The U.S. House Financial Services Committee (the "Committee") considered legislation in response to the GameStop and Archegos trading events.
At the hearing titled "Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part III," the following bills were discussed:
- H.R. ____, the "Capital Markets Engagement and Transparency Act of 2021," which would (i) materially expand the reporting requirements under Section 13(f) ("Reports by Institutional Investment Managers") of the Exchange Act to provide for reporting on short positions and derivative securities and (ii) require the SEC to submit to Congress a report as to potentially limiting the availability of confidential treatment for Section 13(f) reporting.
- H.R. ____, which would amend the Investment Advisers Act to restrict the applicability of the exemption for family offices from being considered an investment adviser to those family offices with under $750,000,000 in assets under management.
- H.R. ____, which would require the SEC to submit to Congress and the SEC Office of the Investor Advocate a report evaluating the effect of the "gamification" of online trading platforms and related recommendations.
- H.R. ____, which would amend the Securities Exchange Act to create requirements regarding retail investor options trading, including (i) a prohibition on the offering of "incentives" to retail investors for their engagement in options trading, (ii) required disclosures to retail investors concerning the aggregate options trading losses experienced by other customers of a broker and (iii) mandating that the SEC establish a procedure for the calculation of aggregate options trading losses. (The term "incentives" is not defined.)
- H.R. ____, to amend the Exchange Act to ban payment for order flow.
- H.R. ____, to amend the Exchange Act to ban trading ahead by market makers.
With regard to the market volatility arising from the GameStop and Archegos trading events, SEC Chair Gary Gensler identified the following factors for consideration:
- game-like features in mobile investment applications;
- payment for order flow;
- the large concentration of retail orders that are routed to a few off-exchange wholesalers;
- transparency in the stock loan market;
- the influence of social media on retail investors' decision-making;
- clearance and the settlement cycle; and
- system-wide risks, including (i) liquidity sufficient to meet margin calls, (ii) the impact of hedge funds' significant monetary losses and (iii) concentration among market makers or brokers.
FINRA President and CEO Robert Cook highlighted payment for order flow and the "gamification" of retail trading platforms as factors that impact market volatility. Mr. Cook underscored the importance of the supervision of options accounts due to the enhanced risks associated with such trading.
Depository Trust and Clearing Corporation CEO Michael Bodson emphasized that the acceleration of the securities settlement will benefit clearing members and securities investors by (i) reducing the risks that margin requirements seek to address and (ii) decreasing costs to clearing members.
The SEC should conduct studies to better understand as much of the GameStop event as it can; Congress should direct such studies as it may find useful. However, it does not make sense to rush into legislation without some determination that there is a material benefit to it.
The bills on "payment for order flow" and on "trading ahead" are particularly notable examples of rushing into legislation. The practice of "payment for order flow" has probably existed for as long as the U.S. securities laws. Perhaps it is a flawed practice; perhaps it should be revised, or even banned. But it should not be banned without full consideration of the scope, benefits and detriments of the practice. The prohibition on trading ahead prohibits activity that is already illegal, but does so using very broad-brush language that would create uncertainty as to its application. Why would it be necessary to add a five-year prison term, for example, to this particular violation or to require a CEO certification as to this particular issue?
Consider how many ways there are to violate the U.S. securities laws. Should each have its own prison term? Should each rule require a certification from the firm's CEO? Legislators need to take a breath and direct any necessary studies before adopting requirements that have consequences that are very difficult to predict and are quite possibly negative.
As far as the areas of study suggested by Chair Gensler, the most interesting one is the influence of social media on retail investors' decision-making. One frequently expressed concern is that the SEC's regulation of broker-dealers, and the imposition of heavy burdens on providing any recommendations to retail investors, actually has negative consequences; that by effectively discouraging firms from serving low-worth investors, the regulators are driving these investors to social media as their source of investment guidance. (See GameStop: Regulators Should Focus Less on "Solving the Problem"; More on "Improving the Situation.")
- U.S. House Financial Services Committee Hearing: Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part III
- Congressional Memorandum: Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part III
- Congressional Testimony, Gary Gensler: Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part III
- Congressional Testimony, Robert W. Cook: Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part III
- Congressional Testimony, Michael C. Bodson: Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part III
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