© Reuters/ANDREW KELLYFILE PHOTO: A monitor displays stock market information on the trading floor at the New York Stock Exchange (NYSE) in Manhattan, New York City
By Katanga Johnson and John McCrank
WASHINGTON (Reuters) - Wall Street regulators need to do more to address market risks highlighted by the "meme-stock" trading frenzy of January 2021 that pitted individual investors in GameStop Corp against powerful hedge funds, a congressional report said Friday.
The report by the U.S. House of Representatives' Financial Services Committee singled out Robinhood's trading app for "troubling business practices" and said regulators need to step up scrutiny of the company.
The report also called for new brokerage liquidity rules and for regulators to hasten a crackdown on the "gameification" of trading, game-like features that prompt users to trade more.
"The meme stock saga has raised questions about how retail trading market infrastructure currently operates and whether it is appropriately designed and regulated," the report said.
Meme stock trading is still happening, with cosmetic company Revlon Inc the latest example.
The report, which was prepared following hearings in February 2021, analyzed how money was made and lost so quickly when GameStop shares surged more than 1,600% in January that year, then collapsed. It will increase pressure on regulators to prioritize the proposed fixes.
During the GameStop episode, retail investors banded together in online forums to push up the stock's price and force hedge funds that had bet against it, known as short selling, to unwind their trades.
The panel did not cast blame but instead proposed tightening regulatory gaps. The report called for the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), Wall Street's self-funded watchdog, to craft new rules to address what it called "a culture that prioritizes growth above stability."
Specifically, the panel recommends the SEC introduce a liquidity rule for clearing brokers, and for FINRA to establish a framework governing liquidity planning for clearing brokers, rather than current voluntary guidance.
Both FINRA and the SEC, which have stepped up scrutiny of "gameification," should also bolster regulations curbing the extension of margin trading to customers, the report said.
The panel also recommends that brokers that execute above a certain threshold of retail orders connect to a public market like NYSE or Nasdaq, rather than sending orders to wholesale market makers for a fee, a practice known as payment-for-order flow (PFOF), as Robinhood had been during the GameStop saga.
SEC Chair Gary Gensler, whose agency also last year issued a report https://www.sec.gov/page/sec-staff-release-gamestop-report#:~:text=The%20Securities%20and%20Exchange%20Commission,several%20questions%20about%20market%20structure on the GameStop saga, has said the agency would address gameification, PFOF and short selling disclosures, among other issues.
He recently unveiled a planned overhaul of trading rules that aim to ensure mom-and-pop investors get the best deal.
(Reporting by Katanga Johnson and John McCrank; Editing by Megan Davies and Jonathan Oatis)
The SEC is trying to reshape the US stock market - but that could mean retail investors will have to start paying fees on trades again
Carla Mozée
June 11, 2022
SEC Chairman Gary Gensler.Alex Wong/Getty Images
Proposed changes to market-structure rules could lead to retail investors paying commissions on trades again.
SEC Chairman Gensler Gensler is proposing the agency consider sending retail stock orders to auctions.
The payment for order flow system is back under scrutiny.
The Securities and Exchange Commission is aiming to shake up the mechanics of US stock trading in the wake of last year's meme-stock frenzy, and some experts in the markets say changes could lead to a shift back to retail investors paying commissions to make trades.
SEC Chairman Gary Gensler in a speech this week outlined six areas of market structure where rules could be updated to foster greater efficiencies, particularly for retail investors. Gensler is proposing the agency consider sending retail stock orders to auctions under which trading firms would compete to execute the transactions to ensure investors receive the best prices.
Such a move could alter the payment for order flow system, or PFOF, under which brokerage firms including Robinhood, TDAmeritrade, and E-Trade are compensated for sending customers' orders to market makers rather than sending them directly to an exchange. Among the biggest market makers are Citadel Securities and Virtu Financial. PFOF supports zero-commission trading at online brokers that serve amateur investors.
A significant PFOF change "may reset the entire playing field and cost individual investors more money because we'll have to go back to some sort of commission model," Sean Bonner, CEO of Guild Financial, a self-direct investment app that focuses on active and retired members of the military, told Insider. Guild, an early-stage business, doesn't use the payment for order flow system.
"I can guarantee you that commission model will be much higher than the rebates paying the payment for order flow — much higher, by a factor of 10s to 100s," said Bonner, who has more than 20 years of experience on Wall Street from floor trading to working as a mutual fund manager. "Retail investors are saving billions of dollars a year on the current payment for order flow model."
Major wholesalers such as Citadel, Virtu, G1X and Two Sigma provided $6.1 billion in price improvements in 2020 and 2021 combined, said BrokerChooser, based on its analysis.
Zero-commission trading in recent years has fueled a boom in activity among individual investors who no longer had to pay their brokers as much as $6.95 for each trade.
Proposed changes to shake up rules in the US stock market was met with criticism from Robinhood's chief legal officer Dan Gallagher this week. "It is a really good climate for retail, so to go in and muck with it right now, to me, is a little worrisome," Gallagher said at a conference in New York, according to The Wall Street Journal. Retail traders are benefitting from zero-commission transactions and fast execution of trades, he said.
Following last year's meme-stock frenzy, Gensler last year asked the SEC to review rules related to equity-market structure, including payment for order flow.
PFOF is banned in some countries. Gensler isn't proposing a ban but such a move would make it "almost inevitable" that retail investors return to a commission-based system, Kerim Derhalli, founder and CEO of investment app Invstr, told Insider.
"I don't think anyone is going to be willing to provide brokerage services on their own without having some form of revenue associated with it," he said. The Invstr app has 3 million users worldwide and the company doesn't use the PFOF system.
"If we return to a commission structure then you could argue that might discourage people from trading as frequently as they have been trading. You could, on the other hand, argue that if people start trading less, and investing more, they'll be better off," over the long term, he said.
"What would seem to be a simple solution would be [for Gensler] to say, 'We're going to make PFOF illegal and … retail trading needs to go through the exchange where it's transparent and the prices are transparent and people can have confidence in the system," said Derhalli.
Bonner at Guild said overall he sees a ban on PFOF hurting retailer traders. "To be honest, a lot of brokers would hope that they get rid of this payment for order flow model and get back to charging for commissions because there's a lot more revenue for the brokers in that."
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