BEVERLY HILLS, Calif. — Gary Gensler and his Democratic colleagues on the Securities and Exchange Commission will try to sell their long-awaited report on the “meme stock” trading frenzy as a clarion call for more regulation.
But if you remove the report’s propaganda, it shows that our markets work pretty well. Even better, small investors have never been protected more from abuse than they are today.
Of course, the Biden administration doesn’t want you to see the glass-half-full version of the trading madness that occurred earlier in the year. They want you to think something is wrong with the plumbing of the markets — and small investors need to be protected — since, for a few days, a handful of stocks soared to astronomical heights for no apparent reason other than people took joy in bidding them up.
Yes, the run-up in shares of GameStop, a has-been video-game retailer, or AMC Entertainment, a teetering movie-theater chain, was weird. Penny stocks trading like Amazon or Apple is a sign that the madness of crowds has taken over.
Don’t blame the markets or even Robinhood, the no-fee trading app that facilitated the frenzy. Blame the Fed.
The incentive for stock gambling comes from zero-percent interest rates and endless quantitative easing — the fancy term for the Fed flooding the zone with liquidity. The perfect conditions for people to trade stocks like they roll dice in Vegas.
But Gensler, the SEC chair, and his Dem cohorts would rather turn the meme spectacle into something it’s not — a scandal that mandates change. The word from Washington that made its way to financial titans attending the Milken Institute Global Conference in California last week is that Gensler will be using this recounting to ban practices like payment for order flow, and possibly force all trading to be completed on public stock markets instead of off-exchange venues.
Why? For Gensler, it’s about ambition. He wants to regulate everything from cryptos to market structure because he wants eventually to be named Treasury Secretary. The idea is to show he’s tough on Wall Street.
For the Biden administration, it’s a good way to score some class-warfare points as midterms approach. And their “bad guys” list starts with Robinhood, the no-fee brokerage app investors used to trade those meme stocks. Its sin, according to the report: Making trading fun with its easy-to-use app that is tapping into the masses’ penchant to gamble rather than invest.
Others on the target list: Citadel Securities and Virtu Financial, market makers that made a ton of money helping Robinhood run the alleged casino, the report said.
They did this through so-called payment for order flow. Robinhood is free for users because it sells its orders to these market makers. Citadel and Virtu then matched the buyers and sellers of the meme stocks and skimmed some nice fees off the bid-ask spreads. This club of Robinhood, Citadel and Virtu might have secret dealings that are harmful to the little guy; investors might be paying no commissions, but they could be losing money on the market makers’ execution.
Even worse, much of this activity was conducted through what the report labels “off-exchange market makers,” and venues derisively known as “dark pools.” They are dark and allegedly sinister because these markets don’t post their prices publicly and are used by the financial elites possibly to screw people, the report suggests.
Yet on closer look, dark pools aren’t so sinister, the report also shows, particularly considering the system they replaced.
Gensler would like to return to the good old days when the vast majority of market action occurred on the floor of NYSE or the Nasdaq in full public view with less opportunity for alleged corruption.
But the history of NYSE market making is hardly devoid of small investor rip-offs. Meanwhile the off-exchange trades are heavily regulated — like everything else on Wall Street. Brokers are mandated to provide best execution, which is why they turn to off-exchange venues. The investor orders are typically executed at better prices than in public exchanges for a lot of reasons. Brokers can move orders to competing venues at a lower cost for small investors.
Don’t believe me. Just read the report, which points out that the vast majority of the market making in shares of GameStop during the frenzy occurred outside of the NYSE or Nasdaq without a mention of small investors being conned.
Now take the report’s findings on payment for order flow. “These payments can create a conflict of interest,” the report says. I’m sure they can but they didn’t. How do I know? The report didn’t mention small investors getting hosed. Given Gensler’s vast ambitions, if Citadel was screwing Robinhood customers, we’d all know about it by now.
Yes, there were hiccups during the meme insanity— Robinhood couldn’t handle the volume of orders and ceased trading in the stocks. A hedge fund nearly went out of business and was bailed out in part by Citadel.
But the system worked, which is obvious as you read through Gensler’s agitprop and focus on his actual findings.