Facts: SEC response to Mimi stock rally

June 24 (Reuters) – A year and a half after Mimi’s stock surged on Wall Street, the U.S. Securities and Exchange Commission is considering sweeping changes to curb overheated stock trading based on social media activity.

The proposed reform would be the biggest change in Wall Street rules since 2005 and would affect nearly every corner of the market, from commission-free brokerages to market makers and exchanges. Read more

The US House of Representatives Financial Services Committee on Friday called on the Securities and Exchange Commission, along with other regulators, to do more to protect markets from similar events. Read more

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The impetus for the change came from the so-called “Reddit rally” in January 2021, in which GameStop Corp (GME.N) and other “meme stocks” popular on social media jumped to sky-high levels when buying from investors who trade heavily through Robinhood (HOOD.O) and other retail brokerages without commissions.

The extreme volatility led to huge losses for hedge funds that bet against MIM shares.

It also led Robinhood and others to restrict trading in the affected securities, which in turn curbed the rally, angered retail investors and rattled market confidence.

Here are some of the issues the Securities and Exchange Commission is examining:

Payment for order flow

Gary Gensler, president of the Securities and Exchange Commission, has criticized payment for order flow (PFOF), a practice in which some commission-free brokers generate revenue by sending customer orders to wholesale market makers in exchange for payments, rather than exchanges.

He said banning the practice is not off the table because it raises a potential conflict of interest, which gives brokers incentives to encourage clients to trade frequently to maximize payouts.

The House Financial Services Committee report said the meme-trading frenzy revealed concerns about the ways PFOF increases complexity and potential fragility in stock markets.

Proponents say PFOF is a major reason why brokerages are able to stop charging trading commissions, and retail investors often get a lower and better rate than they would on the major exchange.

Digital Trade Claims

Gensler criticized “trading scams” as commission-free brokerages encourage excessive trading by using lights, noise, notifications and other tricks to generate more PFOF.

He also highlighted the use of artificial intelligence, predictive data analytics, and machine learning to drive products.

In August 2021, the Securities and Exchange Commission (SEC) issued an advisory on potential new rules to limit gamification and other “claims of digital participation.” The agency is expected to proceed with the rule change in the coming months. Read more

The US House of Representatives Financial Services Committee on Friday urged Congress to adopt legislation authorizing the US Securities and Exchange Commission to examine how its rules should be changed to address new technological developments, such as digital sharing practices and market activity driven by social media.

Focus and Pricing

Gensler said the GameStop saga has highlighted the small number of market makers — middlemen who execute deals and publicly post buying and selling prices for others to trade — who dominate the retail market, which could pose problems for competition.

The House Financial Services Committee said that at the time of the Reddit spike, Robinhood was not affiliated with any exchanges, and of the six market makers, Robinhood routed all of its clients’ orders to, nearly all of whom were unable to execute trades in some meme shares due to market pressures.

“If all of these market makers were unable to execute trades, Robinhood would not have been able to execute trades on behalf of their clients,” the report said.

Almost all retail operations are carried out away from stock exchanges.

This is partly due to rules that allow market makers to offer partial price improvements to sub-pence bids and offers, while exchanges are required to provide pennies prices.

That created an uneven playing field in the competition for retail demand, Gensler said.

Gensler asked SEC staff to recommend potential changes to align the ability to display sub-currency prices on and off the exchange.

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(Reporting by John McCrank in New York and Katanga Johnson in Washington; Editing by Deepa Babington

Our Standards: Thomson Reuters Trust Principles.

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