Smartphone apps, short-selling rules and steps to ensure broker solvency are all sure to get a closer look from Washington policy makers once the dust settles on the market turmoil that has buffeted GameStop Corp. and silver since the start of the year.
Social media is also poised to be scrutinized, with a focus on how Reddit and Twitter have been used to mobilize herds of investors to all make the same trades. Investigations into manipulation will keep the Securities and Exchange Commission busy for the foreseeable future. The House Financial Services Committee has scheduled a hearing for Feb. 18, likely putting government watchdogs and firms such as Robinhood Markets on the hotseat.
Bloomberg News surveyed ex-regulators, financial analysts and academics to get their take on what remedies are needed to fix the stock market in the months ahead. Here’s an overview of their recommendations:
Trading Apps
Apps have fueled the recent proliferation in trading while exposing an army of retail investors to potentially dangerous ways to maximize their bets—including trading options and funding purchases with margin accounts. Lawmakers are already examining what role these new technologies have in making the stock market feel like a video game and sending shares to levels that have no connection to companies’ fundamentals.
Barbara Roper, director of investor protection for the Consumer Federation of America, said the financial incentives of online platforms encourage constant buying and selling, and trading in risky products. “They use nudges that they know will prompt that kind of conduct,” she said.
SEC rules are most strict in cracking down on situations when brokers are recommending stocks, something that Robinhood and other app providers vehemently argue they don’t do. Roper, who has spent her career advocating for retail shareholders, agreed that Robinhood isn’t recommending stocks, which is why she believes the regulations so desperately need to be modernized.
“We need to clearly update our rules to address the way that behavioral psychology prompts can be built into technology driven platforms to ensure that firms can be held accountable for what they’re pushing,” she said.
Jamie Selway, a former executive at broker Investment Technology Group who now works as an investor and an adviser, also said rules are outdated. A big issue for the industry, he said, is whether brokerages are adhering to conduct standards when they allow small-time investors to trade heavily in options.
“Doing something the same way for 20 years is rarely a good plan,” said Selway, who is a financial backer of a startup online trading platform.
In a statement, Acting SEC Chair Allison Herren Lee said the agency is “looking at a number of areas, including compliance with regulatory obligations” and whether investors are getting “adequate and consistent risk disclosure.” A focus is examining “where aspects of our markets need improvement,” she added.
Short-Selling
Short-selling rules have enabled hedge funds to make bets that exceed the market values of some companies. In the case of GameStop, AMC Entertainment Holdings Inc. and other stocks, such positions became catnip for small-time investors, who coordinated their efforts on Reddit message boards to pursue short squeezes that would hammer the hedge funds.
Larry Tabb, an analyst for Bloomberg Intelligence, said it’s clear that when hedge funds put on short positions that equal 150% of a company’s outstanding shares, the attitude of retail investors is “let’s go charge it.” Key to this debate is what’s known as “naked short selling,” in which brokers allow customers to bet against stocks without arranging to borrow shares in advance.
Lynn Turner, who was the SEC’s chief accountant during the 1990s boom for dot-com stocks, credits short-sellers for helping uncover Enron Corp. and other frauds. But he said allowing them to short more than 100% of a stock looks like manipulation.
T+2 and Capital
Broker solvency rules were a key factor in why Robinhood customers rioted on social media last week, as they were outraged that the firm restricted them from buying more shares. But Robinhood said it had to comply with regulations that ensure firms are well-capitalized and not exceeding risk limits.