‘Let the SEC staff do an autopsy’ before jumping to conclusions: Ex-SEC chief economist urges
The anger toward brokerages like Robinhood, WeBull, Interactive Brokers, TD Ameritrade, and others for restricting buy orders of GameStop (GME) last week hasn’t died down.
As the stock surged, politicians on both sides of the aisle, pundits, and Elon Musk all joined in to condemn the system.
Across social media, some have pushed conspiracy theories that Robinhood and others acted in conjunction with hedge funds short the stock to prevent people from buying. Others have suggested the SEC told the brokers to stop the buys, ostensibly at the behest of the “hedge funds,” despite hedge funds also being winners in the rally, as well as the losers.
What needs to happen now, said Chester Spatt, former SEC chief economist and professor at the Tepper School of Business at Carnegie Mellon University, is a measure of order as we ask questions and figure out what happened.
“First, we have to let the SEC staff do an autopsy, and only later should lawmakers be debating possible changes in the regulatory framework,” Spatt told Yahoo Finance. “First, let’s see what the regulatory framework did. Why did it do that? And to what extent are the actions of the participants appropriate?”
The questions we need to be asking
In another interview Friday, Spatt said most people don’t realize the complexity of the plumbing behind what happens when someone makes a trade. Though perhaps a stock should be as simple as buying something on Amazon, it’s still more like buying a house: There’s an agreement when you click “buy,” but then there’s a period before settlement, the moment where transfer of ownership and funds occur. It’s not as long as a real estate transaction, but since 2017, that period has been two days.
In the interval between a buy order is made and settlement, a lot could conceivably happen. In an extreme scenario, the buyer might not come through with funds or the seller with the shares, which is why there are rules and regulations to assure this does not happen.
Some of these regulations deal with brokerages maintaining margin and deposit requirements with clearinghouses. And if a brokerage doesn’t have enough money to essentially back up its customers’ transactions, it can’t use investor money.(This is the case for market orders, not just orders with “margin” despite the word margin in both.)
This is what the CEOs of WeBull and Robinhood said happened. As trading surged in a handful of popular stocks last week, like GameStop and AMC, dramatic swings in the value of those shares spurred the clearinghouse that processes and settles the trades to ask Robinhood for more cash to cover potential losses on the transactions. Robinhood secured $1 billion the following day.
Spatt said that doesn’t mean we should simply take these companies at their word – that’s why we need an SEC autopsy.
The SEC’s monitoring and investigation is “extremely important,” Spatt said, “namely the capital needs of Robinhood and the necessity and possible necessity of the trading limits that they imposed.”
(On Friday the SEC said in a statement it is monitoring the extreme price volatility. “The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities,” read the statement.)
There still are many questions remaining, Spatt continued: “What was the nature of the capital before this happened with Robinhood? Was it inadequately capitalized? What are the restrictions that they’ve imposed mean?”
One question Spatt has — along with most of the internet — is why restrict buying to just one share? And why don’t we always see restrictions when stocks fly up and down the chart, such as when Canadian cannabis company Tilray (TLRY) exploded over 500% in August 2018.
“There might have been differences in magnitude but this is part of what regulators will need to probe and sort through,” said Spatt. “So far, Robinhood has not provided relevant detail publicly — and perhaps they can’t without making themselves vulnerable.”
On the issue of retail investors possibly “manipulating” the market through Reddit forums like r/WallStreetBets, Spatt said it’s unlikely there’s a problem there.
“I certainly wouldn’t think discussing a particular stock would be manipulation,” he said, even in the context of discussing the possibility of a short squeeze. “But this is something else that the staff might be interested in understanding.”
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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.
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