[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
GAME STOPPED? WHO WINS AND LOSES WHEN
SHORT SELLERS, SOCIAL MEDIA, AND
RETAIL INVESTORS COLLIDE, PART II
=======================================================================
VIRTUAL HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
__________
MARCH 17, 2021
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-10
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
U.S. GOVERNMENT PUBLISHING OFFICE
44-343 PDF WASHINGTON : 2021
HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma
GREGORY W. MEEKS, New York BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri STEVE STIVERS, Ohio
ED PERLMUTTER, Colorado ANN WAGNER, Missouri
JIM A. HIMES, Connecticut ANDY BARR, Kentucky
BILL FOSTER, Illinois ROGER WILLIAMS, Texas
JOYCE BEATTY, Ohio FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER, New Jersey LEE M. ZELDIN, New York
VICENTE GONZALEZ, Texas BARRY LOUDERMILK, Georgia
AL LAWSON, Florida ALEXANDER X. MOONEY, West Virginia
MICHAEL SAN NICOLAS, Guam WARREN DAVIDSON, Ohio
CINDY AXNE, Iowa TED BUDD, North Carolina
SEAN CASTEN, Illinois DAVID KUSTOFF, Tennessee
AYANNA PRESSLEY, Massachusetts TREY HOLLINGSWORTH, Indiana
RITCHIE TORRES, New York ANTHONY GONZALEZ, Ohio
STEPHEN F. LYNCH, Massachusetts JOHN ROSE, Tennessee
ALMA ADAMS, North Carolina BRYAN STEIL, Wisconsin
RASHIDA TLAIB, Michigan LANCE GOODEN, Texas
MADELEINE DEAN, Pennsylvania WILLIAM TIMMONS, South Carolina
ALEXANDRIA OCASIO-CORTEZ, New York VAN TAYLOR, Texas
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
NIKEMA WILLIAMS, Georgia
JAKE AUCHINCLOSS, Massachusetts
Charla Ouertatani, Staff Director
C O N T E N T S
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Page
Hearing held on:
March 17, 2021............................................... 1
Appendix:
March 17, 2021............................................... 81
WITNESSES
Wednesday, March 17, 2021
Arnuk, Sal, Partner/Co-Founder, Themis Trading LLC............... 5
Blaugrund, Michael, Chief Operating Officer, New York Stock
Exchange....................................................... 7
Bogan, Vicki L., Associate Professor, Cornell University......... 8
Goldstein, Alexis, Senior Policy Analyst, Americans for Financial
Reform......................................................... 10
Grujic, Alan, CEO, All of Us Financial........................... 13
Kelleher, Dennis M., Co-Founder, President, and Chief Executive
Officer, Better Markets........................................ 12
Piwowar, Hon. Michael S., Executive Director, Milken Institute
Center for Financial Markets................................... 15
APPENDIX
Prepared statements:
Arnuk, Sal................................................... 82
Blaugrund, Michael........................................... 91
Bogan, Vicki L............................................... 95
Goldstein, Alexis............................................ 102
Grujic, Alan................................................. 112
Kelleher, Dennis M........................................... 117
Piwowar, Hon. Michael S...................................... 162
Additional Material Submitted for the Record
Green, Hon. Al:
``Trading hot stocks like GameStop seems fun until you look
beneath the surface.''..................................... 176
Hill, Hon. French:
Coalition Letter............................................. 217
Security Traders Association Letter.......................... 220
Huizenga, Hon. Bill:
Cadwalader Cabinet Commentary, ``GameStop: Regulators Should
Focus Less on `Solving the Problem'; More on `Improving the
Situation'''............................................... 186
Q1 2020, ``The Impact of Zero Commissions on Retail Trading
and Execution''............................................ 200
Wall Street Journal, ``Instant Settlement May Not Be
Gratifying for All''....................................... 212
McHenry, Hon. Patrick:
Letter to Chairwoman Waters dated March 11, 2021............. 215
Letter to Chairwoman Waters dated March 15, 2021............. 216
Coalition Letter............................................. 217
Security Traders Association Letter.......................... 220
Written statement of the U.S. Chamber of Commerce's Center
for Capital Markets Competitiveness........................ 223
Williams, Hon. Nikema:
Written responses to questions for the record submitted to
Vicki Bogan................................................ 237
GAME STOPPED? WHO WINS AND
LOSES WHEN SHORT SELLERS,
SOCIAL MEDIA, AND RETAIL
INVESTORS COLLIDE, PART II
----------
Wednesday, March 17, 2021
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:02 a.m., via
Webex, Hon. Maxine Waters [chairwoman of the committee]
presiding.
Members present: Representatives Waters, Maloney,
Velazquez, Sherman, Scott, Green, Cleaver, Perlmutter, Himes,
Beatty, Vargas, Gottheimer, Gonzalez of Texas, Lawson, San
Nicolas, Axne, Casten, Pressley, Torres, Lynch, Adams, Tlaib,
Dean, Garcia of Illinois, Garcia of Texas, Williams of Georgia,
Auchincloss; McHenry, Lucas, Posey, Luetkemeyer, Huizenga,
Stivers, Wagner, Barr, Williams of Texas, Hill, Emmer, Zeldin,
Loudermilk, Mooney, Davidson, Budd, Kustoff, Hollingsworth,
Gonzalez of Ohio, Rose, Steil, Gooden, Timmons, and Taylor.
Chairwoman Waters. The Financial Services Committee will
come to order.
Without objection, the Chair is authorized to declare a
recess of the committee at any time.
As a reminder, I ask all Members to keep themselves muted
when they are not being recognized by the Chair. The staff has
been instructed not to mute Members, except where a Member is
not being recognized by the Chair and there is inadvertent
background noise. Members are also reminded that they may only
participate in one remote proceeding at a time. If you are
participating today, please keep your camera on, and if you
choose to attend a different remote preceding, please turn your
camera off.
Before we begin today's hearing, I would also like to note
that my staff and I are continuously monitoring the evolving
situation around vaccinations and the COVID-19 pandemic, and
looking for opportunities to begin to return the committee to
normal proceedings as soon as medical experts advise that it is
safe to do so. I have appreciated the coordination from the
ranking member in ensuring proper safety protocols in committee
proceedings thus far, and I am committed to working with him to
ensure that we are following the recommendations of medical
experts, moving forward.
Today's hearing is entitled, ``Game Stopped? Who Wins and
Loses When Short Sellers, Social Media, and Retail Investors
Collide, Part II.''
I now recognize myself for 3 minutes to give an opening
statement.
Good morning, everyone. Today, this committee convenes for
our second hearing on the ongoing volatility involving GameStop
and other stocks. In our first hearing on this matter, I called
for a number of those involved in those events to testify
before the committee. The goal was to get the facts, and so we
heard directly from the CEOs of the trading app, Robinhood;
Wall Street firms Citadel and Melvin Capital; and social media
company, Reddit; as well as Keith Gill, one of the retail
investors involved in WallStreetBets. The committee asked those
witnesses questions on a broad range of issues, touching upon
topics including conflicts of interest and payment for order
flow, gamification of trading and harm to retail investors, the
process for clearing and settling stock trades in the United
States, and the ways that social media and technology are
changing the way our markets function, as well as other related
issues.
I concluded our first hearing by voicing my concerns on how
Robinhood's retail investors are sometimes treated more like a
product than a customer, and Robinhood's actual customer,
Citadel, with its expansive role in our capital markets, may
pose a systemic risk to our financial system. Today, as a next
step, I am convening this hearing with a panel of capital
markets experts and investor advocates so that the committee
can hear their perspectives on these issues and possible
reforms.
As the events in January put a spotlight on gaps in
regulation of our capital markets, the committee must assess
what legislative steps may be necessary. Following this
hearing, I plan to convene a third hearing to hear the
perspectives from the regulators who oversee these markets and
are supposed to be putting investors first. My goal in
continuing to scrutinize these events and the related policy
issues is to ensure that our capital markets are fair and
transparent, that investors have strong protections, and that
Wall Street is indeed accountable and beneficial to the
American economy.
I now recognize the ranking member of the committee, the
gentleman from North Carolina, Mr. McHenry, for 4 minutes.
Mr. McHenry. Thank you, Madam Chairwoman, and thank you for
holding today's hearing.
I fear a pattern is emerging here that regardless of the
facts or data, Democrats are going to use every opportunity to
justify their priorities. Whatever is in the news, whatever
fears people have, they are going to exploit it to justify
advancing an extreme progressive agenda, simply repackaging
old, outdated policy failures with the wrappings of whatever
else is in the news this week, and using that to sell the
American people on the idea that this time, it is different.
Ask yourself, for example, why it is that in the Biden plan,
signed into law last week, the Congressional Democrats landed
on $350 billion in State and local aid when States only have a
shortfall of $1.75 billion right now? That is like your friend
needing $2, and you say, no problem, here is $350. Will that
cover it? The reality is that Democrats are stuck in their
thinking no matter what the data actually tells us. Trust me,
that massive spending bill is just the start, and the same
thing is going to happen with the infrastructure bill and
climate change disclosures as well.
I fear the same thing is happening today with this GameStop
hearing. Democrats are using GameStop to justify more
regulations, greater restrictions, and putting more costs onto
businesses and everyday investors. They will say this
technology is the new scary thing and that it is dangerous, but
let's be honest: None of these ideas are new. Regardless of
what information may be gleaned from conducting oversight or an
investigation, Democrats have already come up with the same old
tired ideas: more taxes; more disclosure; more regulation; more
limitation; more fees; and more government bureaucrats telling
Americans how and what they should be able to invest in. But
these ideas come with a track record.
We know their agenda creates perverse incentives, bad
policy outcomes, and rampant inequality that they then can
seize on politically to say they are going to fix inequality,
but their policies only make things worse, and enhance
inequality. To repeat my point I made in last month's hearing,
because of the Democrats' progressive policies, it is easier
for most Americans to buy a lottery ticket than it is to invest
in the next Google. Because of the regulatory structure, we
have the, ``accredited investor'' definition, which, in the
D.C. spin on regulation, ensures that only the rich get to
invest in things that make you rich. That is backwards and
wrong. Let's remove these hurdles and move forward. Let's find
a way to work together to harness the power of financial
innovation that benefits everyday Americans. Instead of
clamping down on innovation and shutting the American people
out of opportunities, let's stand with the American people who
want a better life.
And on a final note, I want to thank the Chair for laying
out her approach to holding hearings, and I would ask unanimous
consent to submit for the record the letter exchange that we
have had over the last week. Look, folks have been vaccinated.
As an institution, Congress has had opportunities to be
vaccinated. We had hybrid hearings before the vaccine was even
available, and so I am asking, Madam Chairwoman, if we could
return to those practices that we had last Congress, so that we
can actually have both sides represented, and we can have more
productive, better hearings when we have a hybrid model or in
person. And I think that is commensurate with almost every
committee member being vaccinated.
So with that, I yield back, and I look forward to the
hearing.
Chairwoman Waters. Thank you. Without objection, the letter
exchange will be added to the record.
I now recognize the gentleman from California, Mr. Sherman,
who is also the Chair of our Subcommittee on Investor
Protection, Entrepreneurship, and Capital Markets, for 1
minute.
Mr. Sherman. Madam Chairwoman, I thank you for holding this
hearing, and I couldn't disagree more with the ranking member
when he says this hearing is about raw meat for the woke left-
wing masses. I have been to far more left-wing demonstrations
than he can imagine. And let me tell you now, there may be
shouting of slogans like, ``Impeach Trump,'' but I have never
been at a left-wing rally where people are shouting, ``End
payment for order flow. Price improvements for all.'' This is a
hearing on important technical issues that affect investors
which both parties should be trying to protect.
We need to look at short selling and the fact that we
disclose far less here than in Europe. We need to look at the
conflicts of interest involved in payment for order flow. We
need to look at a system where you have best execution versus
Congress getting price-improved best execution and the
gamification and glorification of high-frequency trading. None
of that is partisan, none of it is ideological, and none of it
will get you cheered at a left-wing rally.
Chairwoman Waters. I now recognize the ranking member of
the Subcommittee on Investor Protection, Entrepreneurship, and
Capital Markets, the gentleman from Michigan, Mr. Huizenga, for
1 minute.
[No response.]
Chairwoman Waters. Mr. Huizenga?
[No response.]
Chairwoman Waters. Is Mr. Huizenga on the platform?
Voice. He is on the platform. He is just muted.
Chairwoman Waters. Mr. Huizenga, you are muted.
[No response.]
Chairwoman Waters. Mr. Huizenga, unmute.
Mr. Huizenga. Finally. Okay. Sorry, Madam Chairwoman.
Technology is one of our challenges. I have been trying to
unmute that entire time.
Chairwoman Waters. You are recognized for 1 minute.
Mr. Huizenga. Retail trading has surged in popularity and
in practice due to the rise of app-based trading. These app-
based interfaces, combined with zero-commission trades,
fractional share trading, and lowered account minimums, have
ushered in a new era of investment. Advancements in technology
have improved access to our capital markets and created new
opportunities for countless Americans to participate in our
markets who were previously excluded. Today, nearly 25 percent
of market trading volume is attributable to retail orders. This
is up from 10 percent of trading volume just a mere 2 years
ago.
The median age of Robinhood customers is 31, and more than
half of new Robinhood accounts for the first half of 2020 were
opened by first-time investors. At Charles Schwab, since 2019,
half of their new clients have been under the age of 40. This
is good. How have my colleagues across the aisle responded to
this new era of investment? By falsely claiming this increase
in market participation has caused, ``gamification of the
trading experience'', that markets are rigged, and some have
even gone so far as to equate it to gambling in a casino.
We should be working together to understand how innovation
and technology can improve access to our capital markets
instead of jumping to conclusions. I yield back.
Chairwoman Waters. Thank you. I now recognize the gentleman
from Texas, Mr. Green, who is also the Chair of our
Subcommittee on Oversight and Investigations, for 1 minute.
Mr. Green. Thank you, Madam Chairwoman. I am grateful for
this hearing, and the salient question is, should we continue
to allow a middleman or market maker, who is a high-speed,
high-frequency trader, to execute trades for itself and its
clients. If the answer is yes, then are there sufficient
penalties to deter self-dealing and unlawful trading, mainly
buying or selling ahead of one's clients when the trades of the
clients are known? I thank you, and I yield back.
Chairwoman Waters. I want to welcome today's distinguished
witnesses to the committee: Sal Arnuk, who is a partner at and
co-founder of Themis Trading, an institutional equities agency
brokerage firm; Michael Blaugrund, who is chief operating
officer at the New York Stock Exchange; Vicki Bogan, who is an
associate professor at the SC Johnson School of Business at
Cornell University; Alexis Goldstein, who is a senior policy
analyst at Americans for Financial Reform; Dennis Kelleher, who
is co-founder, president, and chief executive officer of Better
Markets; Alan Grujic, who is chief executive officer of All Of
Us Financial; and Michael Piwowar, who is executive director of
the Milken Institute Center for Financial Markets.
Each of you will have 5 minutes to summarize your
testimony. You should be able to see a timer on your screen
that will indicate how much time you have left, and a chime
will go off at the end of your time. I would ask you to be
mindful of the timer and quickly wrap up your testimony if you
hear the chime. And without objection, your written statements
will be made a part of the record.
Mr. Arnuk, you are now recognized for 5 minutes to present
your oral testimony.
STATEMENT OF SAL ARNUK, PARTNER/CO-FOUNDER, THEMIS TRADING LLC
Mr. Arnuk. Thank you, esteemed members of the House
Financial Services Committee, for inviting me to participate in
this hearing.
Joe Saluzzi and I co-founded Themis Trading in 2002, and we
trade as agents on behalf of money managers, collectively
managing trillions of dollars for long-term investors. We
believe the most damaging elements of what has come to be
called the meme stock craze are playing out because of
extremely poor investor education, conflicts of interest in the
form of order routing inducements, referred to as, ``payment
for order flow'', and a lack of accountability for this poor
investor education and these misaligned incentives.
In our written testimony, we have included more detail and
nuance on why we think there is an issue with how Robinhood
conducts its business. Therefore, we will use our opening
statement to instead talk about payment for order flow, which
is the practice that makes their model exist.
Payment for order flow presents an undeniable conflict of
interest. While it may enable free commissions and explicit
cost, there are implied costs we feel everyone ignores. While
payment for order flow is legal, we have long wondered how it
possibly could be. How can a broker, charged with the duty of
getting its clients the best available prices, do so by selling
the clients' orders to sophisticated high-frequency trading
firms, who, in turn, will make billions of dollars trading
against these orders? While retail brokers and market-making
firms claim to provide price improvement (PI) to these orders,
it is a flawed calculation. It is based off of a slower price
feed called the SIP. It doesn't take into account odd lots and
midpoint exchange order flow, and the NBBO reference price it
uses is largely set by the very same market-making firms
bestowing this PI in the off-exchange environment.
Regulators know this. The SEC recently fined Citadel $22
million for mishandling retail orders, and they also fined
Robinhood $65 million for failing its best execution
responsibilities. They know the concept of PI is flawed as
well. They approved a huge market structure change which
included odd lots in the SIP, and protected them as a quote,
yet our industry sued to block this overhaul. Payment for order
flow increases overall costs in the market for all investors,
including pension funds. When a few HFT market makers buy up
orders that account for as much as a third of the trading
volume each day, the orders are less informed and benign so
that they don't go to the exchanges. What is left on those
exchanges is much, much more toxic and costly to trade with.
Market impact costs are higher and spreads are wider as well.
Two studies that confirm this are the Babelfish Study of
Transaction Costs and Meme Stocks and another academic study
that amazingly points out that when Robinhood experiences
technical outages, spreads in the general market become
narrower. Wider spreads mean that retail investors receive the
worst prices, even after accounting for PI, and all other
investors see their costs increase as well.
The practice of payment for order flow also provides a
disincentive for displayed limit orders on exchanges. These
displayed orders are often stepped in front of by HFT market
makers who piggyback the price set by them. Those market makers
step in and are rewarded with a sale that was only made
possible by the displayed order, which narrows the spread in
the first place. Would any of you, when buying a home, for
example, put a sign in front of the home with the price you
would pay, only to help someone else buy the house ahead of you
for the same price or a dollar more? Yet, this is what happens
to displayed orders in the market every day.
Payment for order flow also takes the form of maker-taker
rebates on exchanges. The practice creates race conditions to
be first in line to get a rebate every time the quote changes.
Investor orders do not dominate these races; market makers do.
Investor orders are typically further back in the queue and
miss opportunities at buying cheaper stocks, but despite this,
brokers representing those investor orders still route largely
to these exchanges for that rebate, and regulators know this
behavior is problematic. In December 2018, the SEC adopted a
transaction fee pilot, whose purpose was to test the effect of
rebates on market quality. Sadly, the exchanges sued and
blocked the pilot. What were the exchanges afraid that the
pilot would confirm?
Finally, maker-taker has taken fixed exchange costs to the
moon. This has resulted in less diverse public markets, which
hurts price discovery. Which market will have better price
discovery, one where the prices are determined by an oligopoly
of four large HFT trading firms, or one where the prices are
determined by diverse investors and traders from all walks?
To conclude, we are all witnessing the dangerous
intersection of poor investor education by a broker that should
know better, and the payment for order flow that creates the
massive incentive in their business model to sell the orders on
its platform to its real customers, the HFT market makers.
Payment for order flow is a flawed and conflict-ridden
practice.
[The prepared statement of Mr. Arnuk can be found on page
82 of the appendix.]
Chairwoman Waters. Thank you, Mr. Arnuk. Mr. Blaugrund, you
are now recognized for 5 minutes to present your oral
testimony.
STATEMENT OF MICHAEL BLAUGRUND, CHIEF OPERATING OFFICER, NEW
YORK STOCK EXCHANGE (NYSE)
Mr. Blaugrund. Chairwoman Waters, Ranking Member McHenry,
and distinguished members of the committee, thank you for the
opportunity to testify today. I am Michael Blaugrund, the chief
operating officer of the New York Stock Exchange. The NYSE is
the world's largest exchange, and our listed companies employ
more than 43 million people worldwide and represent roughly 30
percent of the world's public market value. The New York Stock
Exchange's purpose is to help companies raise capital so they
can change the world and provide an opportunity for investors
to share in their growth. The events of January have raised
questions as to what, if anything, policymakers and regulators
should seek to reform in the equity markets. Whatever
conclusions the regulators reach about what ought or ought not
be done, public policy should build investor confidence in the
markets.
The first of four areas that merit reform is shareholder
disclosures. At the NYSE, we sit at the nexus of issuers and
investors, and both groups have strong feelings about
shareholder disclosures under Section 13(f). Corporate issuers
feel that the current limited frequency and lengthy lag time
for 13(f) reporting prevents them from engaging efficiently
with their investor base, while institutional investors are
concerned that increased disclosures would erode the value of
their fundamental research. We facilitated joint discussions
with representatives of both groups in hopes of identifying a
middle ground. Based on this dialogue, we believe the SEC
should consider shortening the delay for 13(f) reporting and
consider mechanisms that enable direct disclosures to corporate
issuers when a reportable position is established or fully
divested.
