The SEC's response to the 'meme stock' rally
reuters.com
reuters.com
Robinhood had to disable opening new positions, because they are unable to meet their margin requirements. They only survived, because they were granted a discretionary rebate. Otherwise, the DTCC could have taken control of their entire portfolio, and could have liquidated everything to protect its other member firms.
RH had poor internal practices, and did not fully understand how these margin amounts were calculated, nor had they implemented best practices for modelling those. Additionally, they technological infrastructure had already been at the edge of breaking down under the load for days even before the meme stock event.
Citadel Securities had nothing to do with RH not accepting new buy orders. In fact, they were the only one of RH's six market makers who never asked them to route away orders. The only thing the did negotiate for was a reduction of PFOF rebates, because RH was using its own, non-standard approach for calculating those that resulted in RH receiving a huge increase in rebates.
It wasn't just RH that blocked buy orders. Revolut did as well, and at least 2 others if my memory serves me correct.
This is patently false. Not only are the rules clearly written, they will actually help you with your margin model if you ask nicely. They’re unpredictable when they deviate from the model, but that’s to accommodate people who didn’t follow the rules in the first place, e.g. Robinhood.
The restriction were put in place by many brokers not just RH
Rules were automatically applied. Rules someone with two years in operations should be able to model.
The committee met to give Robinhood a bailout. By the rule book, the DTCC had the right to liquidate their collateral. The committee instead chose to take that counterparty risk on themselves, the risk that if Robinhood couldn’t raise emergency capital they’d have to pony up some of their own.
And that committee meeting’s minutes are filed with regulators and actions publicly announced, so even there, tons of transparency.
The reality is that many naive first-time retail investors experienced big losses on the backside of the meme stock rally, to the benefit of a few sophisticated retail investors: the ones who incited the rally in the first place.
This was possible in part because they were working on top of a new system of well-marketed apps that made trades free and incentivized. Taking all the friction out of the system made it easier for a few people to whip it around with emotion.
The problem is structural which is why the SEC is looking at it.
0: https://www.cnbc.com/2021/04/09/investors-have-put-more-mone...
I still recall my first savings account paid 6.44% in 1987 or so, and the inflation rate then was ~3.5%. It was with Lincoln Savings, which some of you might remember had a little collapse problem shortly thereafter. Still, the next one I went to (actually, not due to the collapse) paid 5%.
The traditional story of how a bank works, usually presented in comic-strip form somewhere around 10th grade civics class, was roughly:
* Inflation is M% * Retail lends the bank money at N%, for some N typically >= M. The primary motivation for doing so is less the interest, and more that it's safer to keep the money there than in a dresser drawer where the kids will eventually find it and exchange it for snack foods that are colours that don't exist in nature and premium currency for borderline-pornographic F2P games. * The bank lends it to productive economic entities at N+3%, who convert it into PowerPoint slides, bribes for Congressmen, and freight costs for shipping productive assets from Illinois to Guangdong. * The 3% spread enables the bank to sponsor various golf tournaments and buy impressive buildings that totally weren't a Del Taco last year, to ensure you feel secure that they'll still return your money when asked politely.
I suspect what derails the entire narrative is when the bank no longer needs retail to lend them money. When central banks will do it for virtually free, there's no reason to try to wrangle depositors anymore.
Are you saying that banks are essentially loaning out Federal Reserve funds at a higher rate and deposits aren't a source of cash to loan?
theta gang representative
anybody sell straddles or condors on meme stocks when implied volatility was at 500%?
it was pretty amusing that IV stayed elevated for months, and the vast majority of that time the market was flat, showing that nobody understood meme stock traders but expected a move at any point in time. plenty of time for spread sellers to make a lot of money, in silence.
Normally I despise gamification, but this just reads to me as “Kids these days. Back in my day we had shouting, loud clothing, and platform shoes on the trading floor. None of this new fangled digital stuff!”
Part of it was an explanation of what Payment For Order Flow (PFOF) is. They also had a few short comments by a researcher on the potential conflicts of interest. His opinion was that there are two, and one of them (ensuring customers get a fair price) is solvable but the other (brokerages having an incentive to steer customers toward trades with higher PFOF) is more problematic.
It sounds like the SEC hasn't decided whether to ban PFOF or just require more disclosure about prices, which seems to match up with what that researcher said.
