The U.S. Securities and Exchange Commission plans to soon release its long-awaited report on the GameStop trading saga and it could have implications for brokerages, wholesale market makers, exchanges, and retail investors.
The SEC report is expected to address the issues around the market chaos in late January when a flood of trading through commission-free retail brokerages drove shares in GameStop Corp and other popular "meme stocks" to extreme highs, squeezing hedge funds that had bet against them.
Amid the intense volatility, several brokerages restricted trading in the affected stocks, curbing the rally, infuriating retail traders and rattling market confidence.
Here are some topics the SEC has said it is scrutinizing:
'GAMIFICATION' OF TRADING
SEC Chair Gary Gensler has said the "gamification of trading" by commission-free retail brokerages is a growing concern because it could encourage more trading than is in investors' best interests.
Gensler highlighted retail brokerages' use of artificial intelligence, predictive data analytics, and machine learning to push customized products to their customers and boost revenues.
In March, brokerage Robinhood Markets scrapped the use of confetti animation on its trading app that had marked users' first trades, among other changes, following criticism from politicians and regulators.
PAYMENT FOR ORDER FLOW
Gensler has been critical of payment for order flow (PFOF), the practice of retail brokers, like Robinhood or Charles Schwab Corp, sending most of their customers' orders to wholesale market makers rather than to exchanges, in return for payments.
Gensler has said PFOF raises potential conflicts and has questioned whether brokers are incentivized to encourage their customers to trade more frequently to maximize the payments.
PFOF proponents say it is a major reason most brokerages were able to stop charging trading commissions, which helped fuel retail trading boom. The majority of Robinhood's revenue comes from PFOF.
PFOF defenders say it benefits retail traders because wholesale brokers execute their trades at the best prices found on exchanges or better.
But Gensler has said that because so many trades are now executed away from exchanges, where stock prices are formed, the best prices shown on exchanges may not accurately reflect market sentiment, causing wider bid-ask spreads to the detriment of all investors.
MARKET MAKER CONCENTRATION
The GameStop saga highlighted the small number of market-makers that dominate the retail market, with Citadel Securities executing around 37% of all U.S.-listed retail volume. That could pose competition issues, Gensler has said.
Nearly half of all trades are executed away from exchanges. That is partly due to rules that allow market makers to offer fractional sub-penny price improvement on bids and offers, whereas exchanges have to quote in pennies, which Gensler has said has created an unleveled playing field.
The "sub-penny rule" that limits exchanges to penny quotes was enacted in 2005 over concerns that if smaller pricing increments were allowed, sophisticated traders might use them to jump ahead of retail orders.
CLEARINGHOUSES AND SETTLEMENT TIMES
January's massive volatility in "meme" stocks prompted the post-trade clearinghouse that guarantees trades to demand billions of dollars in extra collateral from retail trading platforms.
In response, several brokers restricted trading in the affected stocks, sparking speculation on Reddit's WallStreetBets forum that the brokers were protecting hedge funds that stood to lose out if the shares rose.
Robinhood CEO Vlad Tenev has argued the problem was largely due the two-day time period it takes to settle a trade, and if settlements were in real time, collateral would not have been an issue.
Gensler has indicated he is in favor of shortening the settlement cycle.
Most of the stocks in the GameStop saga were heavily shorted – a strategy used to bet a stock price will fall – with more than 140% short interest in GameStop, implying that more shares were shorted than available to trade.
That is possible on paper because when shares are borrowed to short and then sold back into the market, the new owner of the shares has no idea they are on the other side of a short sale, and can lend them out, just as the previous owner did.
Gensler has said he considering greater disclosure around short selling and securities lending.
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