The second area for reform is securities lending. Short
selling is an essential practice for liquidity price discovery
and risk management, but the securities lending market on which
it depends is opaque and inefficient. The Financial Industry
Regulatory Authority (FINRA) collects short position
information from its member firms twice a month, but this
aggregate data is insufficient for market participants or
regulators to understand how supply and demand are changing for
stock loans. The NYSE believes the SEC should consider
establishing a consolidated tape for securities lending. A
system that anonymously published the material terms for each
stock loan would provide the necessary data to understand
shifts in short-selling activity while protecting the
intellectual property of individual market participants.
Third, the SEC should eliminate competitive barriers for
public investors. Over the past year, retail trading has been
the fastest-growing segment of the market. It is encouraging to
see increased direct investment as public markets are a
powerful mechanism for reducing economic inequality. The vast
majority of retail order flow, however, never makes it to the
public market. Instead, retail orders are typically routed to a
broker-dealer wholesaler for internalization, a process that
guarantees an execution to the retail customer in exchange for
granting the wholesaler an opportunity to trade with the order
before other market participants. Investors trading on public
exchanges, including the NYSE, have a limited ability to
compete for much of the retail volume due largely to the
difference in the regulatory framework for broker-dealers and
exchanges.
For example, unlike exchanges, wholesalers can offer
privately-negotiated terms for price improvement or payment for
order flow. However, investors trading on exchanges are also on
unequal footing in a more straightforward way. Off-exchange
trading is permitted at price increments as small as one-one-
hundredth of a cent, while investors trading on exchanges are
limited to price increments of a full penny. The NYSE believes
that it is time to level the playing field for on-and-off
exchange price increments. Reducing the minimum pricing
increment on exchanges and active, low-price securities with
lower investor trading costs improves transparency and provides
an increased opportunity for investors trading on exchanges to
interact with retail orders.
Finally, NYSE supports the growing consensus to accelerate
industry settlement cycles from 2 days to 1 day after the
trade. Though a shorter settlement cycle increases the
potential for an operational error, the capital efficiency to
be achieved by the industry is likely worth the risk.
In conclusion, smarter regulation of today's equity market
structure will improve investor confidence, encourage
entrepreneurs to access the capital markets, and allow the U.S.
to extend its global leadership. We look forward to working
with the new Congress, the SEC, the Biden Administration, and
all of our stakeholders on these matters. And I thank the
committee for the opportunity to participate today.
[The prepared statement of Mr. Blaugrund can be found on
page 91 of the appendix.]
Chairwoman Waters. Thank you very much. Dr. Bogan, you are
now recognized for 5 minutes to present your oral testimony.
STATEMENT OF VICKI L. BOGAN, ASSOCIATE PROFESSOR, CORNELL
UNIVERSITY
Ms. Bogan. Chairwoman Waters, Ranking Member McHenry, and
distinguished members of the committee, thank you for the
opportunity to provide my views on an important matter that has
been referred to as a gamification of investing. In my remarks,
I will focus on what research tells us about behavioral
influences with regard to retail investing and the ways in
which policies could better protect retail investor interests
while maintaining individuals' access to financial markets.
Research in the area of household finance is clear and
consistent in finding that participating in financial markets
is a pathway to economic mobility and wealth building for
households in the United States. Thus, it is important to
remove barriers that hinder individuals accessing and safely
participating in equity markets. I strongly believe this, as I
have spent more than 20 years studying household finance and
individual investment decision-making behavior. My own research
has shown the importance of reducing market frictions, like
transaction and information costs, to household participation
in equity markets.
The payment for order flow business model used by Robinhood
and other online brokers does, in fact, reduce the significant
market friction that historically inhibited access to financial
markets for retail investors. Specifically, no direct fee per
transaction is a beneficial way in which the barriers to
participation have been lowered. The payment for order flow
model, however, does not mean that there are no transaction
costs for the retail investor. Transaction costs due to bid-ask
spreads remain, but the exact amount of these costs are not
transparent to the investor. The recent GameStop incident has
highlighted several acute financial market functioning issues
related to payment for order flow conflict of interest and
duration of settlement clearing.
However, one critical issue resurfaced during this time
that is not unique to the GameStop incident and has the
potential for long-lasting negative effects on the finances of
households, the gamification of investing. The practice of
financial institutions responsibly serving retail investors
does not start and end with giving lower-cost access to
financial markets. Robinhood CEO, Mr. Tenev, is quoted as
testifying that, ``Robinhood works to give people what they
want in a responsible, accessible way.'' The gamification of
investing, which has been pioneered by Robinhood, is not
responsible because it has the demonstrated ability to harm the
lives of people by creating financial fragility through wealth
erosion. Beyond merely developing a user interface to
facilitate ease of use for retail investors, online brokers
like Robinhood employ powerful behavioral science-based
techniques to influence investor behavior in a particular
direction. These online brokers use prompts, push
notifications, and other nudges for the purpose of eliciting a
specific behavior: increased trading by the investor.
The nudges to increase trading are not based upon a sound
investment strategy for the specific investor, so why are they
used? Given the payment for order flow model, it is in the
firm's best interest to have more trading volume. More volume
equates to more revenue. Thus, the core of these practices
increase from profits while potentially harming customers.
The realm of financial planning rarely supports day trading
strategies for households. Buy and hold is conventional wisdom
for retail investors. While a special few may have the time,
energy, and knowledge to watch the markets with the keen
attention required to practice day trading successfully, most
households have limited quantities of those resources. With or
without direct transaction fees, it is generally not
advantageous for the majority of households to trade multiple
times per day. From the perspective of traditional finance
theory, one could argue that if individuals behave rationally,
they will not trade if it is not in their best interest to do
so. However, a key insight from behavioral science research is
that nudges have strong and powerful effects. Nudges exploit
behavioral biases to trigger specific responses. Knowledge of a
bias is not sufficient to mitigate its effect on one's
behavior, and mistakes are made even when the stakes are high.
Online brokers can be important vehicles for retail investors
to access financial markets.
For the past few years, Robinhood and similar online
platforms have marketed themselves as working to democratize
finance for all. However, this narrative does not ring true.
This rhetoric detracts from the reality that these firms are
reinforcing the status quo by converting customer orders into
the actual products that are being sold. The customers of these
payments for order flow online brokers are, in fact, market
makers, like Citadel Securities. Hence, it is imperative for
the retail investors to be provided more protection through
regulation. There is a significant opportunity for more
consumer safeguards governing online broker app user interfaces
and enhance regulation around fee transparencies.
Improving and strengthening customer financial protection
laws and regulations is as critical to facilitating economic
mobility as accessing the markets themselves. Thank you.
[The prepared statement of Dr. Bogan can be found on page
95 of the appendix.]
Chairwoman Waters. Thank you very much. Ms. Goldstein, you
are now recognized for 5 minutes to present your oral
testimony.
STATEMENT OF ALEXIS GOLDSTEIN, SENIOR POLICY ANALYST, AMERICANS
FOR FINANCIAL REFORM
Ms. Goldstein. Chairwoman Waters, Ranking Member McHenry,
and distinguished members of the committee, thank you for
inviting me to testify today. My name is Alexis Goldstein, and
I am senior policy analyst at Americans for Financial Reform.
Previously, I spent many years on Wall Street, first as a
programmer at Morgan Stanley in electronic trading, and then as
a business analyst at Merrill Lynch and Deutsche Bank in equity
derivatives. There, I worked primarily as a product manager for
the trading and risk management software that was used globally
by our equity options flow trading desks.
I want to start by thanking Chairwoman Waters for her
leadership in convening the very first congressional
exploration of the issues raised by the volatility in GameStop
equities last month. Many have framed the GameStop mania as a
David versus Goliath struggle. I believe it is more likely a
story about Goliath versus Goliath, where the Goliaths are the
largest Wall Street players, including hedge funds and the flow
trading desks at major banks like Goldman Sachs and Morgan
Stanley. Institutional players have structural advantages over
retail traders: superior data; high-frequency trading
algorithms; and access to trading venues not available to
retail clients.
GameStop's 1,700-percent price run was not the end of Wall
Street's dominance. In fact, it may be a source of major first
quarter profits at large banks with flow trading desks. The
derivatives trading desk that I used to work with took in the
biggest profits on the most volatile days, and that is because
they are mostly agnostic to price movements. They often profit
on market churn rather than on the traditional ways that retail
investors make money, by buying and holding. My time on Wall
Street showed me that institutional players ferociously guard
information about their positions while spending large sums of
money and time trying to figure out what their competitors are
holding. Thousands of Reddit users posting their positions
online is another data point for Wall Street players who are
already creating software to extract and mine it for
information.
It is understandable why a narrative of David versus
Goliath emerged at this moment. Wall Street profits have been
soaring during the pandemic while Main Street has endured
intense and prolonged suffering in a phenomenon that has been
called a K-shaped recovery. In November, 10.7 million workers
were officially unemployed. A disproportionate burden of the
impact of the pandemic has fallen on Black and Brown Americans.
Latinx Americans have faced large losses in employment, and
White workers are getting hired back twice as fast as Black
workers. Given the extreme imbalances in the economy, it makes
sense that the media and the public might be drawn to a story
of the little guy taking down Wall Street, but GameStop shines
a spotlight on issues in the market that long predate this
incident.
Policymakers should focus on examining the footprint of
institutional players in the volatility, investigate if large
hedge funds are creating undue risks and regulatory blind
spots, improve hedge fund trading disclosures, scrutinize
payment for order flow, and consider changes to capital
requirements at brokerages. In the wake of the 2008 crisis,
playing the lottery increased among people who were still
struggling financially. Reddit and Robinhood are driving a new
kind of financial lottery: trading cheap options that require
giant price moves to become profitable. I, myself, have used
Robinhood. I found it to be very streamlined. It has a slick
user interface, but that simplicity has a downside: It provides
its users with far less context and information compared with
other retail brokerages.
The way to truly rebalance the economy is not to
democratize the Wall Street casino, but instead to invest in
rebuilding public institutions. Canceling Federal student loan
debt, which President Biden can do without Congress, would grow
the economy, relieve the disproportionate debt burdens carried
by Black and Brown borrowers, and incentivize science and
engineering graduates to consider careers benefiting the public
good rather than writing algorithms to optimize trading. A
modest wealth tax could be redirected to priorities like
universal child care or tuition-free education, and a very
small financial transaction tax could fund investments in
reducing the racial wealth gap through programs like baby
bonds.
I also want to flag that while this committee, under
previous leadership, has advocated for vastly expanding the
definition of, ``accredited investors'', they have also voted
to limit the oversight tools and the budget of the Securities
and Exchange Commission, essentially making retail investors
sitting ducks for powerful special interests. Trying to
democratize the zero-sum game of trading is not the answer to
our dire economic state. Instead, the country needs
transformational policies that tackle the deep inequalities the
pandemic has exacerbated.
Thank you very much, and I look forward to your questions.
[The prepared statement of Ms. Goldstein can be found on
page 102 of the appendix.]
Chairwoman Waters. Thank you very much, Ms. Goldstein. Mr.
Kelleher, you are now recognized for 5 minutes to present your
oral testimony.
STATEMENT OF DENNIS M. KELLEHER, CO-FOUNDER, PRESIDENT, AND
CHIEF EXECUTIVE OFFICER OF BETTER MARKETS
Mr. Kelleher. Good morning, Chairwoman Waters, Ranking
Member McHenry, and members of the committee. Thank you for
holding this important hearing, and for the invitation to
Better Markets to testify.
We have already heard many of the market structure and
regulatory issues addressed by this hearing are complex, hotly
disputed, and often difficult to understand, but it is
important to remember that they directly affect the economic
activity and growth of the country. In fact, these issues
actually impact how businesses form, grow, and create jobs or
not, and that is what is really at stake and why everyone has a
stake in these issues. Simply put, the purposes of our
financial system and markets are supposed to be a wealth
creation system for the many, not a wealth extraction mechanism
for the few, and that is why the work of this committee is so
important to the lives and livelihoods of all Americans.
However, because of the limited time and the format for
hearings like this, many of those issues won't be able to be
adequately covered today, and that is why the written testimony
I have submitted is so long. It covers many of the issues
extensively and in detail. It is intended to be a resource to
you and your staffs long after this hearing.
While all of that written testimony is, of course,
fascinating and well worth reading, I want to draw your
attention in particular to the attached Appendix C. That
appendix has seven slides that I created to visually show how
payment for order flow works and how retail investors do not
get best execution. Indeed, as I show in those slides, retail
investors are virtually guaranteed to get the worst execution.
That written testimony and those slides demonstrate that the
markets are not a level playing field. They are rigged to
advantage the sell side against retail investors, pension
funds, and the buy side generally. But these markets are too
often a wealth extraction mechanism to enrich the few at the
expense of the many. That is detailed in my written testimony.
I want to make just two quick points before my time is up.
First, our markets may be the envy of the world today, but that
is not preordained, guaranteed, or destined to always be the
case. It is only because people believe our markets are
relatively transparent, well-regulated, and policed. That is
due to the hard work of legislators like yourselves and
regulators like the SEC. That work has engendered faith and
confidence that our markets are fair and relatively free of
fraud. That confidence underpins our markets. Lose that, and
our markets will not function. If they don't function, then our
economy will be hurt. Jobs, growth, and living standards are at
stake. That, unfortunately, is the precipice we currently stand
on.
While the world may be envious of our markets, poll after
poll shows many Americans are losing faith and confidence in
our markets, and that is why the many issues raised by the
GameStop frenzy are so important. If not properly addressed,
they will happen again, and if they do, they will crush
investor confidence, then our markets, and then our economy.
Remember, a growing, thriving economy is the very purpose of
the markets, capital allocation and formation to fuel economic
growth, rising living standards, decreasing inequality, and
making the American Dream available to more people. That
requires a level playing field, full and fair price discovery,
and serious investor protection. Anything that interferes with
that erodes investor confidence and should be eliminated. That
is why payment for order flow and the many other wealth
extraction activities and conflicts of interest revealed and
highlighted by the GameStop frenzy have to go.
Second and finally, Congress must remain deeply skeptical
of the disingenuous argument that retail investors have never
had it so good. While that is arguably true, it is not
attributable to payment for order flow. The actual causes of
increased market access and narrowing spreads over the last 25
years are due to technological innovations, cost reductions,
the introduction of electronic trading, the implementation of
decimalization, and other elements of the regulation MNS
framework. In fact, without payment for order flow and the
other intentionally-created complexity used to disguise the
wealth extraction activities, retail investors would be
significantly better off today, and investors and public
confidence would be higher. That could be the foundation for a
virtuous cycle where more people invest, more capital is
available, more businesses are formed and funded, more jobs are
created, and economic growth increases and broadens,
benefitting all Americans. That is our collective goal.
Thank you, and I look forward to your questions.
[The prepared statement of Mr. Kelleher can be found on
page 117 of the appendix.]
Chairwoman Waters. Thank you very much, Mr. Kelleher. Mr.
Grujic, you are now recognized for 5 minutes to present your
oral testimony.
STATEMENT OF ALAN GRUJIC, CEO, ALL OF US FINANCIAL
Mr. Grujic. Thank you. Good morning, Chairwoman Waters,
Ranking Member McHenry, and distinguished members of the
committee. My name is Alan Grujic. I am founder and CEO of All
of Us Financial, a new San Francisco-based online broker
launched in May 2020, and on a mission to empower retail
investors. Thank you for the opportunity to add to this
important discussion regarding January's unprecedented activity
in GameStop and the associated lessons learned from an
entrepreneurial perspective.
Let me start by saying that I have learned from decades of
direct practitioner experience that most of the choices before
us involve tradeoffs. Most have both costs and benefits and
must be considered in that silver light. I am an engineer by
training, but my career has been in capital markets. For a
decade, I worked for Toronto Dominion Bank across the globe,
and in 2002, I co-founded a high-frequency trading firm,
Infinium, and in 2011, I built and ran a quantitative hedge
fund, Galiam. After looking at market issues from all of these
angles, I found that no one was properly solving a critically
important problem, which is leveling the playing field for
retail investors. Retail investors don't have the same tools as
large institutions, and underperform the broader markets over
time. I decided to apply my experience to try to address this
critical societal need. The narrative that markets are rigged
and that big institutions steal from little girls and guys out
there is mostly not correct. That narrative exploits fear and
reduces rich complexity to a simple fairy tale: find a victim,
finger the villain, promote a hero.
We don't live in Sherwood Forest. Our markets are well-
structured, highly competitive, and expertly regulated. There
is plenty of room for improvement, no doubt, particularly as we
adapt to an ever-changing world. One needed improvement is to
deliver institutional-grade capabilities to reach all
investors, including in the areas of data, knowledge, access,
and influence, and that is our mission at All of Us. Let me be
clear that we currently are pay for order flow (PFOF) at All of
Us, and because we believe in radical transparency and
alignment, unlike some other brokers, we share this revenue
with our customers. We believe this aligns our interests with
our customers, and it helps educate them about how markets
work.
Some view disclosure as a point-in-time regulatory
requirement. We take the view that transparency is a real-time
foundation for our entire business. PFOF is not a necessary
component of our market structure, but it is an effective way
for markets to operate and should not be banned without careful
consideration of its costs and benefits. Importantly,
regulation requires all market makers to trade with customers
at or better than best prices available on exchanges, and there
is a comprehensive execution audit trail for brokers and
regulators to monitor.
As we consider PFOF in this light, there are some truths to
consider. First, market makers and exchanges all provide
valuable services and need to be paid for them. Market makers
provide liquidity, price discovery, and critical customer
services. Exchanges provide, among other things, order matching
and settlement services. These services cannot be provided for
free.
Second, market makers are indifferent between PFOF and
price improvement, because that price for them is the same.
Brokers care, however. They also need to be paid for providing
services in a highly-competitive environment. If we prohibit
PFOF, commissions will likely increase, and valuable retail
innovations, such as fractional shares, may become
uneconomical.
Finally, some claim separating retail institutional flow
harms retail investors. In fact, because market makers' value
is thought of more highly than institutional flow, if we force
them into the same market structure--and this is important--the
average price received will be worse for retail orders and
better for institutional orders than it is today.
In terms of gamification and social investing, social media
platforms and gamification are powerful forces, and, like most
implements, can be used for both good and bad purposes. But
society is evolving, and younger generations want products and
services delivered via social media. Good gamification and
social investing can drive financial literacy and education,
and encourage healthy behaviors, such as regular savings and
investment, and that is a standard we hold ourselves to at All
of Us. Brokerage is highly competitive, and innovations in
social investing will continue to emerge. The right regulatory
balance is to encourage innovation for the benefit of retail
investors while ensuring investor protection. Our markets can
be a wonderful means for Americans to invest and build wealth,
but as the GameStop activity shows, our markets can be
improved, and efforts to educate and improve the experience of
retail investors are critical as markets become increasingly
accessible and more and more people invest for the first time.
I appreciate this opportunity to appear before the
committee today. I look forward to answering your questions
from an entrepreneurial perspective at the appropriate time.
Thank you.
[The prepared statement of Mr. Grujic can be found on page
112 of the appendix.]
Chairwoman Waters. Thank you, Mr. Grujic. And Mr. Piwowar,
you are now recognized for 5 minutes.
STATEMENT OF THE HONORABLE MICHAEL S. PIWOWAR, EXECUTIVE
DIRECTOR, MILKEN INSTITUTE CENTER FOR FINANCIAL MARKETS
Mr. Piwowar. Good morning. Thank you, Chairwoman Waters,
Ranking Member McHenry, and members of the committee, for
inviting me to testify today. My name is Mike Piwowar, and I am
the executive director of the Milken Institute Center for
Financial Markets. Previously, I had the pleasure of serving as
a visiting academic scholar, senior financial economist,
Commissioner, and acting Chairman of the Securities and
Exchange Commission.
Thank you for calling this second hearing on the lessons
learned from the trading activity in GameStop and other so-
called meme stocks. In the first hearing, members of this
committee identified a number of issues that the SEC could
prioritize in its regulatory compliance and enforcement roles.
I hope that my testimony today will be helpful in guiding some
of those priorities.
The Commission has already said that they are reviewing
actions taken by regulated entities to determine whether they
may have disadvantaged investors or otherwise unduly inhibited
their ability to trade certain securities. The SEC's Division
of Examinations has said that one of their 2021 examination
priorities will be to examine broker-dealers to assess whether
they are meeting their legal and compliance obligations when
providing retail customers access to complex strategies, such
as options trading, and the Commission has said they are
investigating whether abusive or manipulative trading activity
prohibited by the Federal securities laws occurred during this
episode.
I have complete confidence that the Commission and its
compliance and enforcement staff will identify and pursue any
evidence of noncompliance or wrongdoing. Accordingly, I will
focus my testimony on the regulatory policy issues that have
been raised in the aftermath of the January trading. The first
part of my testimony focuses on achieving more equitable access
to investing in private companies. The second part focuses on
improving three specific areas of market structure and market
infrastructure policy.
Here is a quick summary. Retail investors enjoy more
choices and face lower costs when investing their hard-earned
savings in public companies than ever before. Retail investors
have taken advantage of these beneficial trends over the past
few decades. The fraction of U.S. households that own stocks,
either directly or indirectly through funds and retirement
savings accounts and pension funds, increased from less than
one-third in 1989 to more than one-half in 2019. Low-income
households saw the biggest gains over this period, but they
still lag high-income households in public stock ownership
rates. In 2019, 15 percent of households in the lowest-income
quintile held stocks in public companies compared to 88 percent
of households in the highest income quintile.
