The Securities and Exchange Commission’s new chairman Gary Gensler will testify before the House Financial Services Committee Thursday to answer questions about his agency’s stance on the growing popularity of zero-commission trading, pioneered by the trading app Robinhood, the dramatic boom and bust of GameStop stock earlier this year, and what new regulations are in the works to protect investors.
In a prepared testimony released before the hearing, Gensler expressed the agency’s concern with the increasing “gamification” and “behavioral prompts” that encourage amateur investors to engage in frequent trading. He defined “gamification” as game-like features, such as points, rewards, leaderboards, bonuses and competitions, designed to keep players in the game for as long as possible.
“Many of these features encourage investors to trade more. Some academic studies suggest more active trading or even day trading results in lower returns for the average trader,” Gensler said. “We need to ensure investors using apps with these types of features continue to be appropriately protected.”
Such trading activities are most seen on zero-fee stock trading apps, such as Robinhood. Robinhood doesn’t charge a commission from it customers. Instead, it makes money by selling customers’ stock orders to market makers, such as hedge funds, in exchange for a small margin payment on each order. The process is known as “payment for order flow” and has increasingly become an industry standard for brokers.
However, because the broker’s earning depends on the number of orders they sell, they are incentivized to encourage customers to trade more often.
“Do broker-dealers have inherent conflicts of interest?” Gensler asked in his prepared remarks. “If so, are customers getting best execution in the context of that conflict? Are broker-dealers incentivized to encourage customers to trade more frequently than is in those customers’ best interest?”
The SEC is concerned about the growing prevalence of “payment for order flow” and certain marker makers’ dominance in the space. Gensler says about 38 percent of equity trading volume is now executed by those “wholesalers.” Citadel Securities, one of the largest market makers out there, has said it executes about 47 percent of all U.S.-listed retail volume.
“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 said, “I’ve asked staff to look closely at these issues to determine which policy approaches may be merited.”
Gensler is also expected to address the SEC’s role in the booming cryptocurrency market and disclosure requirements for historically opaque financial instruments, such as security-based derivatives contracts.
The hearing starts at 12:00 p.m. Easter Time and will be live streamed at the House Financial Services Committee website.