SEC/stock trading: meme stocks are the mother of invention for Gary Gensler


If the water coming out of the tap tastes OK and is cheap, no one cares about the plumbing under the sink. Except perhaps for the chair of the US Securities and Exchange Commission. Gary Gensler is expected this week to roll out ideas for how retail stock orders should be routed and executed.

In recent years, an increasing number of brokerages have offered commission-free trades to retail customers. The rub is that the trades are not costless. Brokerages, notably meme stock specialist Robinhood, sell the transactions to wholesale market makers. These buyers include Citadel Securities, Virtu and Susquehanna. They are hardly household names. But they have captured enough tiny bid-ask spreads to become highly profitable.

Their pipes were exposed last year during the meme-stock trading frenzy, when retail investors wildly bought and sold shares and trades sometimes halted.

Gensler is expected to propose an auction mechanism forcing brokers to improve pricing for end clients. Naturally, incumbents are resisting changes to a status quo that has worked out well for them. They say trading commissions may rise. But equally, prices on trade execution may drop.

Similar arithmetic was exposed in late 2020. Robinhood settled with the SEC for $65mn over allegations it was not upfront with users about its “payment for order flow” practices. The SEC claimed the brokerage failed to seek the best execution terms, ensuring payments it received for order flows stayed healthy

According to the SEC’s analysis, terms were bad enough that account holders would have been better off paying a typical $5 commission on orders of more than 100 shares than using Robinhood for free. For an order of 500 shares, that average execution loss was $15.

It remains to be seen whether an auction system devised by a regulator will do a cleaner, cheaper job of executing trades than competing brokerages and market makers. But we should at least credit the SEC with trying to improve the system creatively instead of just grumpily punishing businesses whose practices it dislikes.

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