While I am not aware of any statistics on ownership rates
by household income level for private companies, the gap is
undoubtedly worse, because SEC rules currently effectively
prohibit low-income investors from investing in this high-
growth sector of the economy. Accordingly, I believe the SEC
should revisit the, ``accredited investor'' definition, and
solicit public feedback on achieving more equitable access to
investing in private companies across all income levels. Based
on that feedback, the SEC should engage in rulemaking to open
up these investment opportunities to all Americans.
I also recommend that the SEC should: one, evaluate whether
and how to move to a shorter trade settlement cycle; two, study
how payment for order flow is working in a zero-commission
environment with a focus on order routing and best execution
requirements; and three, evaluate various alternatives to
increase regulatory reporting and public transparency in
securities lending. My written testimony provides an in-depth
discussion of each of these issues, and I am happy to answer
any questions you may have.
Thank you again for bringing attention to these critical
issues and for the opportunity to testify before you here
today.
[The prepared statement of Dr. Piwowar can be found on page
162 of the appendix.]
Chairwoman Waters. Thank you very much, Mr. Piwowar. I now
recognize myself for 5 minutes for questions.
Last month, the committee reviewed the actions of various
market participants surrounding the volatile trading in
GameStop and other stocks. We discussed how Robinhood, which
caters to retail investors, earns nearly all of its revenue
from selling its customers' orders to firms like Citadel,
raising questions about who really is Robinhood's customer.
Robinhood claims it does its customers a service because it
doesn't charge any commissions, but it costs its customers more
than $34 million last year, and Robinhood paid $65 million to
settle an enforcement action related to selling its customer
stock orders. I understand the allure of Robinhood. When I
first learned about Robinhood, I thought it showed great
promise.
Ms. Goldstein, payment for order flow, which was pioneered
by the fraudster, Bernie Madoff, allows brokers like Robinhood
to make huge profits by routing their customers' orders to
market makers like Citadel, instead of sending them directly to
an exchange, like the New York Stock Exchange, even if it means
brokers won't obtain the most favorable trading terms for
investors. Can you please explain whether you think these
disturbing conflicts can ever be truly mitigated in such a way
that guarantee brokers and other market participants are acting
in the best interests of their customers?
Ms. Goldstein. Chairwoman Waters, thank you for the
question, and thank you for holding this hearing today. If we
look back to 2016 and the Obama Administration, the Securities
and Exchange Commission wrote a memo to its Equity Market
Structure Advisory Committee, and it identified a series of
potential conflicts with payment for order flow. They thought
it might interfere with a broker's duty to receive best
execution for their customers. They thought it might create
perverse incentives for them to route their orders to market
makers instead of to exchanges, and they identified that it
may, in fact, be obscuring the true cost that customers are
paying for their order flow.
I liken it, sort of, to Facebook. If you are not paying for
something, that often means that you yourself are the product,
and Robinhood, many years ago, made upwards of 80 percent of
their revenue from payment for order flow. In that SEC
enforcement action that you identified, they pointed out that
they hid that information from their customers after the
publication of the best-selling book, ``Flash Boys'', made
payment for order flow somewhat unpopular. They took it off of
their frequently-asked questions page.
So, I do think that the Securities and Exchange Commission
should revisit all of those questions that they had previously
in 2016 in the Obama Administration. They should ask, should
this practice be prohibited? Is it too confusing? Does it mask
the true cost of the trade, or should brokers be required to
pass these payments on to their customers, which could be
another way to address the problem?
Chairwoman Waters. Thank you. You indicated that you had at
some point been involved with Robinhood, that you had done some
trading, and that is how you became very knowledgeable about
how they operate. Could you tell us what that experience was?
Ms. Goldstein. I would be happy to, Congresswoman. I have
used Robinhood. I have also used a number of other brokerages.
I was, quite frankly, very shocked at how quickly I was able to
get set up for trading on Robinhood. I have a lot of expertise
in options because I have a history of working with options
trading desks on Wall Street, but even with that expertise, it
is usually much slower when I have tried to use other
brokerages to get permission to trade in certain kinds of
options tradings, like what are known as option spreads, but in
Robinhood, there was no friction. I did not have to fill out
any kind of complicated forms. I was honestly quite surprised
at how easy it was, and I do think that the folks who have
criticized Robinhood for the gamification of it, there is
something behind that.
When you place your first trade, this confetti bursts on
your screen. There are lots of recommendations about the
products you trade. It says, oh, you traded this, so you might
be interested in this other company. So, I do think there are a
lot of questions about the ways that Robinhood may be enticing
people who may not have the needed expertise to trade, for
example, options strategies, where you can lose a lot of money
called spreads, put spreads. So I was, quite frankly, pretty
surprised at how different it was from other brokerages,
especially when it came to how much outstanding risk I had. I
think it is very simplified, and that is often cited as a
benefit, but it is simplified in a way that can be very
dangerous if people don't understand their risk.
Chairwoman Waters. I thank you very much for the testimony.
I now recognize the distinguished ranking member, Mr. McHenry,
for 5 minutes for questions.
Mr. McHenry. Thank you, Madam Chairwoman. Mr. Piwowar, I
would like to actually go to you, and I just want to take a
step back and look at the evolution of retail investing over
the last decade or so and the impact of rules prohibiting
everyday investors from investing in high-tech, high-growth, or
a number of segments of our economy that are currently
prohibited. What was the rationale behind the rules, and what
impact did the prohibition have on investors and investment
opportunities, the accredited investor standard in particular?
Mr. Piwowar. Thank you, Congressman McHenry, for that
question. The original rationale for this rule was quite well-
intended. It was an investor protection rule, and the idea was
that it would protect investors from investing in riskier
securities. Now, I question the premise of that as an
economist. I am only the third Ph.D. economist to be a
Commissioner at the SEC. Most of the SEC Commissioners and
staffers there are lawyers, and they tend to think of the risk
of securities in isolation, the risk of any particular
security.
But when I look at it through the lens of an economist,
what we know is that individual retail investors and
institutional investors don't hold securities in isolation.
They hold portfolios of securities. And so, once I apply the
principles of economics to this, you can add riskier securities
to your portfolio, which, as you point out, also tend to be
higher-growth, and higher-expected returns to your portfolio
without increasing the overall risk that you are facing within
the markets. And what you are essentially doing is limiting the
upside of these individual portfolios.
Mr. McHenry. Does that have any impact on inequality? Does
that exacerbate inequality?
Mr. Piwowar. Absolutely. We know that younger companies
tend to be higher growth, and so what we have seen over the
long term is, over the last 20 years, we have had about half as
many public companies as we did about 20 years ago. And so, by
limiting non-accredited investors to that public company
universe, we are limiting them to a smaller portfolio of
securities, right? We know that there are fewer companies that
are going public at all. We also see in the trend that growing
companies are going public later in their life, so when they do
finally become public, a lot of the growth opportunities to
invest in them have gone by the wayside. And individual,
retail, non-accredited investors didn't get the opportunity to
invest in those companies during that growth cycle, whereas
accredited investors have had that opportunity, which by the
definition of, ``accredited investor'', is somebody who is
already rich, so the rich get richer.
Mr. McHenry. It sounds like this dual track system is
outdated and the rationale is outdated. Mr. Grujic, let's go to
you. Technology platforms like yours are attempting to
democratize investor access to public markets, making it
easier, and we have seen this move over the last really 50
years in this country, attracting a whole new class of
investors, but that has been heightened because of technology,
obviously. Do you think that FinTech could be similarly useful
to everyday investors if they were able to access early-stage
investment opportunities?
Mr. Grujic. Yes, absolutely, and there are a lot of
platforms now. The crowdfunding platforms that are opening up
in this space and the recent regulations, I think, are very
helpful with changes to the regulations to open up this space.
I also concur that the accredited investor rules are outdated.
I have always been very uncomfortable with them. The concept
that we don't have equal rights as citizens to participate in
investments has always troubled me. I do actively participate
in the markets as an accredited investor. I invested in
Facebook before it went public. I have invested in other
companies. That really should be accessible to everyone. At the
same time, if we are to look for investor protections in this
area, they should come in the form of assessing people's
understanding and ability to make these investments, certainly
not based on their wealth.
Mr. McHenry. Okay. It sounds like we need to update our
system and allow more people access to investment
opportunities. And, Mr. Piwowar, I will just close by saying I
agree with your assessment that payment for order flow and
given the regulation of our market structure as it is, they are
only tradeoffs. There is no simple win-win. We need good
disclosures, but it is all a series of tradeoffs. So, I yield
back. Thank you.
Chairwoman Waters. Thank you very much. The gentlewoman
from New York, Ms. Velazquez, who is also the Chair of the
House Committee on Small Business, is now recognized for 5
minutes.
Ms. Velazquez. Thank you, Madam Chairwoman. Mr. Kelleher,
Robinhood seems to have perfected the gamification of trading,
providing the user with the perception that investing through
the app offers recreational game playing with little or no
downside risk. First, are you concerned with the gamification
of the Robinhood app, and second, do you believe Robinhood's
disclosures are properly balancing the potential downside risk
of investing, including the risk of substantial loss, and the
more enticing claims of profitability, and the ease of trading?
Mr. Kelleher. Thank you for your question, and, yes, we
should all be concerned about the gamification of the Robinhood
app. Its primary function is not to get people to invest; it is
to get people to trade. And it wants people to trade because
the more people trade, the more payment for order flow it
receives, the more revenue it gets, the richer they get, and
the bigger the IPO that they have in the pipeline coming. That
is what gamification is about. And Professor Bogan has very
well stated the academic literature about so many aspects of
the app driving people to thoughtlessly engage in trading
rather than thoughtfully engage in trading.
One of the big problems we have here is, unlike Mr.
Piwowar, we do not have Ph.D. economists applying economic
principles here. We have a game-like mechanism that is meant to
actually cause people to drop their defenses, to not think at
all about losses and risks, and to only think about gains and
trading, and everybody should worry about that.
Ms. Velazquez. As we consider issues associated with
gamification, what type of reforms would you recommend?
Mr. Kelleher. I think one thing that should be done, and
Professor Bogan, again, has talked about this, is the aspects
of these apps that actually are scientifically designed to hit
the endorphins of the trader, which is to say, to short circuit
and cut off thoughtful processes that people engage in,
balancing risks and rewards, balancing the need to do something
versus the reflex to do something because something unconscious
has been engaged.
And indeed, as Sal Arnuk showed in his testimony, if you
look at the other platforms, they actually thoughtfully present
material on, for example, options and the risks of options. You
don't see that on the Robinhood app. And indeed, on the
Robinhood app, one of the most often-asked questions, according
to an article I read on the app, is, ``What is a stock?''
Another frequently asked question is, ``What is the S&P 500?''
So, you have a base of customers with extremely low knowledge,
who are being intentionally activated unconsciously to trade
more and more often for the sole purpose of enriching
Robinhood.
Ms. Velazquez. Thank you. Mr. Kelleher, during last month's
hearing, I also brought up the important issue of short
selling. While I said at the time, and continue to understand
that short selling has legitimate purposes, I also said that
too often, I have seen the strategy used against working
individuals and families, first, against Puerto Rico, and now
here with the GameStop craze. Currently, large investors,
including hedge funds, must disclose their long positions when
they own 5 percent or more of a company's share, but no such
disclosure is required for short positions. As we consider
reform, is this type of disclosure for short position something
you will support?
Mr. Kelleher. There absolutely should be greater disclosure
for short positions, both on the institutional investor side
and on the broker-dealer side, and that disclosure should be
increased in terms of frequency and particularly in terms of
content. There is a great deal of synthetic shorting happening
in these markets with total return swaps and other synthetic
products that actually disguise and understate what we even now
publicly know. So, across-the-board, in terms of the actual
entities, in terms of the timing, and in terms of the content,
disclosure should be increased, and it should actually be
pretty well-studied. But regardless of the outcome of that
study, we need more information to the market so that people
can act in a more informed manner.
Ms. Velazquez. Thank you, Mr. Kelleher. And thank you,
Madam Chairwoman. I yield back.
Chairwoman Waters. The gentlewoman from Missouri, Mrs.
Wagner, is now recognized for 5 minutes.
Mrs. Wagner. Thank you, Madam Chairwoman. This is a
question for both Mr. Grujic and Mr. Piwowar. Just briefly, are
there any regulatory barriers to help facilitate increased
access for everyday investors that you see, that we in Congress
could work on removing? Mr. Grujic?
Mr. Grujic. Yes, there certainly are. As I stated in my
opening statement, I think we always have tradeoffs, and so
there are always ongoing frictions where regulations exist, and
sometimes the benefit exceeds the cost. In particular, the ones
that trouble me are the credit investor rules we just touched
on. While not my area of professional expertise, I really feel
that that is highly limiting to the opportunity set for retail
investors. I also think that over the next decade or two,
expansion in private markets is going to be a greater
opportunity for retail investors than public markets, and I
emphasize that that is an area that perhaps is the most
important.
Mrs. Wagner. Great. Mr. Piwowar?
Mr. Piwowar. Thank you, Congresswoman Wagner. I agree with
Mr. Grujic about revisiting the accredited investor definition.
That is the most direct way that the SEC could deal with it.
There are a couple of indirect ways also, if people are still
uncomfortable with investors investing in [inaudible] in a
private company, there is a way to address this indirectly.
Congressman Anthony Gonzalez had a bill last Congress that
would open up the ability of closed-end funds to invest in
private funds that invest in private companies. I think closed-
end funds--a particular type of them are called interval
funds--would be a particularly useful investment vehicle, and
then people would have comfort that the investor would be
protected through a regulated investment advisor. And there are
a number of other things that the Commission could do along
those lines, so they could do it directly and indirectly.
Mrs. Wagner. Thank you. Mr. Grujic, if payment for order
flow were to be banned, how would that impact the commission-
free trading that millions of Main Street investors, who are
currently benefiting from it in order to save for retirement,
buy their first home, or pay for their child's education--how
would that be impacted?
Mr. Grujic. These things are always somewhat indeterminate.
It depends on the innovation that occurs around the changes
that happen. My expectation is that with brokers needing a
return, commissions would return. The problem with commissions
in their former implementation is that they also have the same
misalignment issues of trying to promote more trading
correlated with higher revenues for brokers before there was
any payment for order flow. So, this highlighting of payment
for order flow is tapping that misalignment issue. It is really
not any different from what the State was before payment for
order flow in terms of that aspect.
The things that worry me about reinstituting those
commissions are that there are two things that are less optimal
about fixed commissions. First, they don't reflect the true
economic value of the underlying trade, so if a large trade and
a small trade both build the same fee, that is not an
economically-sound approach.
Second, I believe fractional shares, which haven't gotten a
lot of discussion here, are extremely important and valuable to
retail investors. We talk about giving smaller investors access
to markets, but we have securities that trade at very high
prices. How do we expect those investors to be able to buy an
Amazon or another high-price stock?
And one way that we can do that is we can offer fractional
shares and we do, and as an industry, we have made great
strides there. That also allows a retail investor, even with a
small portfolio, to rebalance it in ways that are optimal. And
so I also worry whether fractional shares would become
uneconomical if we removed payment for order flow.
Mrs. Wagner. Interesting. Mr. Piwowar, is it possible for
payment for order flow to be aligned with the SEC's best
execution requirements for broker-dealers when routing orders
for retail investors?
Mr. Piwowar. Yes, absolutely, and Mr. Grujic brings up
excellent points about how payment for order flow can't be
looked at in isolation. You need to look at unintended effects
of banning it. In fact, the SEC enforces its best execution
obligations all the time and is continually looking at these
issues. And, in fact, as I pointed out in my opening remarks,
one of the exam priorities for the Division of Examinations at
the SEC is going to be looking to make sure that brokers are
fulfilling their best execution requirements. And as Mr. Grujic
points out, in the commission-based world, you just have a
different type of time.
Mrs. Wagner. Thank you. My time has expired, and I yield
back, Madam Chairwoman.
Chairwoman Waters. Thank you. The gentleman from
California, Mr. Sherman, who is also the Chair of our
Subcommittee on Investor Protection, Entrepreneurship, and
Capital Markets, is now recognized for 5 minutes.
Mr. Sherman. American wages are too low. Those opposed to
unionization, progressive taxation, and other efforts to put
money in the hands of working families have a solution: Tell
working families to go play the stock market every day, every
hour, and if you don't get rich, if you can't get by, don't
demand higher wages because it is really your fault. You are a
bad day trader, which is the same as being a bad person.
Casinos and lotteries pay high taxes. Real investment in
equities finances our economy. It is hard to see how day
trading has any ascertainable social benefit.
I want to commend Dr. Bogan for pointing out that zero
commissions does not mean zero cost to investors. It is correct
that it just means zero disclosed costs. The main cost is the
spread, the difference between the bid and the ask. And the
gamification drives you to this, but also the illusion that
Robinhood is able to create that there is no cost to you
because there is no commission, and Dr. Bogan points out the
gamification, the nudges, the confetti. And I just want to say
that if you want an exciting video interface, go to GameStop
and buy a video game. It is not a reason to go to Robinhood and
buy GameStop.
Mr. Kelleher, thank you for pointing out that just saying
investors have never had it so good is hardly an answer. I am
not going to send a love letter to T-Mobile because my phone is
cheaper and better than it was 20 years ago. I expect to get
the lion's share of the benefits of technology. During the last
hearing we had on this subject, I asked the CEO of Citadel, Ken
Griffin, whether the customers of Robinhood get the same trade
execution quality as customers of Fidelity, a broker that does
not accept payment for order flow. Mr. Griffin twisted, turned,
filibustered, and did everything to avoid giving me a straight
answer.
That is why I want to commend the CEO of perhaps his
number-one competitor, Virtu Financial, who went on CNBC and
said, ``Overall, though, during the course of a month, we will
provide more price improvement to Fidelity than we do to
Robinhood. Now, of course, Fidelity charges zero commissions
for online trades, but Fidelity does not accept payment for
order flow, so clearly we could have no payment for order flow
and zero commissions. Further, payment for order flow offered
by market makers was banned in the U.K. almost a decade ago,
and their markets continue to function well.''
Is there any reason the U.S. shouldn't take a similar step
of banning any payment to brokers when they are acting as an
agent for directing their order flow? Mr. Kelleher?
Mr. Kelleher. No, Congressman Sherman. Thank you for your
question. It can be banned and it should be banned. It does not
mean that the intermediaries will not be well-compensated. They
will still be well-compensated because they compensate it as a
spread, and what it would do is if you banned payment for order
flow, it would have the additional benefit of driving a lot
more trading to the public markets, which now are less liquid
and have less trading because so much of it is being skimmed
off, about 47 percent.
We detail this in Appendix C of my testimony. Forty-seven
percent of all the trading is flowing into dark, unregulated,
low-investor-protection, non-disclosure markets by these
internalizers, who are using legalized kickbacks and payment
for order flow to retail brokers like Robinhood. And everybody
is getting rich, but that money is coming from somewhere, and
where it is coming from is the pockets of retail investors.
Mr. Sherman. And I will point out that even if I get a good
execution of my trade in one of these dark pools, the country
is deprived of information about that trade that would be
available if we traded on a market.
Mr. Kelleher. Exactly.
Mr. Sherman. I will just also point out that we live in a
strange world where some people get best execution and some get
price improved excess. And I yield back.
Chairwoman Waters. The gentleman from Oklahoma, Mr. Lucas,
is now recognized for 5 minutes.
Mr. Lucas. Thank you, Madam Chairwoman, and I appreciate
the opportunity to hear from our witnesses today. Mr. Piwowar,
the payment for order flow process was in use when you were a
Commissioner at the SEC and well before then. You suggest in
your testimony that the SEC should hold a roundtable to discuss
payment for order flow and its possible effect on order routing
and best execution obligations. Could you explain to us what
factors the SEC might weigh in evaluating if any changes should
be made to the practice of payment for order flow, based on
your experiences?
Mr. Piwowar. Yes, thank you, Congressman, for the question.
What the SEC would do in that case would be to open up a public
forum and to ask for public comment on it. As much as we think
that the agency is staffed with experts, and they certainly
are, the best available information they have is oftentimes
given from market participants and investors. And through that
process, what they would do is lay out all of the alternatives,
ranging from keeping payment for order flow the same, to, on
the other end, banning it and anything in between, either maybe
changing the regulations around it, or improving disclosure
around it.
And then what they would do is, once they have all of those
alternatives on the table, explicitly look through the costs
and benefits of each, and then choose the appropriate
regulatory path forward based upon that. It may end up on one
extreme or the other, it may end up somewhere in the middle, or
it may end up--things have changed as they are. One of the
reasons why I suggested they looked at it now is because the
SEC has not done a deep dive on it since we have entered into a
zero-commission environment. And so, of course, they should be
looking at this in terms of how the market technologies change.
Mr. Lucas. Mr. Grujic, you explained in your testimony that
separating retail and institutional investment flows largely
benefits the retail investor. Could you elaborate on why the
retail investor would be worse off if both retail and
institutional investors receive the same average price?
