Wall Avenue worries about regulatory fallout from the GameStop saga

Wall Street is concerned about the Yellen regulator’s super-summit, and for good reason, market watchers say.

“The road should be concerned,” said Jamie Selway, former head of electronic brokerage at ITG and now an investment advisor. “There are clearly questions about gamification and whether many of these approaches are appropriate and generate unnecessary trading activity. Regulators are beginning to investigate what behaviors these apps can generate.”

Treasury Secretary Janet Yellen has announced that she will meet with the heads of the Securities and Exchange Commission, the Federal Reserve Board, the New York Fed and the Commodities Futures Trading Commission to discuss whether the recent activities are compatible and fair with investor protection and markets are efficient. “

The meeting could take place on Thursday.

Has there been market manipulation in GameStop history?

Some of these regulators have already made preliminary statements.

The SEC’s mission is threefold: protect investors; Maintain fair, orderly and efficient markets; and facilitate capital formation.

The commission has already warned Wall Street that it feared investors may not have been protected.

“We will act to protect retail investors if the facts show abusive or manipulative trading activity that is prohibited by federal securities laws,” the SEC said in a statement. “Market participants should take care to avoid such activities.”

Is GameStop trading, largely launched by the Reddit trading community, abusive or manipulative trading? That can be difficult to prove.

“There may have been some bad actors, but the media narrative does not suggest a traditional pump and dump,” said Philip Moustakis, former senior counsel in the SEC’s Enforcement Division and current attorney for Seward & Kissel law firm.

“There is still no evidence that the Reddit crowd was involved in any coordinated action or disseminated false or misleading information,” he added. “These are not the elements of a traditional market manipulation case. There has certainly been a lot of decentralized chatter, but it would be difficult to name this market manipulation.”

Another issue that regulators will investigate is the stability of the clearing system.

“The clearing houses are hubs in our system that cannot afford to fail,” former SEC chairman Jay Clayton told CNBC.

What FINRA is up to

The financial industry regulator, which directly regulates brokers and broker-dealers, said in a recent report that one of its main priorities for 2021 will be “gamification” of markets.

“This focus includes risks associated with app-based platforms that have interactive or ‘playful’ features designed to affect customers, their related forms of marketing and the appropriateness of the activities they authorize customers through those platforms,” ​​it said.

Moustakis says this is a warning shot for the broker community.

“FINRA has brought this to the attention of those with playful features. These trading apps are being marketed to a younger customer base and I think FINRA believes that comes with an increased obligation to know your customers,” he said.

A FINRA spokesperson declined to comment, but the agency has made it clear that it fears that gamification may have resulted in investors over-trading or making investments that are not suitable for them.

A key feature of brokerage regulation is “suitability,” the requirement that advisers invest their clients in assets that are appropriate for the risk they wish to bear. FINRA clearly warns brokers and broker-dealers that certain features they offer may meet the “Eligibility” requirements:

“If your company offers customers an app that includes an interactive element, the information provided to customers constitutes a ‘recommendation’, covered by Reg BI, that a broker-dealer must act in the best interests of a retail customer” or suitability obligations according to FINRA rule 2360 (options)? If so, how is your company fulfilling these obligations? ”FINRA said in the report.

“If your company’s app platform design contains ‘playful’ aspects designed to entice customers into engaging in certain trading or other activities, how does your company deal with the potential risks involved and expose them to your customers?”

Eric Noll, CEO of Context Capital and now a board member of FINRA, said FINRA and other regulators have even broader questions to consider: “Regulators will ask, ‘Do we have the risk metrics right around these broker-dealers, especially these big ones Have concentrations around a small number of businesses? ‘”

“The most likely regulatory move is to increase capital requirements for brokers,” he said, not speaking on behalf of FINRA. “Robinhood had to raise money they didn’t have. They had a lot of focus in a very small name. To keep their business they had to hire Longs in GameStop because that was the only way to control their commitments.” “”

Should regulators stop investors from doing stupid things?

A final concern is whether regulators will feel obliged to encourage brokers to adopt a more vigilant stance in order to protect investors from seemingly stupid behavior, such as trading stocks at prices disconnected from rational foundations.

Clayton warned against building what he called “blunt guard rails and blunt rules”. The former SEC chairman said it was difficult to put in place guard rails that would prevent investors from making investment mistakes, but added that certain guard rails like margin requirements were necessary. “I believe in it and I believe that these guard rails should be investigated,” he said.

Where’s Gensler?

One key player is missing: Gary Gensler, former chairman of the CFTC and now the candidate to lead the SEC. His presence is urgently needed to guide this difficult moment, but it may take months to be confirmed.

“We would like to see his verification expedited and verified quickly,” said Selway. “Doing this without him seems difficult.”

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