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Securities and Exchange Commission Chairman Gary Gensler on Thursday warned lawmakers that growing concentration in the securities wholesaling and brokerage industries could lead to market “fragility,” and increased costs for retail and institution investors.
“At the heart of well-functioning markets and the mission of the SEC of fair, orderly and efficient markets is promoting competition in markets,” Gensler said during a hearing before the House Financial Services Committee. “It can be done through transparency, but it’s also looking at our rule set to make sure that our rule set inspires more competition rather than concentration.”
Gensler noted that “our modern 2020s economy tends toward [concentration]” because of the power of “network effects” that cause the value of a service to increase for a user based on the number of other users of that service.
“We’ve seen such concentration come in other markets,” he added. “We know it’s in search, where we all go online and there’s really one dominant search engine and we know it’s true in retail products online.”
The SEC chairman said he has directed his staff to produce suggstions for ways the commission can “promote competition in the face of these network effects that are leading to concentration.”
Gensler was before the committee to discuss the events related to the short squeeze in shares of GameStop Corp.
GME,
in late January that drove up the price of those shares and led to several retail brokers temporarily restricting purchases in order to help manage collateral requirements mandated by their central clearinghouse.
The episode raised public awareness of the growing power of market makers like Citadel Securities that execute a growing percentage of retail trades at the expense of stock exchanges like the New York Stock Exchange or the Nasdaq
NDAQ,
Citadel Securities says that it executes 47% of all retail trades in U.S.-listed equities and options.
The retail brokerage industry has also been consolidating, with a merger between Charles Schwab Corp.
SCHW,
and TD Ameritrade closing last October, just a few years after TD Ameritrade acquired Scottrade. Morgan Stanley
MS,
also completed its purchase of E-Trade Financial Corp. last year, in the wake of E-Trade’s acquisition of Capital One’s brokerage business.
That consolidation, however, was in part spurred by the arrival of new app-based brokerages like Robinhood and WeBull, which accelerated a shift in the industry toward a zero-commission trading model.
One force that may be driving concentration, Gensler suggested, was the practice of payment for order flow, whereby market makers like Citadel Securities pay brokers for the privilege of executing customer orders. Gensler said that market makers can glean valuable intelligence about the market through increased order flow, which enables them to pay better prices for future orders, creating a positive feedback loop that leads to greater concentration.
Democrats on the committee expressed concern that payment for order flow creates a conflict of interest between stock brokers like Robinhood, which earns a majority of its revenue from payment for order flow, and their customers. In his written testimony, Gensler pointed to Robinhood’s recent $65 million settlement with the SEC in part over charges that it accepted worse price execution for its customers from market makers in return for higher payment for order flow.
“That case shows there was an inherent conflict,” he said. “That’s why I’ve asked staff to take a holistic look at market structure and see not only whether customers are getting best execution, but to address some of the increasing concentration in the markets.”
Dan Gallagher, chief legal officer at Robinhood, told MarketWatch at the time that “the settlement relates to historical practices that do not reflect Robinhood today.” He said in an interview Thursday that the company is ready to work with the SEC on new disclosure rules related to payment for order flow. “That would be a good thing, and we’re ready to engage with it.”
Also addressed at the hearing was the topic of “gamification,” or a broad set of practices that critics say are employed by app-based brokers to increase user engagement with the app, often to their financial detriment. Gensler said that while it’s a good thing that new technologies make investing more appealing, the SEC will investigate whether new rules are needed to prevent investors from being seduced into overtrading.
“If you use gamification features and folks are trading more actively and day trading, then all of a sudden they’re risking their investment future,” Gensler said. “So I think we’ve really got to take a look at this.”