Mr. Grujic. Yes, I would be happy to. On the one hand,
retail flow is much more benign to market makers because of its
characteristics. It tends to be smaller orders. They tend to be
more dispersed. They tend to be less correlated. There have
been some experiences with social media, and gamification, and
Reddit that have caused the behavior to be more clumpy. But
generally speaking, market makers love payment for overflow, on
the one hand, because of how it is unsystematic and small. On
the other hand, it has been stated, and I want to speak to
this, that it is dump flow, and that is why they make more
money on it.
The reality is that investors do need to be educated and do
need to make better and better investment decisions, but their
orders will still be smaller, and because they are a larger
constituent of people, there will be more diversity amongst
that order flow, and institutional flow is very different.
Institutional flow is often sliced up, and big flows that
happen in small pieces are very adversarial to a market maker.
When I ran high-frequency trading, we could not get access
to market makers. We had to go directly to the exchanges. They
did not want our flow because they knew that it had certain
characteristics to it that were undesirable. Those undesirable
characteristics are sometimes just size. Very, very large
institutional orders will continue to move markets, and it is
very hard for a market maker who needs to buy and sell to be
able to handle those sorts of risks.
Finally, one thing that payment for order flow does, and it
works very well in a retail context, is it decreases the amount
of time that a market maker is holding risk in their inventory.
So when a market maker tries to make a bid-offer spread, one of
the things that is not appreciated about why a market maker
wants to pay for order flow is they want to find a larger
chance that an order will offset one they have already put into
their books. And so for all of these reasons, when you take a
look at and run mathematical models, you find that the retail
flow is easier to make money on than the institutional flow.
And if we combine them by definition, mathematically, the
average price will get worse for retail and better for
institution?
Mr. Lucas. Mr. Blaugrund, in your testimony, you advocate
for the SEC to develop a system for publishing the quantity,
duration, and other terms for each stock loan. Could you
explain how this would benefit the securities lending market?
Mr. Blaugrund. Thank you for the question. The concerns
that are raised around short selling need to go upstream
further and understand that short positions are established
with a stock loan, and right now, it is an entirely opaque part
of the ecosystem. The Dodd-Frank Act asked the SEC to
promulgate rules in this space. We think they have the
authority to do so, and it would benefit investors and issuers.
Mr. Lucas. I yield back, Madam Chairwoman. Thank you for
the indulgence.
Chairwoman Waters. Thank you very much. The gentleman from
Georgia, Mr. Scott, who is also the Chair of the House
Agriculture Committee, is now recognized for 5 minutes.
Mr. Scott. Thank you very much, Madam Chairwoman. Ladies
and gentlemen, there are great dangers to our financial
services system when non-financial, non-verified information
posted on social media platforms has more market influence than
what is disclosed through our regulated process. And we on this
Financial Services Committee have spent years debating the
standard of care for financial advisors, for broker-dealers,
and for investment advisors. It was a suitability standard for
the financial advisors, and then there was a movement for a
fiduciary standard, and then the SEC came out with the best
interest standard.
Now, regardless of where any of us on this Financial
Services Committee stand, Democrats or Republicans, with regard
to best interest versus fiduciary, we all agree that there
should be some sort of standard, which leads me to this current
situation we are in today. Where is the standard of care as it
applies to Robinhood? This is not the first time that
Robinhood, a broker-dealer, whose stated mission is to
democratize our financial system, has failed to provide
critical protection to its investors, who have suffered greatly
as a result. For example, what standard of care is present when
an inexperienced trader can take out $30,000 in a home equity
loan to make a very speculative trade?
How, under standards of care, is this allowed? Should
Robinhood question the source of funds when consumers are
borrowing money on their credit cards to speculate on risky
trades? Should those who post on Reddit or other social media
sites be required to close when they stand to benefit from
encouraging others to buy stock and drive up the price? Should
the social media sites themselves be held to some kind of
standard when investment advice is posted on their platforms?
Obviously, Dr. Bogan, these are rhetorical questions, and I
don't expect everybody on the panel to have time to answer, but
here is my point. My point remains that there is a huge hole in
our regulatory structure when we are dealing with individual
investors using platforms like Robinhood to trade stocks and
options, and are relying on sites like Reddit for investment
advice and ideas. Is it simply because the platform is
considered high-tech that traditional rules put in place to
protect the investors do not apply? I think, absolutely not.
Dr. Bogan, please give me your thoughts on this predicament
that we are in?
Ms. Bogan. I will say that you make a very interesting
point about the need for thinking about consumer protections,
and I think a primary issue that we need to think about is the
utilization of these behavioral science techniques to encourage
users to trade in a particular direction, and these are new.
This is kind of cutting-edge behavioral economics and
behavioral finance, and we are just now understanding the power
of it. So, I think that it is critically important to regulate
and understand these user interfaces where behavioral biases
are being exploited.
And I want to make a couple of points. I want to say that
even knowledge of a bias is insufficient for it to mitigate the
behavior of a particular user, and mistakes are made even when
it is a large dollar type of transaction.
Mr. Scott. Thank you so much.
Chairwoman Waters. Thank you. The gentleman from Florida,
Mr. Posey, is now recognized for 5 minutes.
Mr. Posey. Thank you, Chairwoman Waters and Ranking Member
McHenry, for holding this hearing today. As many of my
colleagues said at our first hearing on GameStop, our focus
should be on an equity market that efficiently allocates
corporate capital investment to the best-performing sectors of
the economy and provides a powerful framework for risk
management to those who take the entrepreneurial risk that
makes our economy the best in the world.
By and large, our stock markets do achieve these goals.
With due credit to the financial regulation that followed the
Great Depression, we need to keep in mind that regulation, like
any activity, can eventually lead to diminishing returns. We
captured the big benefits from rounds of regulation after the
Depression, and more modestly since then, but with the
exception of maintaining vigilance over the ever-present
incentives that the market has to innovate, we should be
restrained in our recourse to regulation. The next round of
regulation could have far fewer benefits than costs. Common
sense must prevail, and trying not to be too redundant, but
bottom line, Mr. Piwowar and Mr. Grujic, what lessons have you
learned so far from GameStop's short squeeze, and what lessons,
if any, should this committee learn?
Mr. Piwowar. Thank you, Congressman, for that question.
This is just another example of lessons that I have learned
throughout my career both in government and in the private
sector is that when anything happens in the market, whether it
is a flash crash on a global finance basis, or the trading
activity here, or the volatility that occurred last March, is
that, to use your words, we need constant vigilance in terms of
innovation in the markets. The SEC has those tools, and those
tools are what is called retrospective review of existing
rules.
So, as you pointed out, there were statutes that gave the
SEC the authority to promulgate rules. The SEC promulgates
rules that work at a particular time, for a particular state of
markets and technologies, and as markets and technologies
change, and as innovators innovate, the SEC, of course, has to
revisit those rules. That is why in the majority of my
recommendations in my testimony, I suggest that the SEC go back
and re-evaluate. When it comes to markets of technologies, it
is particularly [inaudible] all the time. So, that is why the
SEC has to go back and look at their regulations under the
current market.
Mr. Posey. Thank you. And, Mr. Grujic, do you want to weigh
in?
Mr. Grujic. Yes, I would like to add to that that I think,
exactly as we just heard, we have to try to innovate in a
regulatory environment to a changing world, and this isn't just
a social media effect on finance. Social media, the effect on
news, the effect on politics, and the effect on finance is
both, I think, empowering in that it delivers a lot more
ability for people to be heard, and ability for people to hear
alternative views, and for data to be synthesized for their
benefit. There is a tremendous potential data benefit for
people, but we have also seen some real problems. And I think
that is inherent in a societal change that has not yet settled
into some sort of an equilibrium.
It has been on my mind a lot. The Reddit discussions are in
many ways quite worrisome. They create volatility in the
markets, and volatility is generally bad. It creates all kinds
of dislocations. Some of the behaviors are, probably
unintentionally, actually market manipulation. When groups of
people take action just to move a market price, whether it is a
large player or small players, that is undesirable. There isn't
a fundamental reason for doing that. At the same time, these
are people that, 30 years ago, would have had to have gone to
their broker and accepted that the broker knew better, and they
would pay a whole bunch of money talking to that person on the
phone and had no right to execute their own trades.
So the real tradeoff is that to empower people, it also
creates situations where that empowerment can lead to actions
we didn't anticipate. We really need to think this through, but
I believe we need to move forward. I believe the changes we are
seeing are in the right direction. I think we do need to start
to have a balanced view on which of these are bad for markets,
and bad for individuals. The game is cost-benefit. Everything
we do to restrict things always has costs, and we just have to
carefully weigh that against the benefits of how we are going
to handle this new rule.
Mr. Posey. Okay. My time is going to expire in 10 seconds,
so I yield back. Thank you.
Chairwoman Waters. Thank you very much. The gentleman from
Texas, Mr. Green, who is also the Chair of our Subcommittee on
Oversight and Investigations, is now recognized for 5 minutes.
Mr. Green. Thank you very much, Madam Chairwoman, and thank
you ever so much for the hearing. Madam Chairwoman, I would
like to submit for the record an article styled, ``Trading hot
stocks like GameStop seems fun until you look beneath the
surface.'' This can be found at NBCNews.com on their website.
Chairwoman Waters. Without objection, it is so ordered.
Mr. Green. Thank you. I would like to just read some
excerpts, if I may. ``Payments for order flow are banned in
other countries, and some of those countries would include the
United Kingdom, Australia, and Canada.'' I would also like to
call to the attention of Ms. Goldstein the following: ``When a
firm like Citadel executes orders, it also receives valuable
information on the direction of stock it is likely to take.
Market maker firms handling flow get to see unfulfilled orders
from customers at specified prices the market hasn't hit yet.
These include a type of sell order known as a stop-loss that is
triggered at a price below the prevailing market price. Knowing
how many stop-loss orders are awaiting execution and at what
prices signals where the floor is in a stock. It is information
any professional trader would cut.'' And it also goes on to
indicate in this article, ``It is not trade by trade that
matters. It is the aggregate of them all that allows you to
figure out which way the market is going.''
With this said, and understanding that Citadel has a
disciplinary history totaling up fines of $124 million in
recent years for misconduct over a 3-year period, including
trading ahead of customers who were forced to pay $34 million
more for their trades, and over the same period of time,
Citadel realized revenues totaling $13.2 billion--$124 million
paid in disciplinary fines, but Citadel had revenues of $13.2
billion. So, Ms. Goldstein, it looks to me like we can have a
circumstance where taking the risk of getting caught can be
built into your cost of doing business, such that you are
willing to take that risk because of the possibility of having
such great gains. Would you care to comment on this, please,
ma'am?
Ms. Goldstein. Congressman Green, thank you for the
question. I agree with you completely that too often, I think,
violations of the law are treated merely as the cost of doing
business, and I think that there are a number of things that we
could do to avoid that in the future. One of the things that
the regulators could do, for example, is to eliminate no-fault/
no-penalty settlements where they don't require the firm that
they have taken the enforcement action against to admit any
wrongdoing. Another thing, and this is something I believe that
you yourself have looked into in some of your legislation, is
to go after not just firms, but individuals.
One thing you could do, for example, is create an
attestation, either for the CEO or other executives or the
board of directors, that there is some particular wrongdoing
that they are also responsible for and they may face criminal
penalties. And I would just flag that there are two other
things that the regulators could look at, and that would be
implementing Dodd-Frank Section 954 or 956. Section 956 had a
rule proposed that was never implemented, prohibiting
incentive-based arrangements that the agencies determine
encourage risk taking. So, I think there are a lot of things
that the regulators could do to help prevent recidivism by
firms.
Mr. Green. Thank you. A quick follow up, it seems to me
that knowing the direction the market is moving in, having the
ability in high-frequency, high-speed trade to enter the
market, take advantage of that, knowing that you have clients
that are following you that are going to buy into it, gives you
the opportunity to literally commit what I see as a fraudulent
act, because you know what you are going to be able to pay for
it, and you also know by going ahead of your clients, which is
not permitted under these circumstances, you now get to buy and
sell in such a way as to defraud your clients. Your thoughts?
Ms. Goldstein. Congressman, I think it is a good question.
Citadel and other market makers undoubtedly have huge amounts
of data as a result of the orders that they receive, both the
ones that are executed and the ones that are canceled, and I
think regulators should look very closely if there have been
subsequent violations like the one that you identified where
Citadel was, in fact, found to be trading ahead of its
customers. I hope they continue to scrutinize them.
Mr. Green. Is this a form of self-dealing? You can say yes
or no.
Ms. Goldstein. I think that is a question for the
regulators.
Mr. Green. Thank you.
Chairwoman Waters. Thank you. The gentleman's time has
expired. The gentleman from Missouri, Mr. Luetkemeyer, is now
recognized for 5 minutes.
Mr. Luetkemeyer. Thank you, Madam Chairwoman. My first
question is for Mr. Blaugrund. In my opinion, the market self-
corrected itself on multiple occasions throughout the events in
January surrounding GameStop. I asked this question of the last
witnesses in the last hearing, and I have since talked to lots
of folks involved in the financial services world with regards
to these issues, and they seem to agree with that.
Institutional investors overly shorted GameStop, and retail
investors were able to take advantage of those extreme short
positions. In addition, Melvin Capital and Robinhood were both
in need of capital infusions and found it through the private
markets. Mr. Blaugrund, from your seat at the New York Stock
Exchange, do you believe the market was largely able to correct
itself throughout the events in late January?
Mr. Blaugrund. Thank you for the question, Congressman.
Certainly, the market infrastructure performed in a very
resilient, very stable, very predictable fashion, which I think
is critical for investor confidence, and I would agree that
there were no systemic issues that were presented. I do think,
however, and I think the existence of multiple hearings on the
topic suggest, that there was a fascination with what happened
with these particular stocks, and that in and of itself is a
cause for concern if it erodes investor confidence. So while we
have the best markets in the world, there is always an
opportunity to further perfect them.
Mr. Luetkemeyer. In response to that, yes, it is an unusual
situation, but I think my question is, because it wasn't a
usual situation, we are having these hearings to see if there
was a problem here, if there is something we need to do, was
there fraud, was there somebody else doing something illegal or
wrong? And yet, the system appeared to work in that the retail
investor saw an opportunity to see an overly-shorted stock to
bring the pendulum back, so to speak, and the companies that
had overly shorted were able then to find money in the markets
to shore themselves up. I think it shows that there is some
resilience there.
And to that point, SEC Commissioner Allison Lee recently
wrote in a letter in response to Senator Warren, ``It does
appear that our core market infrastructure has proven resilient
through these recent events'', as my colleagues and I have
noted, ``To date, the Commission staff are not aware of any
structural issues resulting from the recent significant
volatility in price of certain stocks that indicate a
disruption of core market infrastructure.'' So, Mr. Piwowar,
would you agree with the statement that the market
infrastructure remains resilient?
Mr. Piwowar. I would, but I definitely have not seen any
problems with the market infrastructure. But as this pointed
out, that doesn't mean we can rest and assume that it is going
to continue to work in the future. And so, one of the things I
put forward is that we should look at whether we want to think
about shortening the trade settlement cycle.
Mr. Luetkemeyer. I have some questions on that, but to me,
as an outsider looking in, when you have a stock shorted 140
percent, to me, that is a problem. You have more stock shorted
than there is stock available. Do you think we need to limit
the number of shares that can be shorted, or do we limit the
number of times a share can be lent to allow this rollover to
be able to get to 140 percent to stop this? To me, this will be
a way to fix the problem versus other extraneous things. To me,
the market actually worked here. People saw an advantage, that
somebody was doing something wrong and jumped in and took
advantage of it. Now, we have some guys who literally got taken
to the market on it. So, would you like to respond to that?
Mr. Piwowar. Sure, thank you. I think well before the SEC
looks at either limiting short selling or looking at potential
limitations there, I agree with Mr. Blaugrund, we need to start
to upstream. The short-selling market relies on securities
lending. And to your point, the same shares can be lent out
multiple times, and you can end up with the odd situation where
the short interest exceeds the number of shares that are
outstanding. Right now, with that securities lending market,
the SEC could go in and gather up information on an ad hoc
basis and try to piece together what it looked like in the
past, but it doesn't have real-time information. It doesn't
have consolidated information.
And so, before we start directly looking at limitations on
short selling, I think we need to address the opacity issues in
the securities lending market, and the SEC does have authority
to do that. And so my suggestion would be, first, let's gather
the data, and then, based on data, we can make additional
policy decisions going forward.
Mr. Luetkemeyer. To me, with the number of times that you
can lend a share, it seems like you have a situation that is
ripe for musical chairs with your money there. My time is up,
so I yield back, Madam Chairwoman.
Chairwoman Waters. Thank you. The gentleman from Missouri,
Mr. Cleaver, who is also the Chair of our Subcommittee on
Housing, Community Development, and Insurance, is now
recognized for 5 minutes.
Mr. Cleaver. Thank you, Madam Chairwoman. I apologize. I am
medically indisposed, but I didn't want to miss this hearing,
so thank you. Let me associate myself with the comments of the
gentleman from Missouri, Mr. Luetkemeyer--the chairwoman has
titled this committee hearing today, ``Game Stopped? Who Wins
and Loses When Short Sellers, Social Media, and Retail
Investors Collide?'' And so, let me ask this to Ms. Goldstein.
In that whole scenario of short sellers, retail investors, and
social media, when there is a collision, when there is some
congestion, who wins and who loses, and is that predetermined?
Ms. Goldstein. Congressman Cleaver, thank you for the
question. I am also sorry to hear you are indisposed. I hope
you feel better soon. I think when all of these forces clash,
generally, the largest Wall Street players are typically the
ones who come out on top. I used to work at Morgan Stanley.
They had incredibly profitable days when there was volatility.
The same was true at Merrill Lynch. They just have these
certain inherent structural advantages, not just over retail
traders, but even over smaller Wall Street players. And I think
Citadel Securities, in particular, is becoming a larger and
larger force in the marketplace, so it is not just the large
banks. But I think Citadel Securities, in this particular
situation, has profited quite well because they take up such a
large portion of the retail order flow.
And I think one of the things that the CEO of Citadel, Ken
Griffin, said the last time he came before this committee was
that when no one else could provide liquidity, Citadel was
there, and I think he was very proud of that. But I think that
actually raises questions about Citadel's systemic significance
to the financial system.
Mr. Cleaver. Okay. Thank you for your response. And this is
for any of our panelists, shouldn't Congress be irreversibly
committed to ensuring strong investor protections and making
sure that we maintain a fair financial system? Are any of the
panel members in disagreement with that?
Mr. Kelleher. I think you have hit on a bipartisan
unanimous view.
Mr. Cleaver. Yes, because I agree with every question,
every statement that Mr. Luetkemeyer just made, not just
because he is from Missouri, but because I think he is right on
target. So you understand or you would agree, I believe, that
we need to do something, that there is some legislative cure to
prevent this from becoming an unfair financial trading system,
that we have to protect investors? And if you agree with that,
put yourself in my seat. What do you do think we ought to do?
Mr. Grujic. I would like to add my thoughts here, if I
could. I absolutely agree that we need a framework and
regulations that protect society and individuals. I also think
there are a couple of things to carefully consider with my
theme of feeling, my experience of there being tradeoffs here,
is that financial markets are more than just the activities
within those markets. They are an information signaling and
capital allocation mechanism. We have to be very careful about
any frictions we put into the markets. Even if they achieve
certain positive results within the context of the structure of
the markets, they will decrease information signaling, and they
will decrease some of their efficiencies to the wider economy
if we are not careful. So, those are some of the costs and
benefits.
The other side is that technology is very empowering. We
should, in our approach to financial markets, look for all
kinds of different ways that technology can deliver
information, analysis, and empowerment for retail investors.
There is a tremendous opportunity here to dig into that to
level the playing field, because the last thing I just want to
say is, an individual has a very hard time having the same
capabilities as an institution, but technology can bring them
closer to having those capabilities.
Mr. Cleaver. Thank you very much. Thank you, Madam
Chairwoman. I yield back the balance of my time.
Chairwoman Waters. Thank you. The gentleman from Michigan,
Mr. Huizenga, is now recognized for 5 minutes.
Mr. Huizenga. Thank you, Madam Chairwoman. And first,
without objection, I would like to submit the following
articles for the record: A Wall Street Journal article from
March 16, 2021, titled, ``Instant Settlement May Not be
Gratifying for All''; a Greenwich Associates report titled,
``The Impact of Zero Commissions on Retail Trading and
Execution''; and a February 16, 2021, Cadwalader Cabinet
memorandum: ``GameStop: Regulators Should Focus Less on
`Solving the Problem'; More on `Improving the Situation.'''
Chairwoman Waters. Without objection, it is so ordered.
Mr. Huizenga. Thank you. I appreciate that. Let me start
there. It seems like some of my colleagues would maybe like to
return to a pension system where someone else controls the
investments, and you get a guaranteed outcome no matter what,
versus sort of the more individual responsibility that we now
see. Well, that is just not reality.
