SEC Studying Whether New Rules Are Needed for Apps That Gamify Trading, Chairman Says
Gensler is set to testify Thursday before House Financial Services Committee
WASHINGTON—Wall Street’s top regulator is studying whether to impose new restrictions on brokerage apps that would make it easier for investors to trade stocks and other securities, the Securities and Exchange Commission’s chairman is set to tell lawmakers.
In testimony prepared for the House Financial Services Committee, Gary Gensler says applications that “gamify” trading—by using appealing visual graphics to reward a user’s decision to trade—might encourage frequent trading that results in worse outcomes for investors.
Mr. Gensler, who is expected to appear Thursday before lawmakers, also said the SEC would study regulatory changes in response to the March blow-up of Archegos Capital Management, which led to more than $10 billion in losses at top global banks.
In his remarks on gamification, Mr. Gensler suggests that many investor-protection rules were written before trading moved to online platforms that have grown more visually enticing and are sometimes blamed for encouraging investors to trade more. The hearing was scheduled earlier this year after a boom in retail trading drove the prices of several stocks, including those of GameStop Corp. and AMC Entertainment Holdings Inc., far above where they traded in December.
“Many of our regulations were largely written before these recent technologies and communication practices became prevalent,” Mr. Gensler is set to say. “I think we need to evaluate our rules, and we may find that we need to freshen up our rule set.”
Mr. Gensler, a former Goldman Sachs Group Inc. banker who led the Commodity Futures Trading Commission during the Obama administration, also is to say that the SEC is examining whether some large broker-dealers known as wholesalers have too much power in handling retail orders. Wholesalers pay retail brokerage firms, such as Robinhood Financial LLC and TD Ameritrade, for the right to trade with those firms’ customer orders.
The system, known as payment for order flow, has long been scrutinized for conflicts of interest, including whether retail brokers are encouraged to maximize their own revenue rather than ensuring their customers get the best price. Wholesalers say the market is competitive and that they don’t set the rates they pay to the retail brokerages. The system also generally yields better share prices for retail traders than they would get on stock exchanges.
Citadel Securities says it accounts for 47% of all retail trading of listed securities, making it the largest stock-market wholesaler. Virtu Financial Inc. says it executes about 25% to 30% of those retail orders.
“Market concentration can also lead to fragility, deter healthy competition, and limit innovation,” Mr. Gensler says in his prepared remarks. “I’ve asked staff to look closely at these issues to determine which policy approaches may be merited.”
Payment for order flow has swelled as more small investors have jumped into the stock market. The 11 biggest U.S. brokerages serving individual investors collected nearly $1.2 billion in payments for order flow during the first three months of 2021, more than double the amount from the same quarter last year, according to an analysis of regulatory filings by Bloomberg Intelligence.
Robinhood alone generated about $331 million for selling its order flow in the first quarter of 2021, more than triple the amount from the year-ago quarter.
In his prepared testimony, Mr. Gensler says he has asked the SEC staff to prepare recommendations to increase public reporting on short-selling as well as the network of stock lending and borrowing that facilitates it. The Wall Street Journal reported in February that the SEC was studying the move. Short selling is the practice of borrowing shares and selling them on the expectation that they could be bought back later at a lower price.
Some of the gyrations in GameStop shares earlier this year were due to a so-called short squeeze, in which rising prices prompt bearish investors to cut their losses and buy back shares they had sold short, pushing the stock higher still.
Some of the investors who had bet against GameStop were hedge funds, and retail traders communicating on platforms like Reddit’s WallStreetBets boasted that their bullish trades were punishing establishment investment managers.
In his comments on Archegos, Mr. Gensler says he has asked SEC staffers to explore more disclosure of total return swaps, a type of derivative contract that played a key role in Archegos’s meltdown. Archegos—the family investment vehicle of hedge-fund veteran Bill Hwang —used such swaps to amass the equivalent of huge equity stakes in companies like ViacomCBS Inc. and Chinese internet giant Baidu Inc. Archegos effectively owned 25% of some companies, the Journal has reported.
By using swaps instead of simply buying shares, Archegos was able to place outsize bets while paying little money upfront and sidestepping SEC disclosure requirements on the stakes that large investors hold in companies. Some financial-reform advocates say expanding the disclosure rules to swaps could have helped prevent the Archegos debacle.