GameStop Frenzy is a tough application for regulators focused on transparency

Except for the 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: giving information to investors and letting them decide. The GameStop drama was nothing but transparent.

“You can sell trash to the public as long as you say to the public,‘ This is trash and it would be silly to buy it, but would you like to buy it? Said Harvey Pitt, a former SEC president.

What seems to have happened in recent weeks is that a massive wave of retail investors responded: “Yes” to this question, say current and former policymakers. Driven by social networking platforms like Reddit and smartphone brokerage apps like Robinhood, traders raised the price of GameStop to $ 483 per share from less than $ 18 per share three weeks earlier. The struggling video game retailer closed at $ 63.77 on Friday, 87 percent less than its intraday peak on Jan. 28.

“I think there are a lot of very risky people who don’t fully 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 this kind of thing is to touch a hot stove.”

One of the reasons regulators can be hindered is the lack of political will to limit small-investor trade. When Robinhood temporarily blocked its customers from trading GameStop shares during the frenzy, a cry was raised about market access. The large losses caused by these small rates to some hedge funds by bidding for the 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 middle-class people, working people, should be able to take risks in the stock market,” said Rep. Maxine Waters (D., California), who chairs the Financial Services Committee. of the House, in an interview. .

The consensus among regulators so far is that the episode did not expose major issues with the market plumbing. The Treasury Department said Thursday that regulators believe the “basic infrastructure of the market was resilient.” The department said the SEC is reviewing “whether business practices are consistent with protecting investors and fair and efficient markets” and is expected to release a report on the factors that influenced it.

The SEC has intervened earlier when it identified weaknesses. After the “rapid fall” of 2010, when trading in some stocks failed, the regulator worked with stock exchanges to implement new shock absorbers for the market, including circuit breakers for individual stocks that stopped 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 debt markets, which drove the financial crisis. According to Federal Reserve data, the end of the dot-com boom in the late 1990s ended with $ 6.05 trillion in U.S. household stocks between the first quarter of 2000 and the third quarter of 2002. Sales 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 stocks for free, and games-like apps and social networking sites that attract people to trade.

“The fact that our capital markets have this casino infection is something to be fought against,” said Rep. Brad Sherman (D., California), who chairs a House subcommittee on investor protection. and capital markets. He wants to put regulatory hurdles in the kind of “psychic rewards” the Robinhood app offers, such as a confetti graphic celebrating some trades.

The Financial Industry Regulatory Authority, an SEC-supervised industry self-regulator, said this year that it plans to examine brokers offering “gaming-like” investment experiences. In a letter issued to brokerage firms about their examination plans, Finra said it would look at how brokers using these tools reveal investment risks to clients and how they approve those clients for options trading, which is believed to be which have exacerbated GameStop changes.

Waters said he plans to use a Feb. 18 hearing to examine payment for order flow, the deal by which market makers like Citadel Securities pay Robinhood to manage its customers’ operations. Critics of the practice say it adjusts brokers ’incentives and encourages them to maximize their revenue at the expense of customers. Brokers say it results in better prices for investors.

President Biden’s choice to lead the SEC, Gary Gensler, could try to put his stamp on the market by examining Robinhood’s business and its order-flow payment agreements. Gensler has recently lectured on financial technology innovation at the Massachusetts Institute of Technology, which could shape how it handles the rise of low-cost, easy-to-use brokerage applications.

The SEC has repeatedly blessed payment by flow order as a good for investors. Congress has also examined the practice before, but little has resulted from oversight.

Citadel Securities, one of the model’s main corporate beneficiaries, has also become a major force in politics. Its owner, billionaire Kenneth Griffin, was the third largest donor for Republican political campaigns in the 2020 election cycle, according to data collected by the Center for Responsive Politics.

Senator Pat Toomey (R., Pa.), The top Republican on the Senate Banking Committee, praised the system that allows free trade as “amazing” for small investors.

“If anyone is considering a better model of how we get better execution at lower costs and maintain liquidity, then I am heard,” Toomey said in an interview. “But, boy, it would be hard to think given the smooth running of the markets now.”

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