And the ``accredited investor'' definition has been touched
on. I have to tell you, I know some accredited investors whom I
wouldn't have invest $10 of mine, because these people--I would
never call them ``dumb'', but they are ``un-smart.'' And they
may have just fallen into it from a family or from whatever
else, but these are not people who should be investing their
own money, much less my money. And I know some people who are
not accredited investors who are wise, who are smart, who are
temperate, and to whom I would give my money, and I think they
ought to have that ability.
And what it seems like we are having here is this debate
about whether we are going to have access, and that really is
part of it, and gamification has been pointed to and blamed in
many ways. I am here watching the Business Channel while we are
in the middle of this hearing, and I have to tell you, I
counted--there were seven different moving parts on that screen
at one point, seven. Ten years ago, that would have given us
all a headache. Now, we expect that kind of thing.
I have kids who are millennials, and I love movies. I think
they ought to go see some of the classics, and 30 minutes into
it, they will be saying, ``This is boring. You thought this was
exciting, right?'' Expectations have changed. The same is
happening with their own investments. We shouldn't be looking
at investing as something that only grandma and grandpa do. It
should be approachable, and accessible, and safe, and we have
to make sure that we are distinguishing between eye candy and
malicious intent. And what I am hearing a number of folks talk
about is that eye candy equals malicious intent, and that
simply isn't the case.
So, Mr. Piwowar, I do have a question for you on sort of
that subject. While you were at the SEC, and to your knowledge,
has the SEC ever regulated advertising style or product
delivery platforms?
Mr. Piwowar. Thank you, Congressman, for that question.
There are certain advertising rules that the SEC has with
respect to things like past returns and investment performance,
say, in mutual funds and things like that. But to your question
directly on one platform itself, no.
Mr. Huizenga. Advertisement, right, not too many blinking
lights, not too much movement, no confetti. That is not
something that has to do with materiality, correct?
Mr. Piwowar. That is not something that we looked at when I
was at the Commission.
Mr. Huizenga. Okay. I have a couple of things I want to hit
on. The financial transaction tax (FTT), the payment for order
flow versus a rebate system, that maker/taker system, and then
also the T+3 going to T+2 to T+1, so let's see if we can get to
those. Mr. Grujic, what would be the effect of a financial
transaction tax?
Mr. Grujic. The benefits would have to be defined. The cost
would be that it would increase, obviously, the cost of
transacting. That would decrease the number of transactions and
the liquidity in the market. That is just an effect of having
any kind of a friction. So, you would get some amount of
decreased liquidity, some amount of decreased transactions, and
some amount of loss of signaling of optimal prices because
there would be certain price points at which people wouldn't
participate because the tax would price them out. The size of
the tax matters.
Mr. Huizenga. Okay. Mr. Piwowar, while you were at the SEC,
did they ever do a study on this?
Mr. Piwowar. On financial transaction taxes? No, but when I
was in the White House during the Obama Administration, I was
asked to do a memo to some senior advisors, and based upon that
memo and some other information, they decided not to pursue a
financial transaction tax for the reasons that Mr. Grujic
pointed out.
Mr. Huizenga. I suggest you trot that back out. With that,
I yield back. Thank you.
Chairwoman Waters. Thank you. The gentleman from Colorado,
Mr. Perlmutter, who is also the Chair of our Subcommittee on
Consumer Protection and Financial Institutions, is now
recognized for 5 minutes.
Mr. Perlmutter. Thank you, Madam Chairwoman. Mr. Huizenga
was talking about classic movies, and this whole GameStop thing
reminds me of two classics. One is, ``The Sting'', and the
other is, ``The Producers.'' In, ``The Sting'', somebody had a
little information earlier than the rest of the folks and was
able to parlay that into some wins, and, ``The Producers'' was
about overselling a position.
So, I want to start with overselling a position. Mr.
Kelleher, in the previous hearing--and I think Mr. Luetkemeyer
was right on point, and I really want to understand this area--
I asked Mr. Plotkin of Melvin Capital whether his firm was ever
naked short selling on GameStop stock, and he said, ``No, the
systems won't even allow that. That would be impossible for us
to do.'' And according to a report from Bloomberg Government,
which analyzed the SEC data, $359 million of GameStop shares
failed to deliver or be covered, suggesting many of the shares
had been borrowed more than once. I think Mr. Plotkin's
testimony was truthful, but can you explain what is happening
when so many shares fail to deliver?
Mr. Kelleher. Sure. Thank you for your question. The
current regulation only requires broker-dealers to have a
reasonable, or institutions to have a reasonable ground to
believe the security can be borrowed so that it can be
delivered on the delivery date, so it is a reasonable belief.
Now, I don't know about Mr. Plotkin's system, although it
sounded like a pretty good system when he said it, which is, he
says, unless his firm has identified, in fact, the security and
to have a deliverable, it doesn't even allow them to short a
position, but that is not actually the law as I understand it.
As I understand it, it is a reasonable belief that people can
have a lot of reasonable beliefs. And we had massive failures
to deliver GameStop stock in January, so not only do we have a
short position that exceeds about 140 percent of the available
float at the time, but then subsequently, we have a massive
failure to deliver those securities at the time of delivery.
And I am sure, as Mr. Piwowar said earlier, that the SEC is
looking carefully at this, and I would expect their report to
provide us with a lot more information. But as of right now,
the publicly-available information certainly indicates that
there is a very high likelihood of some abusive short selling
by somebody.
Mr. Perlmutter. Okay. So, let me ask you this. Mr.
Luetkemeyer talked about sales, 140 percent of existing shares,
how does that happen?
Mr. Kelleher. In the securities lending business, it
happens because somebody lends a security to somebody, who
lends it to somebody else, who lends it to somebody else. It
goes by the technical name of, ``rehypothecation.'' And what it
does is, you have this cascade effect where you, in fact, have
the same security lent out multiple, multiple times, and then,
arguably, you have short sellers having a reasonable belief at
a period in time that that is the security they could
reasonably deliver at the delivery date. The problem is that
security has now moved to somebody else, who also has a
reasonable belief that the very same security is the one that
he or she can deliver. The way the system works now, it is
almost a house of cards.
I agree with several of the witnesses who said one of the
things that needs to be understood and disclosed at a much more
granular level is not only the activities of the short sellers,
but we need to have greater disclosure and granular knowledge
of what is happening in the securities lending market.
Mr. Perlmutter. Thank you for that answer. Let me go to
something else that is kind of old time. In Colorado, years
ago, we faced dealing with penny stocks and manipulation of the
market with penny stocks. And what we are dealing with here in
GameStop and some of these others is very low-dollar value,
initially, kinds of stocks. Is there any limit to when
something is delisted? Mr. Piwowar, I don't know. Should
GameStop have been on the pink slips at some point?
Mr. Piwowar. Thank you, Congressman, for that question. I
may also defer to Mr. Blaugrund for this because the choice of
listing standards and delisting of stocks, as long as they meet
all of the SEC disclosure requirements, based on the price, is
up to the exchanges themselves. And they have very nice parent
rules on those sorts of things, so I would leave that up to the
exchanges to comment on that.
Mr. Perlmutter. Thank you, Madam Chairwoman. My time has
expired. I yield back.
Chairwoman Waters. The gentleman from Ohio, Mr. Stivers, is
now recognized for 5 minutes.
Mr. Stivers. Thank you, Madam Chairwoman. I appreciate this
hearing and a chance to ask some questions. My first question
is for Mr. Piwowar. Let's kind of set the table, Mr. Piwowar.
Can you sort of help us understand--everybody is talking about
protecting consumers and retail investors. In this GameStop
example, didn't the retail investors win?
Mr. Piwowar. Thank you, Congressman, for that question. We
know there was a lot of trading in the security. We know there
was a lot of retail-sized orders in the security. We know that
for every transaction, it is a zero-sum game, so there is a
winner and a loser. I am not sure we have data in terms of who
the net winners and losers were. We certainly had a situation
where retail investors were empowered with full information
about the risks of the securities and full information about
the price of the securities at any point in time. And some were
probably winners and some were probably losers.
Mr. Stivers. Sure, so let's dig in a little more. There are
some legitimate issues around this, including settlement time,
and T+2 forces some of the broker-dealers, including the folks
like Robinhood who have an app, to put up collateral and
capital based on the time to settlement. If we were to shorten
the settlement to T+1 or not quite instantaneous, but T+
something less than a day, would that have resulted in less
capital required by Robinhood, and would it have then resulted
in allowing some of those retail investors, whose opportunities
to have a buy order were cut off, to keep buying the stock?
Mr. Piwowar. In a short answer, yes, and, more importantly,
it would have taken additional risks out of the system. The
longer the settlement cycle, the more market risk, counterparty
risk, liquidity risk that you have from failures to deliver.
So, one side of the trade doesn't get the securities or the
cash delivered, and maybe the market has moved against them,
and there is an adverse selection problem that is there. And
then also, systemic risk is taken out of the system to the
extent that you have a large number of delivery failures within
the clearinghouse across a number of brokers.
But as you shorten the trading and settlement cycle, I
think, as Mr. Grujic pointed out, you also run the risk of, if
you try to get too close to real-time settlement, you
potentially have the operational risk. And the reason for that
is you have to have multiple systems that have to be operating
at exactly the same way. In terms of why are we at T+2, well, I
will raise my hand. It was me. When I was acting Chairman of
the SEC, I brought us from T+3 to T+2. At that time, 4 years
ago, going from 3 to 2 based on cost-benefit analysis was the
easy regulatory lay up or slam dunk, whatever analogy you want
to use. But we also recognized in our final rule that
technologies change, markets change, and it would probably get
to the point where we should probably move to T+1, potentially
consider real-time settlement, although I think that it is
probably a bridge too far.
So in the final rule, we directed the staff to conduct a
study of potentially moving to T+1, also looking backwards and
seeing what were the benefits exactly of T+2, and do an updated
cost-benefit analysis to see if it was time to move forward.
That study was due to the Commission back in September. I have
publicly called for them to release that study. Congressman
McHenry and Senator Toomey sent a letter to the SEC to release
that study. So, I think this is definitely something they
should put out in the public domain and we should have a debate
about.
Mr. Stivers. And for sure, we are closer to being T+1,
maybe not real-time settlement because there are some issues
around that, but T+1 would have helped solve this problem.
Let's take another step backward, Mr. Piwowar, about retail
investors and the fact with some of these new apps and with
zero-commission trading and partial-share trading, you are
seeing more retail investors have an opportunity to get into
the markets. Isn't that a good thing?
Mr. Piwowar. Yes, to the extent that their brokers are
complying with all of the Federal securities laws, absolutely
it is a good thing. And there is often a comparison made to the
fact that retail investors, on average, when they trade on
their own, maybe overtrade a little bit, or maybe do not do as
well as if they were to put their money into passive index
funds.
Remember, first off, that is an average. There are some
investors that do quite well and some that don't do so well.
There is also the opportunity for younger Americans to learn
that maybe they have an aptitude for trading, or maybe this is
a career for them, that they otherwise would not have expected.
Maybe 10 years from now, we will be seeing somebody
interviewing the top hedge fund manager on CNBC, and they ask,
``Well, how did you learn to trade?'', and the answer is, ``I
learned to trade from one of these trading apps and found out I
had an aptitude for it.''
So, there are a lot of benefits, and then also, obviously,
for saving for retirement. People learn over time from their
mistakes and then maybe move into more [inaudible] investments
that are better for them. But there is no substitute for
learning.
Mr. Stivers. I yield back.
Chairwoman Waters. Thank you.
The gentleman from Connecticut, Mr. Himes, who is also the
Chair of our Subcommittee on National Security, International
Development and Monetary Policy, is now recognized for 5
minutes.
Mr. Himes. Thank you, Madam Chairwoman, and thanks very
much to our witnesses. This is a very interesting conversation.
And I am really excited to follow up on Mr. Stivers' line of
questioning. He asked, ``Didn't retail investors win?'', and
Mr. Piwowar had a view of that, and I want to explore that a
little bit, because I really think an education here is
important, so I want to devote a couple of minutes to that.
Are retail investors winning when they trade on any
platform? And let me be very clear so that nobody lights
themselves on fire right now. I certainly support the right of
people to do what they want with their money. I can go to the
window behind me and peel out $10 bills and throw them out the
window. I can drive 20 minutes and be in a casino where I know
I will lose money, a little bit more slowly than throwing it
out a window, but assuredly, I will lose money. So, look. We
are a free country. People have a right to do what they want.
But that is not what we are talking about here. What we are
talking about is investing in savings. I keep hearing people
say that this is about building wealth and saving for
education. So, I want to figure out whether what we are talking
about here is saving and investing or whether it is gambling,
which was a word that was sort of--somebody cacheted on that
word.
By the way, I think we may be a little complicit in this.
We were all excited--let them trade, let them trade, we said,
and we featured Mr. Keith Gill, a retail trader known as,
``Roaring Kitty'', or something, who apparently made some
money.
But I have reviewed the literature here. There is no
ambiguity. I have looked at the academic studies. I won't list
them all but DALBAR has one out there, and Barber and Odean. It
is very, very clear what happens when retail investors trade a
lot.
Mr. Kelleher, in terms that the folks watching at home can
understand, what happens when retail investors trade a lot?
Mr. Kelleher. They lose, and they lose consistently, and
they lose because they are paying more for every single one of
their orders because we have an order-routing system that is
intentionally complex and designed to extract the maximum
amount of wealth from the retail investor.
Mr. Himes. I get that, Mr. Kelleher--sorry, let me
interrupt. Thank you. That is what I thought you would say. But
it is not just the structure of the system, right? When you
look at the literature, retail investors lose because of a
whole series of human biases, because they do not have teams of
Ph.D.'s studying the stock that they are buying, right?
Mr. Kelleher. Absolutely. It is like saying, let's send the
local Little League team up against the New York Yankees or the
Boston Red Sox or the L.A. Dodgers. Frankly, you have these
institutions that have maximum informational advantage, maximum
technological advantage, maximum sophistication. They get to
use all of that that they have paid billions for, for the
purposes of extracting wealth.
Mr. Himes. Right. And Mr. Piwowar is not wrong, correct?
There is going to be a distribution curve here. There will be
some people who get lucky or who are at the narrow end of the
curve or who do win. But on average, retail--again, for the
folks at home, the more a retail investor trades, the less well
they are going to do, from an investment and savings
standpoint, right? There is no ambiguity in the literature
about that, is there?
Mr. Kelleher. None at all.
Mr. Himes. Okay. So this leads me to my second question.
Mr. Tenev, who runs Robinhood, annoyed me a little bit, because
he told this committee that his customers made $35 billion. Mr.
Arnuk, you are a trader. If I told you that last year my
portfolio made $3,500, would you be impressed?
Mr. Arnuk. No, I wouldn't, and what is really interesting
about the individual anecdotes is that everyone has an
anecdote. I have a young man who is very close to my family,
who called me up saying that on Robinhood, he bought a certain
stock much higher, and he asked for my advice on what he should
do. And he asked me specifically, ``Should I put out a put?''
And I said, ``Do you even know what a put is? Do you know how
to trade options?'' And he said, ``Yes, I am able to trade
options.'' I said, ``What is a put?'' He said, ``It is when you
put out stock for sale.''
So, the very problem here is that we have a broker-dealer
that has abandoned its education and its suitability
requirements, and it has done so because it has this massive
incentive to do so.
Mr. Himes. Thank you. I appreciate that. By the way, do any
of the witnesses quibble with the conclusion that I think I
have been able to tease out here, that the literature shows
that lots of trading by retail investors is really not going to
be a wise investment strategy in the aggregate? Do any of the
witnesses dispute that?
Okay, hearing none, look, let me be clear again here. I
believe that Americans should have the right to do with their
money what they will, but--and let me close, Mr. Arnuk, since
you are an investor, what is a smart strategy for a retail
investors who actually want to make money and save and invest
successfully?
Mr. Arnuk. I don't know if I should answer that. They
should add a dollar cost average monthly into Vanguard index
funds, and buy and hold.
Mr. Himes. Thank you. I yield back the balance of my time.
Mr. Sherman. [presiding]. The gentleman's time has expired.
I now recognize Mr. Barr from Kentucky.
Mr. Barr. Thank you, Mr. Chairman. I have to say, this is
an interesting conversation, and what I hear in some of the
testimony is, I do detect a paternalistic hostility to what I
consider to be the foundation of our free markets, and that
foundation is the freedom to take risk. It is paternalistic,
because I hear an elitist sentiment that only sophisticated,
highly educated, or institutional investors know what they are
doing, and governments should intervene to restrict commission-
free trading to protect retail investors from themselves, that
government knows best and retail investors are simply not smart
enough to allocate their own capital for themselves. I think
there is hostility, because it sounds like some of the
witnesses want to pull risk-taking completely out of the
system. Let's be honest, that is code for doing away with free
market capitalism.
Now, this is the second of what is expected to be a three-
hearing episode on this topic. The Majority has concocted a
series of villains in this saga. First, it was the hedge funds,
who supposedly collaborated and colluded with Robinhood. Then,
it was the practice of short selling. Then, it was payment for
order flow. Now, it is the so-called gamification of investing,
as if creating user-friendly platforms that attract wider
swaths of investors is a bad thing. Provided that no securities
laws are broken or consumer protections are compromised, it is
not the role of Congress or regulators to dictate the
constructs of a user experience. If investors like the
platform, it will succeed. If they don't, it won't.
Mr. Piwowar, how might additional poorly tailored
regulations on financial technologies like app-based investment
platforms slow the expansion of retail investor participation
in the capital markets?
Mr. Piwowar. Thank you, Congressman Barr, for that
question. One of the concerns about slowing down access for
retail investors is the equitable access. What impact will it
have on low-income households who are already put at a
disadvantage from the accredited investor definition?
And if I may just address--I think it was the straw man
argument brought up by Congressman Himes, there is not this
world where people are putting all of their money into a
Robinhood app and trading all of their portfolio all the time,
or they are putting all of their money into a Vanguard index
fund. What we see is that a lot of investors are very
sophisticated. They put some of their money into passive index
funds, low cost, and then take a little bit of it and try to
create a little bit of [inaudible] and see how good they are at
it. And some--
Mr. Barr. Mr. Piwowar, that is a very good point, and I
think we shortchange the intelligence of some of these retail
investors when we just assume that they are not diversified.
Let me ask you another question about payment for order
flow. Would restrictions on payment for order flow or an
outright ban on payment for order flow impact price improvement
for retail investors, and if so, what would that impact be?
Mr. Piwowar. The first likely event we are going to see is
that we are going to return to commission-based trading. Free-
commission trading would go away, again a [inaudible] impact.
And to the second point, we are back in a world where there is
another conflict of interest, and that is the turning of
accounts in order to generate commissions. It has been said
that there is an incentive to generate revenue by more trading
for payment for order flow. That same incentive exists in a
world where you have commission-based trading. And in a prior
part of my career, I actually worked as an expert witness on
behalf of plaintiffs who were arbitrating against--broker
customers [inaudible] arbitration for turning accounts. And so,
again, that is another thing that just has to be monitored for
compliance.
Mr. Barr. I don't have time to ask the question to Mr.
Grujic again, but I think his point about forcing a combination
of retail and institutional flow will have a negative impact on
price improvement for retail investors, and I think that stands
repeating, and an unintentional consequence of excessive
restrictions on PFOF.
Final question, Mr. Piwowar. Mr. Kelleher and some of the
other witnesses have argued today that existing best execution
requirements do not sufficiently address what they consider to
be conflicts of interest associated with payment for order
flow. Do you agree, and has payment for order flow in any way
cancelled broker-dealers' duties to route customer orders to
achieve best execution?
Mr. Piwowar. The answer to your last question is no, they
have not cancelled that. What I have said in my testimony is
that of course the SEC should revisit its best execution rules
in light of zero-commission trading. Best execution is a
multifactor, multidimensional thing that the SEC looks at, and
so markets evolve, technology evolves. Of course, the SEC has
to consider that.
But there has been no diminishing of it. In fact, the SEC
vigorously enforced its best execution rules.
Mr. Barr. Thank you. My time has expired. I yield back.
Mr. Sherman. Thank you. I ask unanimous consent to put in
the record a 2016 report from the Charter Financial Analyst
Institute which found that following the UK's ban on payment
for order flow in 2012, the portion of retail site trades
executing at the best quoted price went up substantially.
Without objection, it is so ordered.
And I now recognize Mr. Vargas, my colleague from
California.
Mr. Vargas. Thank you very much, Mr. Chairman, and again, I
want to thank all of the witnesses for being here. I heard a
speech toward the beginning of this hearing that we Democrats
want to, ``enhance inequalities.'' I always find that an
amazing and staggering quote when my good friends on the other
side of the aisle give a $1.9 trillion tax giveaway to the
wealthiest Americans. I always find that interesting, and the
other notion that somehow we are paternalistic and we should
allow people to trade and be able to do all of these things,
which I agree with, but, here we have a defined benefit plan in
Congress, where we can't make those decisions. So, I always
find that interesting.
Now, there seems to be an inherent conflict in this payment
for order flow that the retail investors get the worst
execution, and I will quote some of the statements made here
today: ``It is really a wealth extractor for the few.''
``Legalized kickbacks coming from retail investors.''
So, Mr. Arnuk, should we prohibit payment for order flow?
