A wonky topic that has gotten loads of recent attention on Wall Street is a requirement that stocks be physically deposited in a purchaser’s account within two days of making an order—a process known as “T+2.”
Because stock prices can fluctuate dramatically over those two days, brokers have to post collateral with an outfit called the Depository Trust & Clearing Corp. to ensure that they have the funds to cover the risks that their customers take. The intent is to prevent brokers from getting burned before transactions settle.
This is largely what happened to Robinhood. When GameStop and other stocks rose to astronomical levels last week, the DTCC demanded that Robinhood post more funds.
Robinhood responded by tamping down on risk by restricting its customers from adding to their buy orders.
With lightning-fast computers now dominating trading, many market participants have argued that two days is too long to settle trades.
“Moving the industry closer to T+1 settlement is good for everyone because the less risk we maintain in the system, the better off everyone is,” said Shane Swanson, a senior analyst at consulting firm Greenwich Associates and a former director of equity market structure at Citadel Securities.
Graham Steele, a former Senate aide who now runs Stanford University’s Corporations and Society Initiative, noted that post-crisis reforms such as the 2010 Dodd-Frank Act did a good job of tightening regulations and capital requirements for big Wall Street banks. But he said recent events show that more needs to be done to ensure the stability of non-bank broker-dealers.
“A broker-dealer like Robinhood sees the shares its clients bought as their risk and their assets, so the risk is supposed to be small,” Steele said. “But with the leverage the broker-dealer provides to its retail client, it actually becomes its risk too. That’s why stronger capital rules are needed.”
Social Media
To ensure investors aren’t using social media to manipulate the market, traders should be required to hold on to whatever they are hyping on Twitter and Reddit for at least 10 days, said Joshua Mitts, an associate professor at Columbia Law School who focuses on securities law.
Such a policy would help prevent “pump-and-dump” schemes in which traders spread false information about stocks to engineer a rally before selling at the highs. Mitts added that the ways in which social media is transforming investing—not to mention just about every other aspect of modern life—means that the SEC might have to take on a role in policing content.
“The SEC could take steps to ensure whatever is disclosed is truthful and that social media outlets aren’t being used as ignition sparks to drive prices in one direction or another without ensuring that people who make these statements have skin in the game,” he said.
Investigating Fraud
Turner, the former top accountant at the SEC, said the regulator needs to be much more deliberate in making clear that it’s on the hunt for fraudsters because doing so might eradicate some of the less scrupulous conduct that now seems pervasive in the stock market.
He urged the regulator to announce that it is investigating the actions of both hedge funds and retail investors, and that agency officials are monitoring Reddit chats.
“Neither side here are angels,” Turner said.
He also advised the SEC to conduct a thorough examination of market fairness. Topics that should be part of that review include social media, the role of market makers and high-frequency trading firms, Turner said.
—With assistance from Robert Schmidt and Jeff Kearns.
This article was provided by Bloomberg News.