SEC Says Brokers Attracted To Order Flow Payout Make Trading A Game To Attract Investors

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The Securities and Exchange Commission said online brokerage firms, enticed to increase revenue through controversial industry practice of paying for order flow, are turning stock trading into a game to encourage activity retail investors.

The main Wall Street regulator released its highly anticipated GameStop mania report earlier this year on Monday. The 44-page report details how the trading frenzy has abated and raised red flags over a number of issues, including the return payments brokerages are receiving, the gamification of exchanges, as well as the news. on short sales. But he stopped before throwing the blame on a single cause or entity.

“Paying for order flow and the incentives it creates can lead brokers to find new ways to increase customer engagement, including using digital engagement practices,” officials said. SEC in the report.

Paying for order flows is one of the biggest revenue streams for Robinhood, the millennial-favored stock trading app that has attracted a record number of new customers over the past year and has grown to become public in August. The practice, however, is under increased scrutiny, as many say it is in a conflict of interest with brokerages being tricked into sending orders to the market maker who pays them the biggest discount. SEC chairman Gary Gensler had warned that banning the practice was not out of the question.

To motivate trading, some brokers including Robinhood have made their platforms visually appealing and offer in-game features like points, rewards, rankings and bonuses to increase engagement. Amid criticism, Robinhood ditched its confetti animation in March.

“The question is whether game features and festive entertainment that can create positive responses from investors lead investors to trade more than they otherwise would,” the report said.

Still, the SEC’s review may fail for some in terms of concrete recommendations and setting the stage for potential changes to U.S. business practices. The agency also didn’t come to a conclusion as to whether any of the exchanges – and the restrictions on trading – were manipulative and whether brokers followed the rules during the mania.

The agency recognizes that the extreme volatility of memes stocks has tested the capacity and resilience of markets.

Risk management and transparency

At the height of the mania in January, a group of amateur traders on Reddit’s WallStreetBets forum bid on heavily shorted “on the moon” stocks, creating massive cuts to names like GameStop and AMC. Unprecedented volatility backfired on Robinhood, which had to call on lines of credit and restrict trading on a list of short-term names as the Wall Street central clearinghouse imposed at one point a tenfold increase in the company’s filing requirements.

“This episode highlights the critical role clearing plays in managing risk for stock trading, but raises questions about the possible effects of sharp margin calls on smaller-cap brokers and other means. reduce their risk, ”the SEC report said. “One method of mitigating the systemic risk posed by these entities to the clearing house and other participants is to shorten the settlement cycle.”

The SEC has also raised the question of whether more transparency in short selling should be required. Currently, securities lending and borrowing is a relatively opaque system, as investors are not required to report their bets bearish and the SEC only collects data on the amount of shares in a company. sold short.

“The interplay between short selling and price dynamics is more complex than these accounts suggest,” SEC officials said in the report. “Better reporting of short sales would allow regulators to better track this dynamic.”

Gensler will be on CNBC’s Squawk on the Street at 9:35 a.m.ET Tuesday to discuss the report’s findings.

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