Wall Avenue is anxious in regards to the regulatory implications of 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 activity is compatible with investor protection are fair and fair. ” efficient markets. “

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: 1) protecting investors, 2) maintaining fair, orderly, and efficient markets, and 3) facilitating 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, a former senior attorney in the SEC’s enforcement department 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, “Jay Clayton, former SEC chairman, told CNBC.

What FINRA is up to

The financial industry regulator is the agency that directly regulates brokers and broker-dealers.

In a recent report on the 2021 priorities, the agency noted that one of its main priorities in 2021 was the ‘gamification’ of markets: “This focus includes risks associated with app-based platforms with interactive or ‘playful’ features This is intended to influence the customers, their related forms of marketing, and the appropriateness of the activities for which they approve customers through these platforms. “

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

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

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

A key feature of the broker-dealer and brokerage community 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 so-called “suitability” 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 had even broader questions to consider: “Regulators will ask if we have the risk metrics for these broker-dealers, especially those who do to do.” Do you have large concentrations around a small number of companies? “

“The most likely regulatory move is to increase capital requirements for brokers,” he told me. “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.” “”

(Note: Noll said he was not speaking on behalf of FINRA).

Should regulators stop investors from doing stupid things?

A final issue is whether regulators feel obliged to encourage the brokerage community to be more vigilant in order to protect investors from what appears to be stupid behavior, such as trading stocks at prices disconnected from rational foundations.

Former SEC chairman Clayton warned against creating so-called “blunt guard rails and blunt rules”. Clayton said it was difficult to put in place guardrails that would prevent investors from making investment mistakes, but said certain guardrails such as margin requirements were necessary: ​​”I believe and believe that these guardrails should be examined.”

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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