(Also point of trivia from the NPR episode: PFOF was invented by Bernie Madoff.)
Generally speaking - I think we're seeing the same dilemma here you see with digital advertising: The "customer" now pays no trading fees, but because they're no longer funding the activity through those fees, they start to become the product sold, and the actual customer getting catered to is now the brokerage paying the best PFOF... which they can likely do because they inflate their earnings by taking a larger cut, which means the original "customer" is still likely paying anyways, but they now have no recourse and no say in how they are bought and sold.
I'm not at all a fan of the kind of perverse incentives that pop up when you have to trust an agent, and that agent is getting paid better by someone else to fuck you.
We have fiduciary duty laws for a reason - this situation leads to bad places.
For comparison - the vast majority of EU states have this banned as under their inducement to trade laws.
Interesting. Didn't know about this. Can you send me a link to something like Wikipedia or an EU regulation?
I think a few of the states are still in limbo (last I heard was something about germany saying that they need to allow PFOF to prove PFOF is harmful first), but my understanding is most folks are treating it as banned.
That said - I'm way outside my area of expertise here, and would welcome someone more knowledgeable to speak on it.
Folks selling stuff they don't own, and then not even fixing the issue in time for settlement?
It's so weird that the SEC doesn't crack down harder on this behavior by the bigger players. The volume in dollars and shares is massive. The penalties way too light.
This would seem casually to create real fragilities in the system.
If I'm reading this correctly about $42B worth of fails in the second half of may alone.
https://www.sec.gov/data/foiadocsfailsdatahtm
and download and total up the value of all the fails - it's eye opening.
Fail-to-Deliver Shares Value PIMCO DIOF Jan. 29 $422M iShares Core Bond ETF Jan. 20 379M iShares U.S. FA Bond ETF Jan. 19 361M GameStop Jan. 28 359M GameStop Jan. 27 292M
These are fails on just one day. It's pathetic this is allowed. You should not be able to sell something you can't deliver.
It’s not. FTD means failure on a particular timeline. Almost all of those shares get delivered in the end.
> You should not be able to sell something you can't deliver
You can trade this way if you want. It’s special settlement and you’ll pay out the nose [1] for zero benefit. But sometimes people do weird things with derivatives and need instantaneous settlement. So someone (usually a bank) with stock certificates will sell them, zero settlement risk involved, for a premium. (This is what someone facing FTD penalties will eventually have to do.)
FTD is a non-issue. It has zero practical downside. It nevertheless serves as catnip for Redditors trying to redirect blame for their gambling losses.
[1] Out of curiosity, I checked with a former colleague. They said they used to charge a flat fee, but recently switched to match crypto fees, since a lot of crypto people have been looking to instantly settle and they’re used to paying massive transaction costs. TIL.
The penalties are pathetic in most cases. If I fail to deliver $100M in treasuries I'm paying maybe 5K a day.
Folks are playing games under the hood with this. Stock price crashing on some shares you sold? Buy them late and settle late. I'd be curious what happened with FTD on things like bear sterns imploding.
I like how folks keep on assuring us that selling something you don't own is a non-issue :) That's a tell right there on where the morals of wall street are - in the toilet.
We are in 2022. We still have T+2 settlement (in part so folks can shuffle stuff on the backend). T+1 should be an obvious no brainer requirement. And frankly I'd go for gross real time personally - and nuke these firms out of the water including their financing and margin revenues.
It sounds like you have an emotional response to this issue, and so might benefit, mentally if not financially, from demanding special settlement.
1) Limiting PFOF because it creates possible conflicts of interest.
2) Limiting "gamification" of trading via engagement prompts.
3) Adding sub-penny prices to exchanges to harmonize them with market makers. This is to encourage more orders to be sent to exchanges instead of market makers.
How are any of these things capitulating to institutional investors?
I'm pretty sure that it came from Socrates.
> The U.S. House Committee on Financial Services on Friday called for the SEC, along with other regulators, to do more to protect the markets from similar events. read more
> The impetus for change came from the so-called "Reddit rally" of January 2021, in which GameStop Corp (GME.N) and other "meme stocks" popular on social media surged to extreme highs on buying from investors trading heavily through Robinhood (HOOD.O) and other commission-free retail brokerages.
