The Securities and Exchange Commission could consider a wide variety of new rules to avoid future volatility and blindingly short periods, such as those in GameStop and AMC Entertainment that caught the Wall Street spell last week.
The agency overseeing US markets could follow a litany of rules, according to Bank of America Merrill Lynch, ranging from a short-rate limit on a specific security to aggressive taxes on short-term trading.
“Brokerage platforms have already created restrictions on margins, options and the trading of certain securities with unusual activity,” BofA analyst Michael Carrier wrote in a note to clients.
Carrier ticked off a list of rules the SEC is likely to follow if it is serious about avoiding the dramatic swings that marked the last week of January.
In addition to the short interest limit and taxing short-term bets, Carrier said the committee may revise payment for order flows and social media surveillance to fend off market manipulation.
It remains unclear when Gary Gensler, President Joe Biden’s choice to chair the SEC, will be confirmed at his post, given the Senate’s focus on confirming cabinet-level nominees and the impending impeachment process of former President Donald Trump.
A SEC representative declined to comment on this story, but referred CNBC to a statement it issued Friday. Although the regulator did not name parties, it pledged to protect individual traders and investigate allegations of unfair trading restrictions that brokers may have imposed.
Still, Bank of America wasn’t the only Wall Street research firm curious to see if, after a few chaotic days, the SEC would eventually take decisive action in a handful of heavily short-short stocks.
GameStop, the poster child of last week’s wild trade, was up 399.9% from the closing price on Jan. 22 to close on Jan. 29. The stock spike, unexpected given the bleak fundamental outlook for the physical video game business, surprised most of Wall Street.
As the week progressed, it became clear that the rally was largely the result of a coordinated group of retailers benefiting from an excessive level of short selling in GameStop shares. The group, which appears to have originated on Reddit, also targeted AMC and headphone manufacturer Koss.
Short selling is a strategy where investors borrow shares of a stock at a specified price in the expectation that its market value will fall below that level when it comes time to pay for the borrowed shares.
When the price of those shares rises rather than falls, short sellers are often forced to buy back the borrowed shares to avoid further losses. When this happens en masse, it can lead to a so-called short squeeze and even a further rise in the share price.
But the explosive moves and subsequent brokerage actions to curb trading angered both sides of the political aisle. Senator Elizabeth Warren, an outspoken advocate for financial supervision, denounced the SEC on Thursday for failing to take action by the regulator.
“We need an SEC that has clear rules about market manipulation and then has the backbone to come in and enforce those rules,” Warren said at the time. “To have a healthy stock market, you have to have an agent on the beat.”
Echoing Bank of America’s analysis, Jefferies shared his own views on how the SEC could try to stop future short-term bottlenecks of the same magnitude.
“With Gary Gensler to be confirmed as the new SEC chairman, the issue of market structure and private investor participation has come to the fore,” analyst Daniel Fannon wrote in a note published Friday.
The analyst said he thinks the regulator could consider greater investor education around derivatives and risk management and increase costs for certain products or services such as leverage and derivatives. He echoed Carrier’s thoughts that eventually the SEC could monitor short positions of hedge funds more closely and monitor payment for order flow more closely.
“Limiting access, increasing margin requirements and limiting inventories create a temporary stop-gap that requires the new SEC chairman to resolve a longer-term problem,” Fannon wrote. “Historically, changes in market structure, even of small size, have taken time and typically included hearings, pilot programs and comments / feedback from market participants.”
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