GameStop Frenzy is a tough call for regulators focused on transparency

Barring evidence that people tried to manipulate the market, regulators may not have much to do. One of the core principles of market regulation in the US is transparency – inform investors and let them decide. The GameStop drama was nothing but transparent.

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

What appears to have happened in recent weeks is that a huge wave of private investors answered “Yes” to that question, current and former policymakers say. Fueled by social media platforms like Reddit and smartphone brokerage apps like Robinhood, the traders are bidding GameStop price up to $ 483 per share from less than $ 18 per share three weeks earlier. The struggling video game retailer closed at $ 63.77 on Friday, down 87% from its intraday peak on Jan. 28.

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

One of the reasons regulators can be hindered is a lack of political will to restrict trade by small investors. When Robinhood temporarily blocked its clients from trading GameStop stock during the frenzy, there was a cry about market entry. The big losses that those little guys inflicted on some hedge funds by bidding on the shares were seen as a democratization of the market. Any attempt to derail that could be criticized as protecting Wall Street.

“Most people believe that middle-class people, working people, should be able to seize their opportunities in the stock market,” said Rep. Maxine Waters (D., California), Chair of the House Financial Services Committee, in an interview. .

The consensus among regulators so far has been that the delivery hasn’t exposed any major plumbing issues in the market. The Treasury Department said on Thursday that regulators believe the “core market infrastructure was resilient.” The department said the SEC is reviewing “whether trading practices are consistent with investor protections and fair and efficient markets,” and is expected to issue a report on the factors that affected this.

The SEC intervened before when it discovered weaknesses. After the ‘flash crash’ of 2010, when trading in some stocks went into disarray, the regulator worked with the stock exchanges to implement new shock absorbers to the market, including circuit breakers for individual stocks that interrupt trading during 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 triggered the financial crisis. The end of the dotcom boom of the late 1990s wiped out $ 6.05 trillion in US household inventory between the first quarter of 2000 and the third quarter of 2002, according to Federal Reserve data. The sell-off triggered a recession, but it was relatively mild.

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

“The fact that our capital markets have this casino contamination is something to fight against,” said Rep. Brad Sherman (D., California), who chairs a subcommittee of the Investor Protection and Capital Markets House. He wants to put regulatory obstacles to the kind of ‘psychic rewards’ the Robinhood app offers, such as a confetti graphic that celebrates certain crafts.

The Financial Industry Regulatory Authority, a self-regulatory body in the industry overseen by the SEC, said this year it plans to scrutinize brokers offering “gamelike” investment experiences. In a letter to brokerage firms about its research plans, Finra said it would look at how brokers using such tools disclose investment risks to clients and how they approve those clients for options trading, which is believed to have exacerbated GameStop’s swings.

Ms. Waters said she plans to use a February 18 hearing to investigate the pay-for-order flow, the arrangement where market makers like Citadel Securities pay Robinhood to handle their clients’ transactions. Critics of the practice say it distorts brokers’ incentives and encourages them to maximize their earnings at the expense of clients. Brokers say it results in better prices for investors.

Gary Gensler, President Biden’s choice to head the SEC, could try to make his mark in the marketplace by examining Robinhood’s company and its pay-for-order flow deals. Mr. Gensler recently lectured on financial technology innovation at the Massachusetts Institute of Technology, which could determine how he is handling the rise of low-cost and easy-to-use brokerage apps.

The SEC has repeatedly blessed the pay-for-order flow as good for investors. Congress has also investigated the practice before, but little came out of the supervision.

Citadel Securities, one of the model’s main 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 collected by the Center for Responsive Politics.

Senator Pat Toomey (R., Pa.), The senior Republican on the Senate Banking Commission, praised the system that enables free trading as “great” for small investors.

“If anyone has a better model in mind for how we get better execution at a lower cost and maintain liquidity, then I’m a listening ear,” said Mr. Toomey in an interview. “But boy, that would be hard 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]