> The intense volatility led to big losses for hedge funds that had bet against the meme stocks.
They don't like that the general populace was able to damage hedge funds, so they're making changes to stop it. I don't really know the changes technically, but the intent is right there.
Payment for order flow isn't actually the problem, large institutions not having, or willing ,to part with the margin collateral was. PFOF is just the gas they put in front to hide the real issue, and it's a real good one because removing it also hurts retail investors, making it unlikely to change much.
In the end, They will likely just put some rules in requiring these apps to more 'carefully educate thier customers on the risk of PFOF', basically continuing to protect the institution while insulting little retail investors as being too stupid for not reading the TOS carefully enough.
You don't have to agree with me, time will tell.
Meme stocks are HODLs; they don't need Robinhood.
This SEC action is about exploitative promotion of day trading -- WSB gambling, not MOASS.
1. Banning payment for order flow. Basically all of r/wallstreetbets agrees with this, too.
2. Anti "gamification" of stock trading. I've commented on this a million times, but the fact that Robinhood graphs have no labels on their y-axis means those graphs are totally meaningless and only there to act like slot machine lights. If retail traders have the same trading options as before, but with real actual information instead of whizbang blinking lights, I don't see how this is a negative.
3. Competition issues because of dominant market makers. That proposal is 100% a benefit to small retail traders at the expense of huge market makers, which goes directly against your thesis.
It always has been and it is made for the institutions to rarely lose and be ahead with the smart money over retail traders.
Tbh this is like putting up the neighborhood poker players against WSOP champions. They might win in the short term but only through luck. Any retail trader getting into any but the most risk-averse type of index investing (ie the type of trade where they are aligned with the wider market anyway) is kidding themselves they can beat people who have at least a 100x advantage compared to them.
It’s not hard to beat them though - just don’t trade. Hold for 30 years in your 401k and you’re good.
I wonder when the stock market is going to adapt some of cryptos tech, so that you can store your stock on your own PC instead of an exchange, like the paper versions.
Compared with all the other stuff that goes on in finance, it's really really hard to see short selling as bad.
https://www.cnbc.com/2018/10/05/experts-including-warren-buf...
We should note that naked shorting was apparently just fine until not that long ago[0].
[0] https://seekingalpha.com/article/4453048-naked-short-selling
Some people confuse naked shorts - which are currently illegal - with the simple finance fact that the same stock can be shorted more than once. Let's say A owns 1 stock. I borrow it from him and short sell it to B. Now I owe A one stock, and B owns one stock. There is no reason(1) I can't borrow that stock from B, and short sell it to C. I now owe A and B each one stock, and C owns 1 stock. You can continue doing this as much as you want, and create effectively infinite short positions without ever doing a naked short.
(1) Well aside from the the practicalities that it overleverages you and if your short position gets called you are completely screwed, and eventually you might not be able to find any stocks to borrow for shorting purposes, but there's no theoretical reason you can't do this.
Perhaps borrowing should involve disclosing other positions in some way.
"I guess that would be the first time somebody's lied under oath."
Why ACATS are so expensive is another question.
> Giving brokers incentives to encourage customers to trade more frequently to maximize the payments
This is also true of brokers who charge commissions. Brokers want their customers to trade. It is a conflict of interest, and always has been, but it's not unique to PFOF. Broker-dealers, unlike an investment advisor, are NOT fiduciaries and are not required to act in their customers best interests.
> Gensler has criticized the "gamification of trading" in which commission-free brokerages encourage excessive trading using lights, noises, notifications and other gimmicks to generate more PFOF.
It's not clear to me what's a gimmick, and what's just a better UI/UX. This seems difficult to police and I'm not convinced retail investors are so dumb that lights and noises make them trade.
I agree broker-dealers are not fiduciaries, but aren’t zero commission trades for customers better than commissioned trades? And is not about maximizing the payments as the SEC says, it is about the lack of “toxicity” in the orders; the assumption is that trading against retail flow is that it is more valuable to market makers because the trades are less likely to be informed on which direction the market is going to go. This does not mean retail traders are not getting the best price, just that market makers are willing to pay a premium to interact with this flow.
> As I recall, broker-dealers are legally required to get you the best price they can.
