SEC may set brief curiosity caps, hike buying and selling taxes to fight wild strikes, analysts say

The U.S. Securities and Exchange Commission could consider a host of new regulations to prevent future volatility and noticeable brief bottlenecks like the one at GameStop and AMC Entertainment that blew Wall Street off last week.

The agency that oversees U.S. markets could have a number of rules that range from a cap on short-term interest in a particular security to aggressive taxes on short-term trading, according to Bank of America’s Merrill Lynch.

“Brokerage platforms have already introduced restrictions on margins, options and trading in certain securities with unusual activity,” writes BofA analyst Michael Carrier in a message to customers.

Carrier has ticked off a list of rules the SEC is likely to adhere to if serious business is to prevent the dramatic swings that marked the last week of January.

In addition to the short-term interest rate cap and short-term betting taxation, Carrier said the commission may review payment for order flows and expand its social media scrutiny to deter market manipulation.

It remains unclear when Gary Gensler, President Joe Biden’s election as chairman of the SEC, will be confirmed to his post as the Senate is focused on approving cabinet-level candidates and the upcoming impeachment trial of former President Donald Trump.

A SEC representative declined to comment on the story, but referred CNBC to a statement it made on Friday. Although the regulator did not mention any parties by name, it vowed to protect individual traders and investigate allegations of unfair trade restrictions brokers may have imposed.

Still, Bank of America wasn’t the only Wall Street research firm curious about whether the SEC could ultimately take decisive action on a handful of sharply shortened stocks after a few chaotic days.

GameStop, the flagship of last week’s wild trade, rose 399.9% from its closing price on January 22nd to closing on January 29th. The stock surge was unexpected given the grim fundamental outlook for the brick and mortar video game business. surprised most of Wall Street.

As the week progressed, it became clear that the rally was largely the result of a coordinated group of retailers profiting from an oversized short sale of GameStop stock. The group, which apparently emerged on Reddit, also targeted AMC and headphone maker Koss.

Short selling is a strategy in which investors borrow shares of a stock at a certain price in the hopes that the market value will drop below that level when it is time to pay off the borrowed shares.

Often times, when the price of these stocks rises rather than falls, short sellers are forced to buy back the stocks they have borrowed to avoid further losses. If this happens en masse, it can lead to a so-called short squeeze and further price gains for the stock.

But the explosive moves and subsequent action taken by brokers to curb trade caused anger on both sides of the political corridor. A staunch advocate of financial oversight, Senator Elizabeth Warren accused the SEC Thursday that the regulator had taken no action.

“We need an SEC that has clear rules on market manipulation and then has the backbone to enforce and enforce those rules,” the Massachusetts Democrat said at the time. “To have a healthy stock market, you have to have a cop on the beat.”

Drawing on Bank of America’s analysis, Jefferies shared his own thoughts on how the SEC might try to stop future short squeezes on the same scale.

“With the confirmation of Gary Gensler as the new SEC chairman, the topic of market structure and participation of private investors has come to the fore,” wrote analyst Daniel Fannon in a statement published on Friday.

Fannon said he thinks the regulator could weigh better investor education about derivatives and risk management, and increase the cost of certain products or services, such as leverage and derivatives. He reiterated Carrier’s idea that the SEC could more closely monitor hedge fund short positions and tighter monitoring of payment for the flow of orders.

“Restricting access, increasing margin requirements and restricting inventory levels create a temporary loophole that leaves the future SEC chairman with a longer-term problem to resolve,” Fannon wrote. “Historically, changes in market structure take time, even on a small scale, and typically involve hearings, pilot programs, and comments / feedback from market participants.”

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