The Securities and Exchange Commission (SEC) is examining what role short selling may have played in the recent events involving GameStop ($GME), according to the outgoing acting chairwoman of the SEC Allison Herren Lee.
“We need to look closely at the conduct of the broker-dealers, those financial intermediaries through which retail investors access the markets,” Lee said on National Public Radio (NPR). “We need to make sure that the decisions that they make when they look to restrict or limit trading are compliant with regulations, that they're transparent to their customers and that they're consistently and fairly applied.”
Lee's interview was after Rep. Michelle Steel (R-CA) and her Congressional colleagues asked for answers in a letter following the surge of stocks like GameStop on the Robinhood app.
“Trading apps aren't just neutral onramps into financial markets for small-dollar investors,” said Erin Lockwood, assistant professor of political science at the University of California, Irvine. “Despite marketing themselves as tools of financial inclusion, they're not providing a public service; they are for-profit companies with their own incentives and their own regulatory obligations, some of which entail, directly or indirectly, imposing limits on what trading activities are allowed.”
The Senate Banking Committee has since confirmed President Biden’s nominee, Gary Gensler to lead the SEC and Lockwood expects the SEC under Gensler to be more actively involved in investigations and regulation.
“It's tricky because it's possible that the GameStop situation did not involve any illegal fraud or market manipulation and that there is considerable political appetite for greater regulation nonetheless,” Lockwood told the Southern California Record. “But this would likely entail new forms of rule-making to govern the gamification of trading via electronic trading platforms -- and that would raise the possibility of either direct or indirect limitations on users' trading activity, though these would be public rather than private rules.”
Questions in the letter that Orange County Congresswoman Steel and her colleagues sent to the SEC include the following.
Is it appropriate for financial services institutions to restrict the purchase but not the sale of a particular stock in response to market changes spurred by honest and freely available information?
“Robinhood's decision to halt trading was driven by their need to meet capital requirements intended to preserve financial stability by offsetting the risks associated with huge position swings in a highly volatile market,” Lockwood said in an interview. “With regard to the appropriateness of platforms like Robinhood restricting trading, the two things to be aware of are the incentives and obligations of for-profit trading platforms and the regulatory distinction between professional and amateur traders.”
Does a broker preventing a retail investor from purchasing a stock such as GME constitute market manipulation given possible conflicts of interest, and should these sorts of actions be permitted?
“In the GameStop affair, Robinhood's contract with Citadel Securities has attracted legislative and regulatory scrutiny because the hedge fund associated with the firm invested in Melvin Capital, one of the hedge funds whose short positions in GameStop stock were undermined by retail investors' squeeze,” Lockwood said. “It's what allows for-profit electronic trading platforms to offer commission-free trading and still remain profitable.”