April 12, 2021
Actions around settlement, gamification and naked short-selling could be on the horizon, according to the experts.
This story is part of "The rise of retail investing," a Protocol special report. Read more here.
CEO at DriveWealth
U.S. regulators will proceed with caution.
For a long time, insider information has been a concern of the regulators as they attempt to even the playing field. Now, we've gotten to where we wanted to be: transparency and affordable access to the markets.
Retail investors have every right to buy a stock and invest their own money as they wish. I believe regulators will move in incremental steps and try to improve the settlement process moving to T+1, and warnings around social media use of promoting stock trades without proper regulatory requirements on retail communications.
I understand why retail investors have embraced their collective voice and power. When you have 140% short on a stock — who's allowing that? That's another area regulators will be looking to have surveillance around securities lending to support short selling. There is value in people taking opposite sides of a trade, that's what makes a market, but their needs to be disclosures in place that prevent abuse, and that's exactly what created the GameStop drama in the first place.
Director of Investor Protection at the Consumer Federation of America
There are a number of issues that are sure to get attention from regulators in the wake of the Robinhood/GameStop events. In particular, regulations related to payment for order flow, best execution, options trading and short selling seem like top candidates for a long-overdue review.
The issue that is of particular interest to me, however, is how regulators will go about updating our sales practice rules to apply to trading apps, like Robinhood, that incorporate psychological nudges and gamification to encourage conduct — like frequent trading and trading in options — that is profitable for the firm, but not necessarily good for its customers.
Those are practices a traditional broker could never recommend to the typical Robinhood customer under the sales practice rules. Robinhood argues, however, that it doesn't make recommendations, so the sales practice rules don't apply. Regulators will need to decide whether they agree and, if so, where the line lies between a "nudge" and a recommendation.
Long before the GameStop events raised the ante, Massachusetts regulators were already arguing in an enforcement action that at least some of Robinhood's features crossed that line. Even if regulators conclude that gamification and nudges aren't recommendations per se, they will still need to decide how those features should be regulated.
In our view, firms need to be held accountable for how they design their apps and platforms to ensure that investors aren't abused. I feel confident that issue will get the attention it deserves in coming months.
Co-founder and CEO at Alpaca
Even shorter settlement duration than T+2. Also, more strict guideline and reporting requirements for the social media platform usage with respect to investing communication.
John Reed Stark
President at John Reed Stark Consulting LLC; former Chief at the SEC Office of Internet Enforcement
The SEC is undoubtedly investigating the shorting by hedge funds of the various Reddit short-squeeze target companies, and may also investigate other participants in the chain of the short transactions for violations of Regulation SHO.
SEC Regulation SHO is designed to stop naked short-selling. In a "naked" short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period. As a result, the seller fails to deliver securities to the buyer when delivery is due. Regulation SHO's "locate" standard requires brokers to have a reasonable belief the equity to be shorted can be borrowed and delivered on a specific date before short selling can occur.
The SEC is likely evaluating the fairness and transparency of the technology used during the short selling process and exploring ways to tighten stock borrowing rules, and strengthen Regulation SHO. If any short sellers or other market participants have violated Regulation SHO, the SEC will not only identify those bad actors and charge the individuals and firms involved, but the SEC will also repair any rules that need fixing.
As for regulating traders like the Reddit users? I doubt much will happen along those lines. The SEC has a duty to protect investors and does not believe in momentum trading. Instead, the SEC preaches a much more fundamental approach to investing. The SEC warns that before buying a stock, investors should research the company and its leadership, read its filings, study its markets, consider its price-to-earnings ratios, evaluate its cash generation versus its debt load, review its earnings expectations versus reality, etc.
However, the SEC cannot become the speech police and neither can Reddit, and in the end, absent fraud, its caveat emptor. My take is that when it comes to dictating how to invest, the SEC job of preaching to investors is probably limited to just that — preaching (not regulating).
CEO at Commonstock
The surge of retail investing created a fascinating tectonic shift in market dynamics, made acute by the GME saga. Regulation changes should address the underlying structural issues that led to disruptions, increase institutional transparency/disclosures and should not restrict individual investors.
I was surprised and disappointed by narratives that blamed some brokers as evil or that retail investors have too much access. Why must there be a villain? GME was a black swan event where unforeseen asset volumes uncovered a gap in the existing regulatory regime. This is where regulation changes should focus, such as:
1. Increased disclosure and transparency rules for institutional investors (especially regarding short interest, to prevent overexposure and systemic risk).
2. Updated capital requirements for brokerages to reflect new market dynamics.
3. Reduced settlement period to T+1.
4. Better communication standards around incidents.
The SEC was created specifically to protect individual investors from institutions. Regulations should not restrict self-directed investors. This would have the unintended consequence of rolling back access and progress for participation and inclusivity. If anything, I'd like to overhaul the accredited investor rules using more relevant standards to increase access.
I was also disappointed that a few companies/legislators opportunistically and incorrectly said "PFOF is bad," calling for regulation to boost their own brand. PFOF is the business model that enabled the increase in market participation, which is unquestionably a net positive for society.
My biggest takeaway is the urgent need and big opportunity to educate people on the underlying mechanics of the stock market. This is why I'm so excited for fintech startups like Commonstock to partner with regulators to improve everyone's financial knowledge!
Founder at Upholdings
Robinhood and other mobile brokerages are the most likely to face new regulations. There are likely to be (1) new disclosure requirements to caution investors prior to trading securities undergoing abnormal volatility, and (2) limitations on the use of social media feeds within brokerage apps. Unfortunately, brokerages are already highly regulated entities, and we do not expect either of these requirements to prevent this from happening again.
The real issue in this saga is the promotion of publicly traded securities by anonymous accounts on social media, namely Reddit and Twitter. In contrast to brokerages, social media properties are highly unregulated, which emblazoned the bizarre trading in GameStop's shares. We believe nothing short of an outright ban on the anonymous promotion of securities is required to fix this problem.
Trust in media outlets — both traditional and new — is at a lifetime low. This is an opportunity to begin fixing that with more authentic voices.
See who's who in the Protocol Braintrust and browse every previous edition by category here (Updated April 11, 2021).
Kevin McAllister ( @k__mcallister) is a Research Editor at Protocol, leading the development of Braintrust. Prior to joining the team, he was a rankings data reporter at The Wall Street Journal, where he oversaw structured data projects for the Journal's strategy team.
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