With PFOF, broker-dealers are still required to honor the best price posted by the national exchanges as per Reg NMS.
> I'm not convinced retail investors are so dumb that lights and noises make them trade.
Are you sure about that? IMO, It isn’t too dissimilar from making brokerage accounts more like slot machines or candy crush. If you can make something more addictive for your customers to use, it could be a problem. Making it illegal to use push notifications to trigger FOMO seems like an easy move to make on this front.
Yes. But enough people misunderstand the markets to think e.g. Citadel is secretly influencing the DTCC. Even in this thread. That creates systemic political risk to the market.
The real problem is the gamification Robinhood et al pushed without concern for the consequences. But if PFOF has to go as a way to expose the actual cost of transacting to retail traders, that’s not the worst trade-off.
The fact they don't consider this simple solution tells me it's all bullshit to protect the larger institutions.
Gary Gensler, the SEC chief, 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 return for payments, rather than to exchanges. He has said a ban on the practice is not off the table as it raises potential conflicts of interest, giving brokers incentives to encourage customers to trade more frequently to maximize the payments. The meme stock trading frenzy exposed concerns about the ways in which PFOF increases complexity and potential fragility in the securities markets, the House Financial Services Committee report said. Proponents say PFOF is a major reason brokerages were able to stop charging trading commissions, and retail investors often get a lower, better price than they would on the main exchange.
Gensler has criticized the "gamification of trading" in which commission-free brokerages encourage excessive trading using lights, noises, notifications and other gimmicks to generate more PFOF. He has also highlighted the use of artificial intelligence, predictive data analytics and machine learning to push products. In August 2021, the SEC issued a consultation on potential new rules to limit gamification and other "digital engagement prompts." The agency is expected to proceed with a rule change in the coming months. read more The U.S. House Financial Services Committee on Friday urged Congress to adopt legislation mandating the SEC study how its rules need to change to address new technological developments, such as digital engagement practices and social media-driven market activity.
The GameStop saga highlighted the small number of market-makers -- brokers that execute trades and publicly post buy and sell quotes for others to trade -- that dominate the retail market, which may pose competition issues, Gensler has said. The House Financial Services Committee said that at the time of the Reddit rally, Robinhood was not connected to any exchanges, and of the six market makers Robinhood routed all its customers' orders to, nearly all were unable to execute trades in certain meme stocks due to the market stress. "Had all these market makers been unable to execute trades, Robinhood would have been unable to execute trades on behalf of its customers," the report said. Nearly all retail trades are executed away from exchanges. That is partly due to rules that allow market makers to offer fractional sub-penny price improvement on bids and offers, whereas exchanges have to quote in pennies. Gensler has said that has created an uneven playing field in the competition for retail orders.
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As an aside, institutional investors, like pension funds, are not trying to generate +500% returns on options or meme stocks. They're not trying to beat traders. They're more comfortable with stable rates of return over the long term. +2%-3% per year. Not hard to beat for a day trader.
Had Robinhood had actual exchange connections, would they have been able to execute the trades? If the exchange can match a buyer and a seller, you don't need a "market maker". Market makers provide liquidity in infrequently traded assets. For frequently traded assets, you don't need market makers, just matching of buyers and sellers.
To "match buyers and sellers", one needs to buy from someone at time T, and hope to sell to someone else at time >T, during which time the market could have gone up or down. It's a risk-taking processes and a problem that's underappreciated by those who never actually tried to look at the basics of how an exchange works.
Also the best bid and offers on exchanges are often already market makers. To say you "don't need" market makers because of liquidity is a bit circular.
I have a friend who works in HFT[0][1], over a beer or three in central London a few years ago he told me that in his world a common description of retail trading is "dumb flow".
When your intentions to trade are being sold to the HFTs before your trades are even priced, I guess that does indeed rate you "dumb".
[0] https://en.wikipedia.org/wiki/High-frequency_trading [1] https://clsbluesky.law.columbia.edu/2015/12/15/is-high-frequ...
HFT only trades against institutional multi-block traders. The institutional people wrote Flash Boys to distract you from that.
Who do you think benefits most that this myth continues to propagate? The myth that the common man, with 1,000 USD to his name, can go on a trading app and do better than the financial elites and gain financial independence? Why would anyone in the market want to disabuse you of this when it brings in so much dumb money.