We just heard something put into the record by my good friend,
Congressman Brad Sherman. Should we prohibit it?
Mr. Arnuk. Thank you for the question, Congressman. I
absolutely believe we should ban payment for order flow in all
of its forms. It distorts order routing. It distorts order
routing on exchanges. It distorts order routing and best
execution in the off-exchange markets as well.
Consider this: Robinhood, with its carrot of payment for
order flow, has a duty to get best execution, as well as the
suitability I referred to earlier. But to get that best
execution, they would need to access the 20 percent of New York
Stock Exchange midpoint orders that are the 50 percent of the
orders and trades that take place in the market that are odd
lots, which are predominantly what so many of the Robinhood
traders are trading due to their small account size.
Yet, why can't Robinhood do that? Because they aren't even
connected to any of the exchanges. The only relationships that
they have developed are wholesaler relationships where they
receive payment for directing orders to high-speed market
makers uniquely tooled to profit over those orders.
Mr. Vargas. Thank you. Mr. Kelleher, do you disagree with
anything that you just heard from Mr. Arnuk?
Mr. Kelleher. No. He is exactly right. And, in fact, I
would go a little bit further. The Congress doesn't have to ban
payment for order flow. The SEC should take the position right
now that payment for order flow violates, or facilitates the
violation of the best execution duty. We know, for a fact, that
today about 47 percent of all trading is happening off
exchange, in dark, unregulated markets. None of that flow goes
to the public exchanges. And we also know that the trading in
those exchanges gets worse execution than they do on the public
exchanges. And what has happened over time is this artificial
construct of best execution based on what is called the
National Best Bid and Offer (NBBO), on the exchanges.
So they are claiming, and Mr. Tenev said in the last
hearing, ``We got price improvement. We do great for our
customers.'' According to what? It is according to the NBBO,
but the NBBO only reflects about 40 percent of total orders, in
the least liquid market that there is at the time right now,
which is the LIT markets. And Mr. Arnuk is right. It doesn't
include odd lot and it doesn't include, by the way, hidden
trades, also 20 percent of the market.
So what they are saying is, we do great things. You can
look at this. We do price improvement. We do better than the
NBBO. But both of those benchmarks are misleading, if not
intentionally false, and the SEC should take the position that
that violates the duty of best execution today.
Mr. Vargas. Let me ask Ms. Goldstein, would you agree?
Ms. Goldstein. Congressman, it is a great question. I think
that there are a number of ways to approach this problem. I
think you could prohibit payment for order flow. I also think
that you could ask that brokers have to pass on payment for
order flow to their customers, or allow their customers to opt
out of payment for order flow.
I don't know that there is a single solution for how we
address this, but I do think that it needs to be addressed, in
some way.
Mr. Vargas. Let me go to Mr. Blaugrund. You represent an
exchange. Should we prohibit it?
Mr. Blaugrund. I think there is a real public interest in
having the broadest set of market participants interact with
one another from an order flow perspective. That being said, I
think the SEC has announced their plans to study the question
of whether payment for order flow is consistent with best
execution obligations, and we look forward to reviewing their
findings.
Mr. Vargas. I yield back.
Mr. Sherman. I see our chairwoman has returned, and I am
happy to return the gavel to her. Madam Chairwoman?
Chairwoman Waters. One moment please.
Who is up next, Mr. Chairman?
Mr. Sherman. It has been suggested to me, at the request of
one of our witnesses, that we take a 5-minute break. We can do
that or we can move on.
Chairwoman Waters. Without objection, let us take a 5-
minute break. Thank you.
[brief recess]
Mr. Sherman. [presiding]. The Chair has asked me to
continue to preside, and I believe our break is over. I now
recognize Mr. Williams from Texas.
Mr. Williams of Texas. Thank you, Mr. Chairman. I am very
concerned that there is going to be a Federal overreaction to
this whole GameStop saga. CBOE's Volatility Index, better known
as the VIX, has historically been used to gauge fear in our
capital markets. When this number is approaching record highs,
people are uncertain on the direction of how that market will
move, and investors, quite frankly, get nervous.
Just one year ago, in March 2020, the VIX reached an all-
time high of 82, and the Dow Jones proceeded to crash by 26
percent. On January 28th, the day that we have now dedicated
two full committee hearings towards, and with more plans in the
coming months, the VIX was in the 30s and the change in the
overall market barely even registered.
So, while a few stocks such as GameStop may have seen some
historic individual metrics in January, none of these
individual securities appear to have posed a systemic risk to
the markets as a whole. Rather than pursuing radical changes to
our capital market structure, we should be looking at the very
tailored issue that prevented retail investors from placing
trades on securities that day, when they wanted to.
Mr. Piwowar, can you discuss your views about how changes
to market structure should be done, and if it makes sense for
Congress to step in now instead of waiting for the SEC to study
that issue and go through a thorough rulemaking process with a
cost-benefit analysis?
Mr. Piwowar. Thank you, Congressman, for that question.
Having served both on the staff of the Senate Banking
Committee, and at the Commission, I feel like I can address
this question.
Because markets and technologies change all the time, I
believe the SEC is better-positioned to look at these changes
and put it through their cost-benefit analysis. The SEC is
bound by statute, by a number of statutes, to take into account
the costs and benefits of various alternatives that are out
there, including the baseline scenario of what the existing
situation is, for example, shortening the trade settlement
cycle. The current situation is T+1, and they could evaluate
that through the lens of cost-benefit analysis and say, well,
what would be the relative cost and benefits of going to--we
are at T+2, what would be the relative cost and benefit of
going to T+1 or T-zero, and explicitly look at this.
It's the same thing in payment for order flow. They could
look at likely effects. They can get the benefit from market
participants, investors, and academics, and take all of that
information and address their regulations accordingly, within
the broad context of the Federal securities laws. That does not
mean Congress doesn't have a role here. I think you all have a
very important role here. To the extent that you think any of
these market structure or market infrastructure policy changes
should be prioritized by the Commission, I believe that would
be an important role for this committee to try to come together
and find consensus on what are the two, three, or four most
important areas for the SEC to focus on. Because, as you know,
you have given them a broad mission, with broad authorities,
sometimes, for prioritizing those.
Mr. Williams of Texas. Okay. Thank you for that.
[Inaudible] Americans be able to put some of their hard-earned
paychecks in the stock market and have the same ability to
succeed as any large institutional investor. Unfortunately,
many Americans believe that the system will always be rigged
against them and they have no way to compete against the big
players, after watching this situation play out. Whether that
view is warranted or not, we need to be working to continue to
empower the retail investors.
So, Mr. Blaugrund, I know there have been a lot of
conversations around access to market data. Can you talk about
the New York Stock Exchange and what it is doing to get better
market data into the hands of the average American looking to
make more informed investment decisions?
Mr. Blaugrund. Thank you for the question, Congressman.
NYSE publishes market data through the Consolidated Tape, which
is an industrywide utility, and also through proprietary market
data products. All of these products are filed with the SEC,
available broadly, and according to a standard rate card.
In general, the retail community consumes market data
through the Consolidated Tape, which has largely kept prices
steady for many years. The retail investor typically has their
market data paid for by the broker, and it costs about $1 a
month. Market data is now consolidated in a matter of about a
dozen microseconds by NYSE and NASDAQ systems, and then
rebroadcast to the retail community.
Mr. Williams of Texas. Thank you for that answer, and, Mr.
Chairman, I yield back.
Mr. Sherman. Thank you. Mr. Lawson of Florida is now
recognized.
Mr. Lawson. Thank you, Mr. Chairman, and Chairwoman Waters,
and I welcome all of the members to this panel today. This
question I have is for the whole panel. Citadel Securities
reportedly handles almost as much trading volume as NASDAQ.
Further, Citadel [inaudible] traded along with the market maker
were two financial account products, more of the overall equity
market than the New York Stock Exchange. With respect to
Citadel, some have raised concerns about a single market maker
managing such a large volume of retail order flow, and what
that means in terms of pricing. Why does Citadel have such
dominance in financial markets that it imposes a systemic risk
to our entire U.S. financial system?
Can you all speak more on these concerns?
Mr. Piwowar. Congressman, this is Mike Piwowar. Having
served as acting Chairman and sat on the Financial Stability
Oversight Council and met with the other principals and the
deputies and looked at sources of systemic risk, I don't have
any concerns that the Citadel market-making business poses any
systemic risk to the system, and the reason for that is even
though they are a dominant player right now, we have to look at
what would be the scenario if they failed. And the concerns
that we have for systemic risk ultimately go to cascading
failures, and what we really ultimately worry about is whether
the banks fail, because they are [inaudible].
In the case of Citadel Securities, if their market-making
function were to cease, let's say, tomorrow, what would we see?
Well, we would see that there is an incredible amount of
competition within that industry among market makers. And we
would see that those market makers would come in and compete
very quickly to capture that market share, and due to
technology, they would be able to scale up very quickly at low
cost in order to do that.
So, I don't see any systemic problems with the Citadel--
Ms. Goldstein. Congressman Lawson, may I offer a differing
view?
Mr. Lawson. Go ahead.
Ms. Goldstein. I believe that there are a lot of questions
about systemic risk of Citadel overall and Citadel Securities.
One thing that is important to do would be to look back a
decade. Citadel Securities actually tried to become an
investment bank in 2008, and one of the things that reports and
analysts said at the time is that they had certain regulatory
advantages over the large U.S. banks, because as a hedge fund
and a market maker, they are not overseen by the Federal
Reserve, and so there was no one looking at the holistic risk
across all of Citadel's firms.
They gave up on their dream of becoming an investment bank
in 2011, and they shifted to retail trading, which people on
Wall Street widely see as easier to profit from, quite frankly.
Whether that is right or wrong, that is the perception on Wall
Street. And Mr. Griffin, the CEO of Citadel, said, in his
written testimony to this committee that, ``When no one else
was able to provide liquidity, Citadel was there'', and he has
really talked up their dominance in the marketplace.
And so, I don't know that it is an open-and-shut case. I do
think that there are risks of interconnection. I think there
are questions about liquidity, and I do think that the FSOC
should investigate it.
Mr. Grujic. I would like to add that as a market
participant, I see the market makers as highly competitive and
there is excess capacity, and I think the removal of Citadel,
even though the largest, would have very little impact as
someone looking to execute in the financial markets. And also,
liquidity is not a point in time; it is a continuum. So when
Citadel makes statements like, they were the only ones there,
perhaps they were the only ones there at the very, very best
price, but an incrementally worse price was available from
other market makers.
So, I would concur with Mr. Piwowar that the impact of
Citadel stopping trading tomorrow would be minimal to the
execution quality we receive.
Mr. Kelleher. I don't think there is any circumstance under
which Citadel Securities is not a systemically significant
firm, and FSOC should investigate it. In addition, the SEC
should not exclude companies like Citadel from Regulation SCI
(Systems Compliance and Integrity), which is supposed to have
resilient infrastructure. And the SEC inexplicably excluded
broker-dealers like Citadel from that regulation and those
requirements.
So, there is a risk on the infrastructure side, and there
is a risk on the systemic institution side. For anybody to say
that if Citadel shut down today, even for a day, that means 26
percent of all U.S. equities volume, in 8,900 listed
securities, would stop. It executes 47 percent of all U.S.
listed retail volume. It represents 99 percent of the traded
volume of 3,000 listed options. To say that the system would
work perfectly fine if all that evaporated today and
competitors came into the market, that may ultimately happen,
but until it ultimately happens, you are going to have a
systemic event, and to deny that is to deny reality.
Mr. Lawson. Thank you.
Mr. Sherman. The gentleman's time has expired. I now
happily return the gavel to our chairwoman.
Chairwoman Waters. The gentleman from Arkansas, Mr. Hill,
is now recognized for 5 minutes.
Mr. Hill. Thank you, Madam Chairwoman, and let me say that
both of the hearings that you have convened on this important
topic have had excellent witnesses, and the hearing discussions
are among the best I have seen in my service in Congress.
I would first like to ask unanimous consent to insert two
letters for the record. The first is a March 19, 2021, letter
from a coalition of organizations interested in our tax system,
in opposition to the imposition of a financial transaction tax.
And the second letter is dated March 17th, from the Security
Traders Association, also in opposition to a securities
transaction tax.
Chairwoman Waters. Without objection, it is so ordered.
Mr. Hill. Thank you, Madam Chairwoman. This has been, as I
said, such a very interesting discussion. I really appreciate
the extensive discussion we had on securities lending. I think
the committee took away good information there that we can ask
the Commission to follow up on. And I think we have had a lot
of discussion about best execution and the obligations under
best execution, that it is a mandate on the part of all market
participants, and that the SEC, in their exam process in this
current period, will be looking at that as a special exam
focus. Those are helpful points.
Dr. Piwowar, there were a couple of points made that I
thought I would get your comments on. Mr. Sherman asked about
the ultimate cost, which, of course, in a retail trade is the
spread between the bid and the ask. There is no doubt about
that in a non-commission world. Does the competition among
market makers, under payment for order flow or not, really
improve that spread and thus lower the cost to retail
investors?
Mr. Piwowar. Thank you, Congressman, for that question. We
do have some insight into that. As some people have mentioned,
there is some transparency on this issue, so the SEC requires
each of the market makers to file an execution quality report
in the language of the SEC Rule 605 reports.
So we can see, for example, Citadel is the one that comes
up--we can see for them, or any other market maker has to put
out their statistics, and we can look at things like the speed
of execution for various order types and what is called price
improvement for those various order types. But we can actually
see, measured against the NASDAQ offer whether, in fact, they
are offering net price improvement, whether they are executing
at the spread or whether they are executing outside the spread.
Mr. Hill. Yes, that is helpful. And also, Mr. Sherman
talked about the LIT market, those quotes that go across an
exchange, but as noted by our friend from the New York Stock
Exchange this morning, all quotes are presented at retail in
milliseconds, whether they took place off the exchange or on
the exchange. Is that correct?
Mr. Piwowar. That is correct.
Mr. Hill. Yes. Thank you. I also was concerned--my friend,
Mr. Green, from Texas, made some comments about Citadel, and
had obviously some discussion just a moment ago about Citadel
Securities. And I was curious as to your views about the
separation of businesses owned by Citadel. Mr. Green's
allegation--and I do not want to put words in his mouth--is
that somehow, Citadel could use the information that they
garner from being a market maker, payment for order flow,
understanding the stop-loss position, and a number of names,
and somehow prey on that information over at Citadel's hedge
fund. Really, I found that shocking. That is against the law,
is it not, Dr. Piwowar?
Mr. Piwowar. Absolutely, it is against the law. The SEC has
put in place a number of restrictions, and so, effectively, the
hedge funds and securities market making divisions at Citadel
have to operate separately. The SEC regularly examines to make
sure that they have put in place proper protections in there,
and if they find that any firm is violating those, they will
vigorously enforce them.
Mr. Hill. Yes. Thank you. Mr. Grujic, I really appreciated
your testimony. I really enjoyed learning about your company
today. We had a lot of discussion about the sales practices of
Robinhood in the previous hearing. Quickly, could you address
your policies on low-dollar stocks, not penny stocks, but even
if they are exchange-listed, what your position is there and
how you qualify your investors for either options or margin on
your platform.
Mr. Grujic. We don't yet offer options on our platform. I
have a lot of experience trading options and we are thinking
through how to best do that. We have taken note of the issues
that have occurred at Robinhood and general [inaudible] with
retail investors accessing options.
Mr. Hill. Thank you, Madam Chairwoman. I may submit some
additional questions for the record. I want to thank the panel
for their participation, and I yield back.
Chairwoman Waters. Thank you. The gentlewoman from Iowa,
Mrs. Axne, is now recognized for 5 minutes.
Mrs. Axne. Thank you, Madam Chairwoman, and thank you,
witnesses, for being here today. My husband and I have a
digital design firm, so one of the areas that I have been
focused on in regard to this is some of the newer brokers
having designed their platforms and how they have done that.
Dr. Bogan, you have done some tremendous research in
behavioral finance. Just a quick question to start, can app
design influence what decisions people using that app make?
Ms. Bogan. Thank you for the question. Absolutely. App
design and the way the platform is designed and the user
interface can influence the type of decisions that a retail
investor makes, almost on an unconscious level. And I want to
make a clear point, there is a difference between retail
investor access, which is great and provided by appropriations;
retail investor environment, which kind of is ease of use; and
retail investor manipulation, in that there are certain
behavioral science techniques that are used to trigger
investors to behave in a particular way that may not be in
their best interest.
Mrs. Axne. And that is why Robinhood has behavioral
researchers, correct?
Ms. Bogan. I can't speak to why they have behavioral
researchers, but I can say that some of the features of their
platform have been shown in research to elicit particular
behaviors, like more trading. For example, they have a list of
kind of the most popularly traded stocks. That brings attention
to particular types of stocks, and we know from the research
that just having attention to particular stocks increases
trading in those stocks, whether or not it is in the best
interest of the investor to do so.
Mrs. Axne. So as you mentioned, it increases trading, and
do you think that encourages savings and investment or do you
think that just encourages greater tendency towards more
trades?
Ms. Bogan. Yes, there is a difference between investment
and trading. Just trading multiple times a day for trading's
sake, the research is very clear that is never in the best
interest of a household. Buy and hold is the conventional
wisdom. And so, buying is fine, but this multiple trading and
turning portfolios has never been shown to be beneficial to a
retail investor.
Mrs. Axne. I appreciate that. I am especially concerned
about this given the fact that Robinhood's incentives are so
heavily weighted on making sure that their users trade more,
because that is what puts money in their pocket.
Mr. Arnuk, Robinhood has said that if its payment for
market makers like Citadel is based on a percentage of bid-ask
spread, can you explain why that is different from other firms
and how that incentivizes Robinhood to have their users trade
wider stocks or even riskier products, like options?
Mr. Arnuk. Thank you for the question. I really appreciate
it. The first thing we should notice is that 92 percent of
Robinhood users' trades are outside of the S&P 500, which is to
say that they are in stocks where the spreads are 5 times as
wide as they are for the S&P 500. These are wide-spread stocks.
At some point, in late 2019, Robinhood understood this and
renegotiated the way they collect payment for order flow from
the other market makers. It has always been a fixed mil per
share, in other words, 15 mils per share, or 20 mils per share.
That is how it has always been done. But presumably because
Robinhood noticed the trading patterns of its users, they
negotiated to instead receive a percentage of the spread. So,
this is an amazing misalignment of interest.
The Robinhood trader wants the stocks they trade to have
the smallest spread as possible, the market maker who is buying
the orders wants the spreads to be as wide as possible, and
Robinhood, their agent, the broker, wants their spreads to be
as wide as possible. I think that is fantastic in a negative
way.
Mrs. Axne. Massachusetts found that 68 percent of
Robinhood's options-approved users in the Commonwealth had
limited or no user experience. When you talk about the options
and the risk of the spread there, what do you think is going to
be the outcome for 99 percent of these users who don't have the
experience and getting into this type of market?
Mr. Arnuk. It is going to be unfavorable, and in the end,
if you look at the average account size across different retail
trading platforms, the average account size at E*TRADE may be
$250,000. At TD Ameritrade, it is $150,000 or $110,000. At
Robinhood, it is $5,000. And they are outsized trading options.
And while spreads in stocks are wide--I yield back.
Mrs. Axne. Thank you so much.
Chairwoman Waters. Thank you. The gentleman from New York,
Mr. Zeldin, is now recognized for 5 minutes.
Mr. Zeldin. Thank you to the witnesses for being here, and
to Chairwoman Waters and Ranking Member McHenry for holding
today's hearing. I represent the First Congressional District
of New York, which encompasses much of Suffolk County on Long
Island. My home district is full of people from all walks of
life, and industries, so having access to cost-efficient
investing is crucial.
Mr. Piwowar, a lot of my constituents were concerned with
the inability to buy certain stocks when some broker-dealers
placed limits on trading those stocks. And the main reason why
this happened is because many broker-dealers had to post
additional collateral to comply with capital requirements at
clearinghouses. You have written about shortening the trade
settlement period to both increase efficiency and lower the
cost of investing. Can you speak a little bit more to how using
technology to shorten the trade settlement period could benefit
retail investors and limit the potential for broker-dealers to
have to impose restrictions on certain trades?
Mr. Piwowar. Thank you, Congressman, for that question.
Yes, the shorter the trade settlement cycle--a couple of
things. One, investors get access to their cash sooner, or
their securities; and two, the less margin that brokers have to
post at the Depository Trust & Clearing Corporation (DTCC) in
order to guard against failures to deliver. So, it takes a
number of risks out of the system, as I mentioned, counterparty
risk, market risk, credit risk, and liquidity risk, as well as
systemic risk of cascading list of failure.
Shortening the settlement cycle would provide those
benefits. Again, going to real time, it possibly increases
operational risk to make sure everything works correctly. So,
what we need to do is find the right balance.
Mr. Zeldin. Thank you. It is also important that the data
privacy for these investors is protected against any potential
vulnerabilities. At the first hearing in this series, back in
February, I asked Ms. Schulp from the Cato Institute whether we
should be concerned with companies with ties to the Chinese
Communist Party (CCP) investing in broker-dealers operating in
the United States. She responded that it is a potential
national security concern and that the rules that the broker-
dealers have to comply with regarding user data should be
applied equally to broker-dealers, no matter whether the parent
company is a U.S. or foreign company.
