us. “We need to reduce it, not … allow it to increase,” Green said.
Jared Blikre is a correspondent focused on the markets or Yahoo Finance Live. Follow him @SPYJared