Securities and Exchange Commission Chairman Gary Gensler has directed staff at the agency to prepare for potential new rulemaking and enforcement actions related to the recent short squeeze of shares in GameStop Corp. and other so-called meme stocks, which could affect app-based stock brokers and the market makers that execute a growing share of retail trades in America.
According to prepared testimony for a Thursday hearing before the House Financial Services Committee, Gensler has directed his staff to request public input on new rules that could set boundaries on what sorts of features online stock brokers like Robinhood can employ on their smartphone apps, given accusations that these features encourage overuse of the app.
“Many of these features encourage encourage investors to trade more,” Gensler will tell the committee. “Some academic studies suggest more active trading or even day trading results in lower returns for the average trader.”
Gensler will also address payment for order flow, or the practice of market makers paying stock brokers for the privilege of executing customer orders, arguing that it raises the questions of whether broker-deals have an inherent conflict of interest.
In December Robinhood agreed to pay the SEC $65 million to settle charges that it failed to properly disclose its practices of payment for order flow and that it provided customers with inferior execution prices in order to earn higher payments from market makers. Gensler will note to the committee that in the United Kingdom and Canada, the practice of payment for order flow is banned.
The chairman also plans to express concern about the size and power of market maker Citadel Securities, Robinhood’s largest source of revenue, given that it executes 47% of all retail trades in U.S.-listed equities and options.
“History and economics tell us that when markets are concentrated, those firms with the greatest market share tend to have the ability to profit from that concentration,” Gensler’s testimony reads. “Market concentration can also lead to fragility, deter healthy competition, and limit innovation.”
Robinhood and Citadel were thrust into the headlines in January, after the broker and some of its competitors restricted purchases of shares of GameStop GME, +2.58% and other companies championed on social media, where users argued they were being unfairly targeted by short sellers.
The social-media promotion lead to a frenzied rise in the prices of these stocks, which forced brokers selling these stocks to post ever-higher collateral at the central clearinghouse that handles all U.S. equity volume. In response, Robinhood and other market makers temporarily barred customers from purchasing shares, in a move that created widespread outrage in the retail investing community.
The episode also drew greater attention to the lack of required disclosure around the practice of short selling, whereby an institution borrows the stock of a company, and later sells it in the hopes that the price will go down, so that it can repurchase the stock at a lower price and earn the difference. According to Gensler’s testimony, he plans to direct SEC staff to consider new rules that would require greater disclosure of large investors’ short positions.
Gensler will also express concern about the potential for bad actors to manipulate prices of securities on social media, given the importance of forums like’s Reddit’s WallStreetBets to the rise of meme stocks in recent months. He will reference the increasingly popular practice among institutional investors using algorithms and machine learning to monitor discussions on social media, and the potential for “nefarious actors” to “send signals to manipulate the market.’
“I’m not concerned about regular investors exercising their free speech online,” the testimony reads. “I am more concerned about bad actors potentially taking advantage of influential platforms.”