SEC chief warns of growing monopoly power of market makers and retail brokers at GameStop hearing


Securities and Exchange Commission Chairman Gary Gensler on Thursday warned lawmakers that increasing concentration in the wholesale and securities brokerage industries could lead to market “fragility” and increased costs for investors. retail and institutional.

“At the heart of the proper functioning of markets and the SEC’s mission of fair, orderly and efficient markets is to promote competition in the markets,” Gensler said in a hearing before the House Financial Services Committee. “It can be done through transparency, but we also need to look at our set of rules to ensure that our set of rules inspires more competition than concentration. “

Gensler noted that “our modern economy of the 2020s is tending towards [concentration]Because of the power of “network effects” that increase the value of a service to one user based on the number of other users of that service.

“We have seen such concentration occur in other markets,” he added. “We know it’s in research, where we all go online and there really is a dominant search engine and we know it’s true in online retail products.”

The SEC chairman said he had asked his staff to produce suggestions on ways in which the commission can “promote competition in the face of these network effects which lead to concentration”.

Gensler was before the committee to discuss events related to the short sale of GameStop Corp. shares. GME,
+ 0.82%
In late January, this pushed up the price of those shares and led several retail brokers to temporarily restrict buying in order to help manage collateral requirements mandated by their central clearing house.

The episode raised awareness of the growing power of market makers like Citadel Securities who execute a growing percentage of retail trades at the expense of exchanges like the New York Stock Exchange or the Nasdaq NDAQ,
+ 0.37%.
Citadel Securities reports that it executes 47% of all retail transactions in stocks and options listed in the United States.

The retail brokerage sector also consolidated, with a merger between Charles Schwab Corp. SCHW,
+ 2.17%
and TD Ameritrade closed last October, just a few years after the acquisition of Scottrade by TD Ameritrade. Morgan Stanley MS,
+ 1.79%
also completed the purchase of E-Trade Financial Corp. last year, following the acquisition by E-Trade of the brokerage business of Capital One.

This consolidation, however, was in part boosted by the arrival of new app-based brokerage firms such as Robinhood and WeBull, which have accelerated an industry shift towards a commission-free trading model.

One force that can lead to concentration, Gensler suggested, was the practice of payment for order flow, whereby market makers like Citadel Securities pay brokers the privilege of executing client orders. Gensler said market makers can glean valuable market information through increased order flow, which allows them to pay better prices for future orders, creating a positive feedback loop that leads to greater concentration.

Democrats on the committee expressed concern that payment for order flows creates a conflict of interest between stock brokers like Robinhood, which derives the majority of its income from payment for order flows, and their clients. . In her written testimony, Gensler pointed to Robinhood’s recent $ 65 million settlement with the SEC in part over accusations that it accepted worse price execution for its clients from market makers in exchange for higher payout for order flow.

“This case shows that there was an inherent conflict,” he said. “That’s why I asked the staff to look at the structure of the market holistically and to see not only if clients are getting the best execution, but also to deal with some of the increasing concentration in the markets. “

Dan Gallagher, Robinhood’s chief legal officer, told MarketWatch at the time that “the settlement relates to historical practices that do not reflect Robinhood today.” He said in an interview on Thursday that the company was ready to work with the SEC on new disclosure rules related to payment for order flows. “It would be a good thing, and we are ready to commit to it.”

The topic of “gamification” was also brought up during the hearing, or a wide range of practices that critics say are used by app-based brokers to increase user engagement with the app, often to their financial detriment. Gensler said that while it’s a good thing that new technologies make investing more attractive, the SEC will consider whether new rules are needed to prevent investors from being tempted by overtrading.

“If you are using gamification features and people are trading more actively and day trading, then all of a sudden they’re risking their investing future,” Gensler said. “So I think we really need to take a look at this. “


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