Welcome to GameStop on Capitol Hill, round two. Maxine Waters, the chairwoman of the House Financial Services Committee, told the gathering Wednesday morning (March 17) that this second go-round would be absent some of the celebs made by the Game Stop trading controversy like Vlad Tenev, and warned that “as the events in January cast a spotlight on gaps in regulation of our capital markets, the Committee must assess what legislative steps may be necessary.”
While all witnesses offered different perspectives in their written statements on what went wrong in January, the bulk of their comments boiled down to a few major issues. Those issues include investor education, greater market transparency and equality, and taking a closer look at the “payment for order flow” system by which brokerage firms gain benefits and compensation for directing trades to particular entities — such as high-frequency trading (HFT) market making firms — for execution.
In his statement, Themis Trading Partner Sal Arnuk went right for that last issue, calling attention to the fact that payment for order flow (PFOF) causes a disconnect between a broker and his customer — especially in the case of Robinhood.
“They recently changed their PFOF method from one giving them a set payment per share to one giving them a percentage of the spread instead,” he said. “Think about this: A Robinhood trader wants the spread in the stocks he/she is trading to be as narrow as possible. The HFT market maker buying those orders benefit most when that spread is as wide as possible. And now Robinhood benefits most when the spread is as wide as possible as well! This is an amazing misalignment of interests.”
He added that Robinhood’s founders attained a $12 billion to $20 billion valuation primarily based on PFOF, which means it is in the company’s interest to encourage more customer trading, even if it’s not in their best interest. “This tells you Robinhood knows full well the value of its herded and gamified product base; they knew to educate their users just enough to incentivize trading and maximize their own revenue as a result of it.”
Cornell Associate Professor of Finance Vicki Bogan echoed Arnuk’s sentiments and pointed out the dangers of gamifying investing. She said brokers like Robinhood use “powerful behavioral-science-based techniques to influence investor behavior in a particular direction,” by using “prompts, push notifications, and other nudges for the purpose of eliciting specific behaviors — increased trading by the investor.”
Dark Venues
Perhaps the most anticipated testimony came from New York Stock Exchange Chief Operating Officer Michael Blaugrund. He broke the reforms he sees needed into four categories: modernizing shareholder disclosures; providing transparency for securities lending; accelerating industry settlement cycles from two day to one day after the trade; and eliminating competitive barriers for public investors, in which he discussed the advantages broker-dealer “wholesalers” have over public traders both in terms of where they trade and how much they can make trades for.
Blaugrund said that at the end of 2020, “more shares were executed in private, dark venues than on lit public exchanges with price discovery.” He added: “The NYSE believes that it is time to harmonize the on and off-exchange price increment regimes. From a public policy perspective, if sub-penny trading is allowed in private dark trading, we believe similar conventions should also be allowed on public lit exchanges.”
In the end, the day’s testimony aimed at protecting traders — particularly young ones — from being manipulated by actors looking out for their own bottom lines.
“Many have framed the GameStop mania as a David vs. Goliath struggle,” said Alexis Goldstein, senior policy analyst for Americans for Financial Reform. “I believe it is more likely that, when we have full information about this episode, the story will more closely resemble Goliath vs. Goliath. The ‘Goliaths’ in this case are the largest Wall Street institutional players: hedge funds, especially those that employ high-frequency trading algorithms, and the ‘flow’ trading desks at major banks like Goldman Sachs and Morgan Stanley. Retail traders driven by the WallStreetBets subreddit and the exuberance that ensued may end up losing big, notwithstanding the squeeze they put on some institutional players.”
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