SEC says brokers enticed by payment for order flow are making trading into a game to lure investors

The Securities and Exchange Commission stated on-line brokerages, enticed to improve income by means of the controversial trade observe of payment for order flow, are turning stock-trading into a game in order to encourage exercise from retail investors.

Wall Street's predominant regulator on Monday launched its extremely anticipated report on the GameStop mania earlier this 12 months. The 44-page report detailed how the trading frenzy went down and raised purple flags on a variety of points, together with the back-end funds that brokerages obtain, gamification of trading, in addition to disclosures on quick gross sales. But it stopped in need of laying blame on a single trigger or entity.

Long-awaited SEC report on GameStop is outClosing Bell

"Payment for order flow and the incentives it creates may cause broker-dealers to find novel ways to increase customer trading, including through the use of digital engagement practices," SEC officers stated within the report.

Payment for order flow is likely one of the largest income sources at Robinhood, the millennial-favored inventory trading app that raked in a document variety of new prospects over the previous 12 months and went public in August. The observe, although, is beneath elevated scrutiny as many say it has a battle of curiosity with brokerages incentivized to ship orders to the market-maker that pays them the most important rebate. SEC chair Gary Gensler had warned that banning this observe isn’t off the desk.

To inspire trading, some brokers together with Robinhood made their platforms visually attractive and supply game-like options resembling factors, rewards, leaderboards and bonuses to improve engagement. Amid criticism, Robinhood removed its confetti animation in March.

"Consideration should be given to whether game-like features and celebratory animations that are likely intended to create positive feedback from trading lead investors to trade more than they would otherwise," the report stated.

Still, the SEC assessment might fall quick to some when it comes to making concrete suggestions and laying the groundwork for potential modifications to U.S. trading practices. The company additionally didn't attain a conclusion as to whether or not any of the trading — and the restrictions on trading — was manipulative and whether or not brokerages performed by the foundations throughout the mania.

The company acknowledge that the acute volatility in meme shares examined the capability and resiliency of the markets.

Risk administration and transparency

At the peak of the mania in January, a band of beginner merchants in Reddit's WallStreetBets discussion board bid up closely shorted shares "to the moon," creating large quick squeezes in names like GameStop and AMC. The unprecedented volatility backfired on Robinhood, which had to faucet credit score strains and limit trading in a listing of the short-squeeze names because the central Wall Street clearinghouse at one level mandated a ten-fold improve within the agency's deposit necessities.

"This episode highlights the integral role clearing plays in risk management for equity trading, but raises questions about the possible effects of acute margin calls on more thinly-capitalized broker-dealers and other means of reducing their risks," SEC's report stated. "One method to mitigate the systemic risk posed by such entities to the clearinghouse and other participants is to shorten the settlement cycle."

The SEC additionally introduced up whether or not extra transparency of quick promoting ought to be required. Right now, securities lending and borrowing is a comparatively opaque system as investors aren't required to report their bearish bets and the SEC solely collects knowledge on how a lot of a firm's inventory is offered quick.

"The interplay between shorting and price dynamics is more complex than these narratives would suggest," SEC officers stated within the report. "Improved reporting of short sales would allow regulators to better track these dynamics."

Gensler can be on CNBC's Squawk on the Street at 9:35 a.m. ET Tuesday to talk about the findings of the report.

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