By Dave Michaels and Paul Kiernan
WASHINGTON -- The trading mania around shares of companies like
GameStop Corp. this week poses a dilemma for Gary Gensler, the
Biden administration's choice to head the Securities and Exchange
Commission: While broadening investor participation, the stampede
also poses new risks that could spread to other participants.
The SEC generally encourages greater involvement of retail
investors. But as more individuals become short-term speculators
trading on momentum signals and not much else, the agency could
come in for blame when bubbles burst and investors are saddled with
losses. There are also implications for the brokerage business,
which feeds off the higher demand and can be hobbled by the
volatility it creates.
The SEC said Friday that it would examine whether any traders
manipulated prices by exhorting others on social-media websites to
buy the trendy stocks. The upheaval occurs at a time when Congress
has questioned the regulator's supervision of the retail investing
landscape.
"There are problems emerging that are going to have to be dealt
with, and my guess is Gary Gensler will want recommendations on his
desk when he walks in on the first day," said Mark Berman, a
regulatory consultant and former SEC official.
Since stepping down from his role leading the Commodity Futures
Trading Commission in early 2014, Mr. Gensler has been teaching
finance at the Massachusetts Institute of Technology and writing
about financial-technology innovation, including the rise of
cryptocurrencies such as bitcoin.
A different trend appears to be at work this week: the
combination of social media and financial technology that makes it
easier and cheaper to trade. SEC officials who briefed House
lawmakers this week said that social media isn't a new factor in
trading but has become a more important driver in retail investing,
according to a person familiar with the meeting.
A younger generation of traders has shunned traditional
gatekeepers -- brokers who give advice over the phone or in person
-- in favor of making their own decisions about which securities to
buy.
Inexperienced investors looking for trading ideas can ride the
momentum created by communities such as Reddit's WallStreetBets,
where gung-ho traders goad one another to buy shares and hold them
until the price goes "to the moon," as the traders often say. Their
tolerance for losses is high, and many participants revel in buying
stocks that are disfavored by bigger investors such as hedge
funds.
Trading platforms such as Robinhood Markets Inc. have benefited.
Robinhood doesn't charge commissions, and its "gamification"
features celebrate trading with digital confetti and enable push
notifications that keep the market on users' minds.
This week's surge in trading temporarily prompted Robinhood to
prevent customers from buying some of the most popular stocks. The
firm said it made the move for risk-management reasons. Robinhood
and other online brokers were asked to provide more cash to
clearinghouses to cover transactions.
The four-member SEC said Friday it would closely review the
firms' explanations for their moves to limit trading.
SEC rules were updated in 2019 to require stockbrokers to act in
the best interests of investors when providing investment advice.
But Robinhood, Charles Schwab Corp. and other online trading
platforms avoid such rules when they enable investors to buy and
sell shares on their own, without the intermediation of a
broker.
Democratic lawmakers have said the rules are too weak, mainly
because they didn't ban many conflicts of interest that brokers
face. Democrats are likely to have more influence over the SEC's
agenda because they will control relevant committees in both the
House and the Senate.
"These wild fluctuations are just the latest indication that
many private-equity firms, hedge funds, and other investors, big
and small, are treating the stock market like a casino, giving
little consideration to the companies, communities, workers, and
consumers that may be affected by these risky bets," Sen. Elizabeth
Warren (D., Mass.) wrote Friday in a letter to the SEC.
Sen. Sherrod Brown (D., Ohio), who will take over as chairman of
the Senate Banking Committee, which oversees the SEC, said this
week he would convene a hearing to examine the tumult and the
commission's supervision.
His counterpart in the House, Rep. Maxine Waters (D., Calif.),
chairwoman of the Financial Services Committee, said Thursday she
will hold a hearing.
"We must deal with the hedge funds whose unethical conduct
directly led to the recent market volatility," she said in a
statement.
But Sen. Pat Toomey (R., Pa.) said low-cost trading platforms
have largely been a positive development for smaller investors and
urged restraint.
"When examining this episode, regulators and Congress should
tread with extreme caution and avoid needlessly inserting
themselves into equity markets," Mr. Toomey said in a
statement.
Barbara Roper, director of investor protection at the Consumer
Federation of America, said the GameStop episode suggests rules
ought to be updated to account for brokers' ability to drive
investor behavior using psychological cues rather than outright
recommendations.
"They have these nudges that are designed to encourage conduct
that is profitable for the firm and not necessarily good for their
customers," Ms. Roper said. "The companies need to be accountable
for their nudges."
One of Mr. Gensler's recent MIT lectures looked at Robinhood,
Charles Schwab and other firms that offer free trading, a trend he
traced to the abolition of fixed commission rates in the 1970s,
according to a video of the class available online.
Mr. Gensler didn't criticize Robinhood in his lecture but
explained how its growth influenced other brokers to copy its
pricing model.
"What we've found whether it is in Facebook or many other online
applications outside of the financial world, it is zero fee," Mr.
Gensler said in the lecture. "And then the business model is
earning money is some other way."
Mr. Gensler didn't respond to a voice-mail message seeking
comment Friday.
With commissions at zero, online brokers have to make money
other ways. One is to sell customers' orders to high-speed traders,
which execute them like a stock exchange would. The speedy traders
have profitable ways to trade with mom-and-pop orders and get
deeper insight into market demand.
The SEC is short handed following the departure of former
Chairman Jay Clayton and many of his senior staff. The acting
chair, Democratic commissioner Allison Herren Lee, made a brief
statement about the market turmoil for the first time on
Wednesday.
Ms. Lee's office didn't immediately respond to a request for
comment. It is unclear how soon Mr. Gensler will get a confirmation
hearing, where senators are likely to question him about this
week's events.
"She's got an awkward position being acting chair, and that is
got to have a limiting effect," said James Cox, a law professor at
Duke University. "It means all the more reason to try and
accelerate the confirmation for Gensler and get his staff in."
--Siobhan Hughes and Orla McCaffrey contributed to this
article.
Write to Dave Michaels at dave.michaels@wsj.com and Paul Kiernan
at paul.kiernan@wsj.com
(END) Dow Jones Newswires
January 29, 2021 18:15 ET (23:15 GMT)
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