Gary Gensler, the top securities regulator for the Securities and Exchange Commission (SEC), recently proposed rule changes to overhaul how Wall Street handles retail stock trades. The potential overhaul comes amid growing public controversy surrounding brokerage firms and market makers, and their relationship with retail investors.
The proposal, which comes as a response to the retail stock mania of 2021, would require trading firms to directly compete with one another to execute trades from retail investors. Proponents argue that the proposed overhaul would boost competition within the industry, and provide a fairer trading environment for non-institutional retail investors. The rule change would also mandate that market makers disclose more data regarding the fees they earn, as well as the timing of trades for the benefit of investors. To enhance competition, auctions would become more open and transparent, and provide investors with better, more accurate information including monthly summaries of price movements.
Likewise, the proposal calls into scrutiny the practice of “payment for order flow,” or PFOF, in which brokers are paid by market makers to route orders. PFOF recently attracted controversy in early 2021, when amateur retail investors went on a buying spree of so-called meme stocks, bidding up the price of stocks including GameStop (GME) and AMC (AMC), inflicting losses upon hedge funds which had previously shorted the shares. The shares were typically purchased through commission-free brokers such as Robinhood.
If implemented, the rule changes would likely be the largest regulatory overhaul of the financial services industry since the passage of the Dodd-Frank Act of 2010, over a decade ago. Formal proposals are expected to take place during the fall, and implementation of the proposed changes would require an SEC vote of approval.
The proposal has been met with positive feedback from many industry practitioners and analysts, with the potential to generate greater transparency and investor trust. Others, including Dan Gallagher, Chief Legal Officer at Robinhood, were more skeptical. Defending Robinhood’s current model of commission-free trading, which has helped boost retail investor participation in the market significantly, Gallagher noted a more thorough economic analysis was necessary to justify the rule changes.