I have been concerned for some time, in general, with the
sharing of U.S. individual user data with the Chinese Communist
Party. I sent a letter, for example, to the Treasury Department
in October 2019, expressing concern with the potential sharing
of U.S. user information by TikTok to its parent company,
ByteDance, and asked for a CFIUS review.
Additionally, yesterday I urged Treasury and Commerce to
take immediate regulatory action against companies with ties to
the CCP, that have the capability to acquire Americans'
biodata, specifically by sending letters to Treasury Secretary
Yellen, urging her to direct the Committee on Foreign
Investment in the United States (CFIUS) to reassess the Chinese
company BGI's acquisition of Complete Genomics, and to acting
Secretary of Commerce Wynn Coggins, urging her to place all of
BGI's subsidiaries on the Department's entity list.
Chinese companies are required by law to regulate online
behavior that deviates from the political goals of the CCP,
obey the CCP's censorship directives, and participate in
China's espionage. These policies regulate companies like
TikTok in the China market, and increasingly, their overseas
business.
I remain concerned that broker-dealer trading
appropriations that are subsidiaries of Chinese companies with
ties to the CCP like Weibo, which has significant investment
from Xiaomi, have not received enough regulatory scrutiny, and
cause data privacy concerns for U.S. retail investors.
Mr. Piwowar, I think these issues are particularly timely
to discuss in light of the upcoming U.S.-China meeting in
Alaska. This isn't the first time Chinese investors have tried
to buy into our capital markets. You were an SEC Commissioner
in 2018, when the Commission rejected the proposed acquisition
of the Chicago Stock Exchange by a Chinese-led group of
investors. Can you speak a little to the concerns the SEC had
at that time?
Mr. Piwowar. Yes. Thank you, Congressman. As you mentioned,
there was a Chinese-led investor group that wanted to buy the
Chicago Stock Exchange. It had passed CFIUS review and it came
to the Commission, and under our State, there are certain
prohibitions and limitations in terms of ownership of the
exchanges, to make sure that we are protecting investors and
that they are fulfilling all of their obligations.
All we did was simply ask questions about who their
investors were, and very quickly, some of those investors fell
away, and in other cases, they were not able to provide us with
answers that made us comfortable that they would, in fact, be
able to fulfill their duties under the Federal securities laws.
So, that was the basis for us rejecting that application.
Mr. Zeldin. Thank you. I yield back.
Chairwoman Waters. Thank you. The gentleman from Illinois,
Mr. Casten, is now recognized for 5 minutes.
Mr. Casten. Thank you, Madam Chairwoman, and to all of our
witnesses, I want to echo what my friend, Mr. Hill, said. This
has really been an exceptional hearing. I have been learning a
ton.
Mr. Arnuk, you made a comment in your opening remarks that
really struck me, and I want to make sure I understood this
right, if I scribbled it down right. You said the spreads
become narrower when Robinhood's servers go down. That is a
heck of a statement. Can you explain that in a little more
detail, and to the degree you have any confidence on whether
that is a correlation or a causality?
Mr. Arnuk. Thank you for the question, Congressman. When
Robinhood would have a technology outage, those retail orders
would not go to off-exchange venues and would come back to the
exchanges. And when those orders came to the exchanges, not
surprisingly, more order flow migrating to the exchanges with
narrow spreads.
First of all, that meant that the retail investors who are
trading through any other app are getting narrower spreads and
better price improvement and an improved experience and less
cost, but it also means that the rest of the market--the
institutions, the pension funds, the mutual funds--that really
represent 90 percent of the long-term investors, are able to
interact with that order flow on the exchanges, and that order
flow, for the same reasons that the market makers want to
monopolize it just for themselves, when it is participating in
a diverse environment on a public sunlit exchange, the best
outcome accrues to everybody, with those narrower spreads and
less toxicity on the exchange.
Mr. Casten. That is really helpful, and as I am sure you
saw, last month when Robinhood's CEO Vlad Tenev testified
before us, he said that Robinhood customers received more than
$1 billion in price improvement in the first half of 2020. Can
you just tell us briefly, is price improvement a proxy for best
execution?
Mr. Arnuk. No, not at all. Thank you, again. Price
improvement is an arbitrary calculation. It is based on a
construct that we created, the National Best Bid and Offer
(NBBO). It does not include odd lots; 50 percent of the orders
and trades on the exchanges are odd lots, and the NBBO does not
include those, and those odd lots are in between the spreads.
It doesn't take into account hidden orders on the exchange.
Exchanges have hidden midpoint orders. It doesn't take into
account dark-pool midpoint orders.
There is a whole mess of liquidity that demonstrates that
the best available price is certainly not the NBBO. So to say
that, I price-improved the NBBO by X, I don't care--$1 billion,
$2 billion, $3 billion in aggregate, it rings false. It is not
the truth.
Mr. Casten. I want to then get to a more general question,
and it is not just about Robinhood, but again, that is why we
are here. As you mentioned in your exchange with Mrs. Axne, it
was really remarkable, about the trajectory of Robinhood
shifting from flat rates to a percent of the spread payments
for their payment for order flow.
But in his testimony, Mr. Tenev not only acknowledged that
point but said that in their options market--this may be true
in equities as well--but he said in their options business,
they categorically do not route trades to anyone with whom they
do not have a payment for order flow agreement.
So without speaking to Robinhood generally, if you are a
brokerage that is earning your revenue as a percent of the
spread, and you are only routing trades to people with whom you
earn payment for order flow, is there any universe where that
is consistent with actually fulfilling your best execution
obligations?
Mr. Arnuk. Absolutely not. They have no mechanisms to trade
directly on any of the numerous venues that exist to trade.
Dark pools exchanges, these cost money, and apparently
Robinhood is more interested in the revenue side of their
business model than actually incurring costs where they can
fulfill their duties to seek best execution, the best prices
everywhere.
Mr. Casten. Mr. Kelleher, I have 30 seconds left. Is there
anything you would like to add to what Mr. Arnuk has said?
Mr. Kelleher. No. He is exactly right. Frankly, the SEC
could consider taking fraudulent action for people who claim
price improvement off of NBBO, because it is, at best,
misleading, if not a fraudulent claim, and knowingly so.
Mr. Casten. Thank you, and I yield back.
Chairwoman Waters. Thank you. The gentleman from Georgia.
Mr. Loudermilk, is now recognized for 5 minutes.
Mr. Loudermilk. Thank you, Madam Chairwoman. I appreciate
all of the witnesses being here. And I want to associate myself
with Mr. Hill's comment earlier, which was regarding the
content and the discussion that we have been having in these
two hearings. I think it has been very informative. It has been
very interesting, the content, and I think these are
discussions that we should be having.
Now, with that said, in the first hearing on this topic I
raised concerns about the fact that some of my colleagues on
the other side of the aisle were using this situation with
GameStop as an opportunity to push for more regulations, even
before we had all the information in. Now it is ironic, because
regulation is exactly what paused the trading with Robinhood in
the first place.
As I mentioned that, the chairwoman responded and said that
no one is calling for more regulations at that time, but I had
already known at the time that some had been asking for
regulations, and obviously we live in a political era to where
a crisis can't go without using it to do something. And as we
know, Elizabeth Warren and others are using this issue to
demand a laundry list of new regulations on options trading,
payment for order flow, short selling, even a devastating
financial transaction tax that would require the average person
to work 2\1/2\ years longer so they can recover.
We all know in a free market system, which truly investing
is within that free market, especially when you bring in the
average consumer, they know that there is a risk involved. The
greater the potential profit that you can make, or the return,
the greater the risk you are going to have. That is just the
basis of the market, any free market system. And so we have to
be very cautious as we are going forward in trying to make a
risk-free environment with high returns. It just doesn't work
in that environment.
In fact, I know of several people who have never been
involved in the stock market, but they took their stimulus
money, as several were working, and they said, ``Look, I don't
need the stimulus money, but I know that eventually the
government is going to tax it back from me, so I will, at
least, start making some money. I can't make any money by
investing in a savings account because interest rates are so
low. Money markets are useless.'' So they have opened these
trading accounts, and they are actually using some of the
stimulus money to invest. And they are concerned about some of
what is going on.
These calls for more regulation, I think are ill-advised
and premature, for multiple reasons. The witnesses at the first
hearing said the markets are not broken, and the SEC Chair and
SEC Commissioners have said that core market infrastructure has
been resilient through all of this. What's more, the SEC is
looking into these events, and so far has not indicated that
there was market manipulation. Adding more regulations would
now be like a judge handing down a sentence before any charges
are actually filed.
Mr. Piwowar, can you describe how options trading, payment
for order flow, and short selling are already regulated by the
SEC and other agencies?
Mr. Piwowar. Yes. No, they are highly regulated. Short
selling, there are a number of requirements that--I will take
them one at a time. Short selling--the SEC has done a number of
things to prohibit what is called abusive short selling, the
illegal short selling, things like naked short selling, not
locating or borrowing the securities before short selling.
Regulation SHO, which was passed in 2004, and putting on not
only obligations to make sure you deliver those shares but
actually putting on the penalties for those, to the brokers
themselves, not to the individual. So, it was an interesting
way they dealt with that, and the number of fails to deliver
went way down.
Now again, that was 17 years ago. Is that a rule that the
SEC should possibly revisit? Absolutely, they should be doing
that.
Options trading also is highly regulated by the SEC. There
is a dedicated team within the Division of Trading and Markets
that oversees just the options market, and the Examinations and
Enforcement teams also have individuals who monitor for
noncompliance and wrongdoing in those markets.
And I apologize. Was there a third one that you asked
about?
Mr. Loudermilk. It was the short selling and order flow,
payment for order flow.
Mr. Piwowar. Payment for order flow. Yes, that is another
one where the SEC has regulations on that. We talked
extensively about the best execution obligations. Of course,
they should revisit whether they are working well in here. Of
course, they should revisit the transparency of payment for
order flow. Some of the witnesses have talked about the fact
that some of the measures of price improvement in the 605
statistics are not perfect. Rather than just throw them out and
say we can't use them, I would take a different approach. Why
don't we make them more transparent and more useful for
investors so that we can actually see how much improvement is
actually being given in the markets?
Mr. Loudermilk. My time is up. I will submit the other
questions for the record, and I yield back.
Chairwoman Waters. Thank you very much. The gentlewoman
from Massachusetts, Ms. Pressley, is now recognized for 5
minutes.
Ms. Pressley. Thank you, Madam Chairwoman, for convening
this hearing, and I thank all of the witnesses for joining us
here today. I represent the Massachusetts Seventh Congressional
District, which, like all districts across the country, is
reeling from the economic impacts of this pandemic. In
Massachusetts, since February 2020, over 200,000 fewer people
are employed, children in 12 percent of households do not have
enough food to eat, and many of the smallest businesses have
permanently shuttered their doors. Research shows that
following the 2008 recession, gambling in cheap lottery tickets
increased among those who continued struggling financially.
In this economic recovery, I am concerned that Robinhood
has positioned itself well to take advantage of this trend but
with much higher stakes from my lowest-income constituents.
Robinhood boasted the platform is democratizing finance for the
benefit of everyday Americans, positioning itself as the great
equalizer of capitalism. Meanwhile, it is running targeted
advertisements on social media that say, ``Millions of people
will soon begin receiving stimulus checks. As you consider
whether to spend, pay down debt, or save, we want you to be
prepared,'' with a link back to their own blog, which says
that, ``Never investing at all is a missed opportunity.''
Many of my constituents now just have a $1,400 stimulus, or
what I call survival check, in their bank account to get them
through months of expenses, and are positioned to lose hundreds
of thousands of dollars in options trading if they take that
gamble.
Ms. Goldstein, what do you make of these targeted
advertisements under the guise of promoting financial literacy?
Is Robinhood really increasing its own profits by attracting
new users after many existing users left the platform due to
the trading halt in GameStop?
Ms. Goldstein. Congresswoman, I have seen the same
advertisements you are talking about. I keep getting them over
and over again, in fact. And I do think that Robinhood--there
was a survey that was done by Fortune in the wake of Robinhood
freezing trading in GameStop and other main stock names, and
they found that about half of their users were considering
leaving Robinhood for another brokerage in the wake of that.
So, I absolutely think that Robinhood is looking to attract a
new user base that hasn't previously perhaps participated in
the financial markets, to account for what I suspect is a large
amount of users that they lost as a result of freezing trading
in GameStop.
And I should just flag that I disagree with the assessment
that regulation is the reason that Robinhood froze trading or
that the clearinghouse capital requirements are the reason.
Most major brokerages have very serious, dedicated teams that
evaluate the risk and the capital that they need to put forward
every day, and I suspect it may be Robinhood's inability to
manage its own risk and not the fault of any regulation.
Ms. Pressley. Okay. Providing an opportunity for people to
make informed investments in part of their financial planning
is not a bad thing. However, targeting the vulnerable Americans
who are receiving Federal relief during a pandemic suddenly is.
And this is not the solution to their hardship.
Ms. Goldstein, Robinhood proposes that turning everyday
Americans into day traders is democratizing finance, but you
have written that the real solution to breaking the power of
finance is to rebalance the recession-wracked economy. What
does democratizing the economy really look like?
Ms. Goldstein. Congresswoman, I think it means that we need
to rebalance our economy so everybody isn't struggling or
looking for the next gold rush scheme in order to pay their
rent if they are facing eviction. I think you have been a real
leader in this space, and so has the chairwoman and so has
Representative Adams and many others who have called on the
President to cancel student debts through executive authority.
I think there are a lot of different ways that we can tackle
this problem.
But I think one thing that we should think about, and you
all, as policymakers, can think about, is there is no way to
save for retirement right now that doesn't give a cut to Wall
Street. Unless you buy a savings bond or unless you are rich
enough to purchase a municipal bond, we always have to give a
cut to Wall Street if we want to save for our future. And 47
percent of Americans have no exposure whatsoever to the stock
market, and so they are not going to be able to use Robinhood
to try and make some wealth for themselves. And I think we need
to come up with other solutions in order to figure out how we
can build wealth, and there are a lot of potential solutions.
The American Rescue Plan is a part of it, but I think we need
to do much more, and I thank you for your leadership on the
resolution on cancelling student debt.
Ms. Pressley. Thank you. I have tons of ideas: canceling
student debt; Federal job guarantee; baby bonds. One thing is
for sure, we need to be investing in people and in jobs, and
thinking about transformational, bold policies, and that is
what I will continue to push for to close the wealth gap and to
create opportunities in our communities.
Thank you for being here today.
Chairwoman Waters. Thank you very much. The gentlelady
yields back. The gentleman from West Virginia, Mr. Mooney, is
now recognized for 5 minutes.
Mr. Mooney. Thank you, Madam Chairwoman. In the aftermath
of the market volatility in January, acting Chair of the SEC,
Allison Herren Lee, released a statement saying that the SEC
would, ``act to protect retail investors when the facts
demonstrate abusive or manipulative trading activity that is
prohibited by Federal securities laws.''
So my question is for Mr. Piwowar. Will you discuss the
types of fraud that are currently prohibited and detail the
breadth of securities laws that govern manipulation and false
statements?
Mr. Piwowar. Thank you, Congressman, for that. I am not
sure I can address all of them in 5 minutes but I will maybe
give you an overview of some of them.
One is you cannot trade on material nonpublic information
in the breach of a fiduciary duty. So, that would be insiders
having information that they are using to disadvantage retail
investors. You cannot engage in manipulative trading activity,
and that can take the place of doing, for example, the typical
pump-and-dump schemes, where people put out into the
marketplace and the internet, wherever, false and misleading
information that would paint a rosy picture of a particular
company, trying to increase the share price after they have
already bought the security. So, they pump up the securities
and then dump their shares at the high price, leaving retail
investors holding the bag afterwards.
You cannot engage in other manipulative trading activity,
in the case of very high frequency trading. You cannot do
spoofing and those sorts of things to give the appearance that
you are providing liquidity and pull that away in order to
induce traders to trade in those sorts of things.
There are all kinds of different securities laws that
protect investors. I will also note that the SEC's Enforcement
Division has a specific enforcement group dedicated to market
abuses, and it is one of, actually, the most effective and most
productive enforcement teams at the SEC in rooting out these
abuses.
Mr. Mooney. Quick follow-up, Mr. Piwowar, you indicated in
your testimony that you had confidence that the SEC is well-
equipped to identify and act upon market manipulation as it
relates to the GameStop case. Is that correct?
Mr. Piwowar. Absolutely correct. One, they have the
authority to do it, and two, they have an incredible
enforcement staff, particularly the market abuse team is very
good at looking at these. There is not only the enforcement
staff in Washington, D.C., but also 10 different regional
offices across the States are looking into this.
Mr. Mooney. Okay. I just want to say, listening to the
interviews from some on the left, you might not realize that
the SEC already has the tools to go after market manipulation.
Instead, you hear accusations, like those from Senator
Elizabeth Warren, that our capital markets are rigged for the
rich and powerful. If anything, the GameStop case is an example
of how lots of small retail investors can bet against a large
hedge fund and win. It is not a rigged market. It is a free
market.
So when I hear some of the so-called solutions offered by
my friends, my Democratic colleagues, that they put forward, I
am reminded of the quote from the great Milton Friedman: ``Many
people want the government to protect the consumer. A much more
urgent problem is to protect the consumer from the
government.''
As we hear these proposals from Democrats on these panels,
I just think we should ask ourselves, will this actually help
retail investors? A couple of questions, like, would
restricting or banning payment for order flow really help
retail investors that benefit from no-commission trading? Would
a financial transaction tax benefit the retail investors that
would be forced to pay it? The answer to both of those
questions is no.
So, instead of using January's market volatility to
advocate [inaudible] protect investors from these attempted,
failed, so-called solutions that will do more harm than good.
Thank you, Madam Chairwoman, and I yield back.
Chairwoman Waters. Thank you. The gentleman from New York,
Mr. Torres, is now recognized for 5 minutes.
Is Mr. Torres on the platform?
[No response.]
We are going to move on to Ms. Adams. The gentlewoman from
North Carolina is now recognized for 5 minutes.
Ms. Adams. Thank you, Madam Chairwoman. Thank you very
much. And thank you to all of the witnesses as well.
Mr. Blaugrund, did the markets operate the way they were
supposed to, or are there some fundamental vulnerabilities that
have been exposed? From the vantage point of the stock
exchanges, where, if any, are the existing weaknesses within
the system?
Mr. Blaugrund. Thank you very much for the question. I
think, as the SEC reported and as a number of the panelists
have noted, the core market infrastructure operated very well.
It is very resilient. It is very available. From the exchange's
perspective, our job is really to do four things: ensure
continuous price discovery; facilitate risk transfer; regulate
our members' activity in the market according to exchange rules
and securities laws; and ensure compliance of listed companies
with their continued listing standard obligations. All of those
functions operated well.
However, it certainly is the case that the retail investor
experience was uneven across retail brokerages, and it is the
case that for a listed company like GameStop, you are left with
a lot of confusion about how a modern market structure could
result in your stock having such volatility in such a short
period of time.
I think when we look at potential reforms for the
marketplace, there are a couple of relatively low-hanging
fruits that we can focus on that would have significant
benefits and reasonably low impacts in terms of unintended
consequences.
Ms. Adams. Okay. Thank you, sir. Let me move on. Ms.
Goldstein, I would like to bring up the problematic use of
forced arbitration by both financial institutions and tech
companies. Section 921 of the Dodd-Frank Act gives the SEC the
authority to limit or restrict forced arbitration, which
currently is overseen by FINRA. Should the SEC use this
authority under Dodd-Frank to examine whether it makes sense to
curtail forced arbitration for gamified investment companies?
Ms. Goldstein. Congresswoman, thank you for the question.
Absolutely, I do think the SEC should take a long-overdue
action to restore investor choice and make sure that we are
prohibiting forced arbitration and prohibiting class action
bans. There is a lot of talk in the discourse right now about
cancel culture, but I like to think about forced arbitration as
cancel culture for companies who try to cancel the victims of
crimes by silencing them and putting them in arbitration and
not letting them speak their voice in a court law and tell
their truth. They don't have a right to appeal, and it is this
secretive process that, in my opinion, tries to cancel their
own customers.
So I absolutely think that the SEC should do whatever it
can to restore investor choice and prohibit forced arbitration.
Ms. Adams. Thank you, ma'am. Do you believe the current
arbitration process works, or should the SEC step in and
exercise its authority under the Dodd-Frank Act when it comes
to FinTechs, in particular?
Ms. Goldstein. Congresswoman, I think that arbitration can
work for some people, but it is by no means a guarantee, and I
do not think that companies should be forcing their customers
into arbitration without having the choice of going to argue
their case in a public court of law if they choose to do so. I
think it should be up to the customer, and I don't think that
companies should be forcing them into arbitration.
Ms. Adams. Thank you very much. Madam Chairwoman, I yield
back.
Mr. Sherman. [presiding]. Thank you. Our Chair is voting
now and has asked me to take over and recognize Mr. Davidson of
Ohio.
