Frenzied trading of GameStop Corp. and other companies last month is reviving debate in Washington about changes that Wall Street has long opposed, including taxing stock purchases, banning brokerages from selling their customers’ orders and reining in short-selling.
The ideas being floated by some Democratic lawmakers have long been on the wish lists of consumer advocates, who argue they would prevent financial firms from preying on retail investors and curb the excessive speculation that’s transformed the stock market into a casino, rather than a place where companies raise money to grow their businesses. But industry executives counter that policy revamps often have unintended consequences and that a transaction tax would ultimately increase trading costs for all shareholders.
The January tumult — sparked by readers of Reddit’s WallStreetBets chat room and users of Robinhood Markets’ popular trading app — will be examined by the House Financial Services Committee at a hearing next week and the Senate Banking Committee is planning to follow. While getting a rules overhaul through a bitterly divided Congress won’t be easy, here’s an overview from analysts, consumer advocates and other experts on what might be on the table:
Payment for Order Flow
At the heart of the zero-commission trading platforms offered by Robinhood and other online brokerages is so-called payment for order flow, in which the firms steer investor trades to high-volume market makers such as Citadel Securities in exchange for fees.
The arrangements have helped expand access to stock markets by dramatically lowering costs for retail investors. Indeed, the free trades offered by Robinhood have become ubiquitous with competitors such as E*Trade Financial Corp., Interactive Brokers Group Inc. and Charles Schwab Corp. all following suit.
Citadel Securities, Virtu Financial Inc. and other firms that buy orders make money by taking advantage of minuscule price changes in the market — seeking to almost instantaneously sell shares for more than they paid for them.
Critics contend that payment for order flow can leave brokerages beholden to giant financial firms, including high-frequency traders, with their customers unaware of the potential conflicts. The Securities and Exchange Commission has also brought cases tied to the practice, including fining Robinhood $65 million in December for allegedly failing to inform clients that it sold their orders — claims that the firm didn’t admit or deny.
“Payment for order flow is essentially legalized bribery that creates conflict of interest that incentivize brokers to breach their duties to their clients,” said Better Markets Inc. Chief Executive Officer Dennis Kelleher, who wants to see it banned.
Tyler Gellasch, a former Senate and SEC counsel who now leads the Healthy Markets Association, offered a similarly caustic view.
“In few other circumstances do we say, ‘Look on the one hand you have a duty to give customers the best prices; on the other hand you’re allowed to accept bribes and not pass it through, or even disclose to your customers how much they are,’” Gellasch said.
But Graham Steele, a former Senate Banking Committee staff member who now leads the Corporations and Society Initiative at Stanford’s University’s Graduate School of Business, said challenges to payment for order flow have been raised in response to previous market disruptions, but lawmakers and the SEC have failed to find a way to address the problems it poses.
“The same issues come up every time and there’s a reason that progress hasn’t been made,” Steele said. “A lot of the market participants feel like this is the worst option except for all the others.”
One issue that might be particularly thorny for lawmakers who are skeptical of payment for order flow is that they probably have constituents who love trading stocks for free. Figuring out a way to boost safeguards while preserving that expectation for no-cost trades could be difficult.
Financial Transaction Tax
Discussion about imposing a tax on financial transactions dates back more than a decade, to when then-President Barack Obama’s administration thwarted plans for a levy that were advocated by congressional Democrats and the European Union after the 2008 financial crisis. More recently, Hillary Clinton campaigned for president in 2016 on a Democratic platform backing a transaction tax and Senator Bernie Sanders pushed the idea in his campaign for president last year.
Transaction tax backers like Bartlett Naylor, a financial policy advocate for Public Citizen, say charging a few basis points every time a financial asset is traded would cut down on high-frequency trading and cause investors to think twice before making speculative bets. Opponents such as Tom Quaadman, who leads the U.S. Chamber of Commerce’ Center for Capital Markets Competitiveness, contend that such a tax would “increase the costs for pension funds and harm investors.”
And even some supporters like Kelleher of Better Markets and Gellasch of Healthy Markets say a transaction tax wouldn’t have prevented the kind of wild trading that pushed GameStop shares to stratospheric levels.
“I don’t think a financial transaction fee would have had any impact on the trading in the meme stocks,” Kelleher said, contending that the levels being proposed are too small to serve as a deterrent. Gellasch said high-frequency traders and other market intermediaries would simply pass their costs along to investors.
Increased Disclosures for Short Sellers
At present, hedge funds don’t have to disclose their positions when they bet against a company’s shares, as happened with GameStop. But should they be required to?
Both Naylor of Public Citizen and Kelleher of Better Markets generally favor more regulation. “The world will not end if short-sellers have to disclose more information, because the world hasn’t ended in Europe,” Kelleher said.
“Greater transparency there would be better for everybody,” Gellasch said. “It would also dispel some of the misinformation out there.”
Gellasch added that there are nascent efforts in Congress to require more disclosure, but he cautioned against taking steps that would undermine what he and others see as the crucial role played by short-sellers in helping to keep share prices in line with a company’s potential earnings. That clearly got out of whack with GameStop, which closed as high as $347.51 a share last month despite not being expected to post a profit for years.
“You do want to be careful, I don’t think you want to overcook it,” Gellasch said.
Lynn Turner, a former SEC chief accountant, has argued that another issue lawmakers and regulators should examine is the size of short bets. Amid the GameStop frenzy, many market observers were shocked to learn that hedge funds and other professional investors had made bearish wagers against some companies that exceeded 100% of their stock, trading that Turner said looks like manipulation.
The House plans to hold the first hearing on the GameStop mania Feb. 18. Payment for order flow, a tax on trades and short-selling rules will be debated significantly by lawmakers and witnesses, Gellasch predicts, with all three issues standing a good chance of being part of legislative proposals that emerge after the hearing.
While a transaction tax requires action by Congress, Gellasch contends that the SEC already has authority to crack down on payments to brokers and to boost disclosure of short bets. But a demand from Capitol Hill — or even lawmakers issuing a bill that never becomes law — is often needed to get the agency to get moving on divisive policies, he said.
“There’s a big difference between what they’re authorized to do and what they do,” Gellasch said. “Congressional legislation can sometimes nudge the SEC to do something.”