Mr. Davidson. Mr. Sherman, I thank you, and I thank our
witnesses for your explanations. We are all reading through
your comments and drawing our own conclusions. I don't know if
we will have moved any closer to consensus, but I hope that we
will look at some important work done about blockchain.
On the day of our first GameStop hearing, I sent a letter
to the Depository Trust & Clearing Corporation (DTCC) to
request a status update on two of their internal projects,
Project Ion and Project Whitney. These projects explore the
potential future use of blockchain technology within our
capital market infrastructure. Last week, I received a response
from them, and I would just like to take a second to thank DTCC
for their ongoing transparency with me and with my staff.
Between their response to my letter and their February 24th
White Paper, I am optimistic that we will find a solution to
improve upon our current capital market infrastructure. I look
forward to continuing our ongoing conversations with the issue
and hope to expand that with colleagues.
When you talk about market structure, Mr. Piwowar, you are
clearly an expert on the cycle, and as we talk about the clear
feasibility of moving from T+2 to T+1, even to T-zero, could
you differentiate between, say, T-zero and same-day settlement
as an example versus real time, and basically focus on netting.
Why is that something people focus on? You could be same-day
and do it real-time or you could be same-day and do it in a
netted effect. Could you explain that?
Mr. Piwowar. Thank you, Congressman. And I think some
people refer to that as same-day, but allowing meeting would be
like T+1/2, or something like that, as I think people are
talking about it.
What happens is you have multiple market participants
bringing a number of transactions to the clearinghouse, and
they can clear those on a gross basis, which means they have to
clear every transactions that is there. And that would be
hundreds of billions of dollars.
But what the clearinghouse can do to improve the efficiency
of doing this is to net some of these trades. So, for example,
if you and I are two market participants, maybe we are
algorithmic traders and we have two orders that are of the same
size and happen to be the same price, we can net those out and
not even have to clear--I am on one side and you are on the
other. And there are ways to do partial netting and those
things, and it introduces a lot of great efficiencies to the
system.
Mr. Davidson. Thank you for that, and I understand some of
those efficiencies are similar to a sweep account; there is no
benefit beyond the one day, in terms of intraday for a lot of
things. But there are times where it does make a difference.
One of the key things is custody, and part of the challenge is,
how do you prevent multiple claims to the same shares? As Mr.
Perlmutter highlighted, clearly, when you have that gap you had
people promising the same shares to multiple parties, and that
is what you can clearly do with real time. Do you think you can
get there if you settle for anything less than real time?
Mr. Piwowar. There are a couple of points there. One is, we
talked about the rehypothecation situation in securities
lending, and I think that is where there is consensus among the
panel members here to getting greater transparency into that
market and to look at whether there are any regulatory actions
that need to be taken there.
In terms of T+1/2 or T+1, this is where the SEC should put
this out for comment. There are competing costs and benefits on
both sides of this. One issue that has not come up in this
hearing, that I have pointed out in my Wall Street Journal op-
ed and in other places is that the SEC, once you get the T+1 or
same-day, the SEC can't do this alone. You also have to get the
bank regulators involved, because we need to make sure the cash
gets there, and now you are bringing in the bank-regulated
payment system, PCH. Add to that, what about foreign currency
transactions for cross-border trades? That has to be settled.
So it's not something that you can't overcome, but this is
one where the SEC is going to have to coordinate with the bank
regulators to make sure that all of these pieces fit together.
Mr. Davidson. I thank you for that, and I will say that the
blockchain coupled with the payment system, smart contracts,
could settle all that without an intermediary. And I think
that, at scale, is the question, and we may be a ways out from
that.
I want to highlight just the SEC suspending trading for
certain shares based off of essentially social media posts. You
talked about stocks that are not paid much attention to. With
the democratic access to capital that is happening because of
FinTech, because of technology broadly, and because more people
are looking at doing it, essentially the SEC is saying, well,
we are going to intervene, and just because a stock gets more
attention, we can suspend that. I think that is a dangerous
thing for them to filter. Just because a stock starts getting
attention, they are going to close off the market access.
I wish I had time to explore this, but the ramifications
for the SEC doing that are really big. It essentially says they
are going to impose a value range, and when you deviate from
that, it is a problem.
Thank you, and I yield back.
Mr. Sherman. Now, I yield 5 minutes to Ms. Tlaib of
Michigan.
Ms. Tlaib. Thank you so much, Mr. Chairman, and thank you
all so much for being here.
Mr. Kelleher, I know that earlier, you had testified that
our markets are the envy of the world, and I think, to quote
you, you said they are, ``transparent, well-regulated and
policed.'' We have heard a lot from my colleagues across the
aisle that retail investors should have more access to markets,
like private equity. So, Mr. Kelleher, did you know that the
private equity industry controls more than 8,000 companies in
the United States? That is more than double the number of
companies publicly traded on the U.S. stock market.
Mr. Kelleher. Right. The premise of much of the discussion
so far has been that--
Ms. Tlaib. I have questions related to that.
Mr. Kelleher. Sorry.
Ms. Tlaib. I have questions related to that. I just wanted
you to be aware, as I am asking some of the questions. But
across the country [inaudible].
Mr. Kelleher. I am not actually able to hear what the
Congresswoman is saying.
Mr. Piwowar. I can't hear it either.
Mr. Sherman. Yes. We will try to deal with the technical
difficulties. We will suspend the clock on the gentlelady's
time.
Mr. Kelleher. Congresswoman, nobody was able to hear what
you just said.
Ms. Tlaib. Sorry. Can you hear me now?
Mr. Kelleher. I can.
Mr. Sherman. We can hear you, Ms. Tlaib, so why don't you
proceed?
Ms. Tlaib. Thank you so much, Mr. Chairman. I apologize for
that, Mr. Kelleher. One of the things that I would like to hear
from you is, do you think the current regulation of private
equity meets your standard of, ``transparent, well-regulated,
and policed?'' Yes or no?
Mr. Kelleher. Absolutely not.
Ms. Tlaib. Is it true that private equity firms don't have
to share data on their climate risks?
Mr. Kelleher. Correct.
Ms. Tlaib. How about how they treat their workers in their
portfolio company?
Mr. Kelleher. Not that I am aware of.
Ms. Tlaib. Is it true they do not have to share data on
whether they are promoting racial equity and diversity?
Mr. Kelleher. They do not. They are private companies. The
disclosure is almost zero.
Ms. Tlaib. That is right. And even though they, again,
control more than double the number of companies publicly
traded on the U.S.--it is double. It is 8,000 companies in the
United States. So, I thank you for that, Mr. Kelleher.
Ms. Goldstein, would you agree that private equity firms
use this lack of transparency to shield themselves from harm
they do to our workers and our communities?
Ms. Goldstein. Yes, Congresswoman, I agree.
Ms. Tlaib. Ms. Goldstein, we know that pension funds are
some of the largest investors in private equity. That is where
it impacts my residents. Many of my residents in my district
are relying on their pensions to retire with human dignity.
Aren't their retirements at a higher risk because we don't
require private equity firms to make the same disclosures as
publicly traded companies?
Ms. Goldstein. Congresswoman, yes, I think that is a risk
of private equity. I think it is also a risk with hedge funds,
which also lack many of the disclosure standards that other
types of firms have to submit. So yes, I would agree with you.
Ms. Tlaib. I am asking many of my colleagues, and I think
this is something that we can work together on, in a bipartisan
way, and I am really grateful for the committee to be focused
on making public markets fairer and more transparent for retail
investors. But we truly do owe it to our working people, our
neighbors around the country, to hold private equity firms to
the same standard, rather than allow them to continue looting
businesses across the country.
I yield back.
Chairwoman Waters. Thank you. I now recognize Mr. Budd from
North Carolina.
Mr. Budd. Thank you, Madam Chairwoman. This is the second
committee hearing on this topic, and once again, I am appalled
by some of the comments I have heard from my colleagues on the
other side of the aisle. The notion that retail investors are
even being referred to as, ``dumb money'', I think it is
absolutely insulting. Let's remember that retail investors are
smart and they are a force to reckoned with, and that
revolutionizing the market in any legislative or regulatory
changes to interfere with their ability to trade and have
access, I think that would be an absolute tragedy.
Mr. Piwowar, do you believe that the SEC is well-equipped
to make value judgments as to what constitutes a good or a bad
game-like feature, and in your opinion, do you believe that
gamification is actually this grave systemic danger that my
friends on the other side of the aisle make it sound like?
Mr. Piwowar. Thank you, Congressman, for that question. In
terms of the gamification that Robinhood is apparently using, I
am not a customer, I don't have the app, so I can't comment on
that. Certainly, the SEC is well-equipped to look at whether
certain gamification features violate existing standards under
the law, and they will prosecute accordingly to that.
One point I want to mention is that gamification, as a term
as is being used here, very narrowly, is to point out that
there are types of games that are out there, simulations, that
are very valid ways for people to learn. In fact, business
schools, MBA programs are abandoning many of the traditional
case method and lecture-type classes and encouraging the
students to learn through gamification, simplification.
Cybersecurity classes are being taught through gamification.
You can't teach it out of a textbook, and those sorts of
things.
So, this is part of our society that is going forward. It
is obviously something the SEC has to look at. But to paint a
broad brush and to say that gamification is necessarily bad or
a systemic issue, I think would be too broad of a brush.
Mr. Budd. My view is this makes the SEC take their eye off
the ball. Do you think the SEC should instead focus on the
traditional role of determining when investment advice has been
provided by a brokerage?
Mr. Piwowar. Yes, in fact they are well-equipped to do that
and they, in fact, just updated the regulations on that. The
SEC just recently promulgated Regulation Best Interest, which
was on the broker-dealer side, what was the old suitability
standard has now been enhanced to be called the Regulation Best
Interest, making it very close to, if not higher than the
fiduciary standard on the investment advisor side. And also,
the SEC doesn't do it alone. They also have FINRA, the self-
regulatory organization, that has its standards and polices
those standards.
Mr. Budd. Thank you. There has been a lot of attention
given to the clearance and the settlement process. In your
former capacity as acting Chairman of the SEC, you led the
effort to move officially from T+3 to T+2. So following up on
my friend and colleague from Ohio, I look at the blockchain and
I see a potential avenue for innovation in this area. Is it
possible for clearinghouses, in addition to real-time
settlements on a blockchain, to coexist while pursuing
something like T+1 or T-zero?
Mr. Piwowar. Yes. I think there are a couple of ways that
we could do this. When we move from 3 to 2 we put in the final
rule that the SEC should continue to study and look at what the
industry enhancements were in terms of technologies to
facilitate moving to 1 or real-time settlement. I think real-
time is further off, and the question is, do they want to put
all their eggs in one basket and try to pursue real-time, which
could take a long time, or the SEC could do a dual-track
approach, which is, let's look at potentially moving to T+1 in
the short term but also signal to the industry that in the long
term, they are thinking about moving to same-day settlement, to
the extent that things like blockchain evolve to that point,
and again, having to coordinate with the banking regulators to
make sure that the cash actually gets there through the bank
payment systems. Their systems are outdated too.
Mr. Budd. Thank you. As technology evolves, we still want
to have the position that we are the financial envy of the
world, the financial markets are the envy of the world. So,
what sort of regulatory requirements should the SEC update in
their review in order to remain and continue to grow in our
strength?
Mr. Piwowar. Thank you, Congressman. I think as a general
matter, the SEC should be in the habit of periodically
reviewing all of the rules. I think, to your point, in the
markets, in particular, because markets and technologies evolve
so quickly, things like payment for order flow, things like
transparency in that market, things like making the securities
lending market more transparent, are all fruitful areas for the
SEC. And to your point, we are the envy of the world, but
everybody is gunning for us, so we need to make sure that we
maintain our leadership.
Mr. Sherman. The time of the gentleman has expired, and I
now recognize Mr. Torres from New York for 5 minutes.
Mr. Torres. Thank you, Mr. Chairman. I have concerns that
payment for order flow perversely incentivizes the highest
payment for the broker rather than the best execution for the
customer. There is a reason we call it payment for order flow.
No one calls is best execution order flow.
My first question is for Ms. Goldstein. Should payment for
order flow be permitted?
Ms. Goldstein. Congressman, thank you for the question. I
always refer back to the 2016 SEC memo where they asked this
question. I think that is one approach we could take. We could
just outright prohibit it. Another thing the SEC could do would
be to require the brokers to pass on the payments for order
flows to their customers. And another approach could be
requiring that customers be able to opt out. I think there are
multiple approaches that they could take, but I do think that
we do need to do something, yes.
Mr. Torres. I am concerned about the conflict of interest.
About a week ago there was a hearing in the Senate, and
according to Duke University School of Law Professor Gina-Gail
Fletcher, who testified at a Senate hearing, the racial gap in
retail investing has been cut in half in 5 years.
And so, here is what I am struggling with, how do we
address the conflict of interest? How do ban the worst of
payment for order flow without losing the gains that appear to
have been made in market access?
Ms. Goldstein. Congressman, I think it is a great question.
I think we need to just ensure that the SEC can take all of the
enforcement actions that it needs to take. I have been very
enthusiastically listening to all of the Republican Members, in
particular, giving the SEC lots of work to do, and I would
encourage those Members to make sure that the SEC is adequately
funded so it can pursue all of these investigations into
whether or not best execution is being upheld by brokerages,
and whether or not there are any particular conflicts of
interest. And so, I would encourage them to make sure that
there are the right appropriations.
And I think we just need to make sure that the markets are
fair, and that doesn't just mean funding our agencies, but that
means looking into whether there are regulatory blind spots. I
personally think that there is a big regulatory blind spot in
hedge funds and in private equity funds. For example, we don't
know what amount of stock hedge funds are shorting, because the
Form PF that they have to disclose their positions on does not
include shorts of stocks.
So, I think we have a combination of, we need to make sure
that we are enforcing the law and have the resources to do it,
but also make sure that, perhaps we need more legislation to
address regulatory gaps, and then we won't have to choose
between those two things that you outlined.
Mr. Torres. And I strongly support greater transparency. I
have a question about brokers. The controversy surrounding the
GameStop short squeeze arose from Robinhood's decision to
restrict trading. Setting aside Robinhood for a moment, it
seems to me that brokers, in general, have almost absolute
power to restrict whatever retail trading they want, whenever
it wants. Should there be any legal limits on the ability of a
broker to impose trading restrictions? Should we limit trading
restrictions to conditions of market volatility? What are your
thoughts on that?
Ms. Goldstein. Congressman, I think it is a good question
for the committee to consider. I do think brokerages need to
make sure that they don't go belly-up, and I do think that
Robinhood, in particular, perhaps was facing a period where
perhaps they didn't manage their own internal risk
sufficiently. Perhaps they didn't predict what their capital
requirements would need to be to the clearinghouse, and so I
think that might have been a failure of their own business. But
if the choice is between prohibiting trading in a stock that
they might not be able to handle, because perhaps they haven't
managed their business well, or just going under, I kind of
understand that you might want to take the less drastic
approach.
Mr. Torres. I want to interject, because my time is running
out. I have a question on market makers. Suppose there was a
company named Goliath, with a market-making arm and a trading
arm. And suppose the market-making arm collects vast quantities
of retail and real-time information about vast numbers of
retail investments. Could the market-making arm legally share
that information with the trading arm?
Ms. Goldstein. No. No, they need to have a firewall
between. If they have a prop trading desk and their market
makers, there must be a firewall.
Mr. Torres. That is great. That takes care of my questions,
so thank you.
Chairwoman Waters. Thank you very much. The gentleman from
Tennessee, Mr. Kustoff, is now recognized for 5 minutes.
Mr. Kustoff. Thank you. I would like to thank the
chairwoman and the ranking member for convening today's
hearing. I would also like to thank all of the witnesses this
morning and this afternoon.
Director Piwowar, if I could, with you, I think one thing
that--or at least I would think everybody could agree on,
regardless of what side of the aisle you are on, is going back
to GameStop, that day in late January, we don't want any
investor or any trader being shut out, if you will, not being
able to make a trade, to buy or to sell.
When we had our hearing last month with GameStop, I
questioned the CEO about his arguments that the settlement
time, T+2, T+3. What I got out of it was that he essentially
thought that if it were same-day settlement or even T+1, that
they may not have been in the situation that they were in,
having to deny people access to their app.
My first question to you is, would you agree, if it were
T+1 or same-day settlement, would we have seen the scenario
that we did in late January, with GameStop?
Mr. Piwowar. Thank you, Congressman. I don't know the exact
numbers but I do know that if there was a shorter trade
settlement cycle, Robinhood's margin calls would have been a
lot less. Now, I don't know how much they would have been
relative to their financial resources, but it would have been a
lower likelihood certainly.
And if I may, a point that Ms. Goldstein is bringing up is
that the situation was uneven across broker-dealers here,
right? So, one of the things the SEC is looking at is not only
across the industry, whether to shorten the trade settlement
cycle, but also whether or not Robinhood's risk management
policies and compliance procedures were actually adequate. And
that is something they are looking at in here too.
So, when I say we should look at shortening the trade
settlement cycle it is not because of the particular
performance of one broker. They happened to bring the issue up
and it is something that I felt very passionately about when I
was at the Commission and started a path on, and they continue
to do that. But I don't think we should overlook the fact that
we had different impacts across different brokers.
Mr. Kustoff. Thank you. I may have said, ``CEO of
GameStop.'' I did mean, ``CEO of Robinhood'', and I appreciate
you interpreting that and correcting it.
You went through this exercise when you were with the SEC
and helped to lead the effort to shorten the settlement time.
Can you take the other side of the argument, if you would? Why
would people advocate against going from T+2 to T+1? What are
the arguments against that?
Mr. Piwowar. Sure. So, one is cost. The industry is going
to have to incur some costs in order to do that. Now, what the
SEC has to do is weigh those costs against the benefits from
shortening the trade settlement cycle. Again, the benefits are,
you are lowering market liquidity, credit, and systemic risk in
the system. Once you start approaching real-time, you are
actually increasing operational risk, because everything has to
work perfectly together at the same time--the cash has to get
there, the securities have to get there, if you have a foreign
currency settlement that has to happen at the same time. And
so, the arguments against are just based solely on a cost-
benefit framework.
Now, 4 years ago, cost-benefit analysis showed that T+2 was
the clear winner. Four years have passed and we have changes in
technology, we have changes in markets. It is time for them to
re-evaluate, and I wouldn't be surprised if T+1 were the clear
choice, but maybe not. That is why I believe the SEC should at
least go through the exercise.
Mr. Kustoff. And if you were to project--let's assume that
the SEC does make the decision to go to T+1, what is a
realistic framework or time period?
Mr. Piwowar. Thank you, Congressman. Again, the SEC can't
do this in isolation. Once you go down to 1, they are going to
now have to get the bank regulators involved, because you have
to make sure that the cash payment systems align with the
security settlement system. The SEC could put itself on a
timeline, but you have to also get all the bank regulators.
So, that is why I was advocating that Secretary Yellen
should start a workstream at the Financial Stability Oversight
Council, which is the coordinating body among all of the
regulators. And so, using her power as Chair of the FSOC, she
can actually help shorten that time period by getting the
regulators to all row in the same direction.
Mr. Kustoff. Thank you, sir, and I yield back.
Chairwoman Waters. Ms. Dean is now recognized for 5
minutes.
Is Ms. Dean on the platform?
If not, we will move to Mr. Garcia. The gentleman from
Illinois, Mr. Garcia, is now recognized for 5 minutes.
Mr. Garcia of Illinois. Thank you, Madam Chairwoman, and
Mr. Ranking Member, for the discussion today, and, of course,
all of our witnesses.
Last month's GameStop hearing revealed a lot of different
viewpoints about what happened, who was responsible, and what
we can do about it. As always, there are a lot of technical
details, but when people in my neighborhood think about
finance, they aren't thinking about these details. They are
thinking about losing their house, as many did in 2008. They
think about the stock market at record highs during this
pandemic while unemployment soars. In short, they think about a
game rigged against them. And if you ask me, what happened to
GameStop earlier this year proves them right.
I have some questions for a couple of our witnesses. Mr.
Kelleher, people talk a lot about how retail trading is
democratizing finance and helping the little guy, but from your
testimony it seems like the current system of retail trading
does the opposite. It rewards huge firms that can handle lots
of trades and it rewards high-frequency trading. Do you think
that payment for order flow model of retail trading actually
entrenches big players?
Mr. Kelleher. It does, and the fact that those big players
have almost no disclosure obligations and very few regulations
makes it even worse. The one thing that hasn't been brought up
that is a major problem, is that the Citadels of the world are
a big part of the shadow banking system. There is a lack of
transparency. There is a lack of regulation. There is a lack of
oversight. There is a lack of accountability. All of that
enables secret wealth extraction by the big dogs in finance,
all at the expense of the retail investor and the retail
trader, and that all needs to be looked at and changed.
But the one thing we know for sure, and Sal talked about
this earlier, is the retail investor ends up getting, time and
time and time again, the worst deal. That doesn't mean we are
not in favor of more retail investors. We would love to see
more retail investors. We just think it should be a level
playing field. We think they should be treated fairly. Right
now, they are discriminated against dramatically. They are in a
terrible position and being picked off, and they shouldn't be.
So, we are not against democratization. What we are for is
a level playing field, transparency, accountability, and
fairness, and that will increase confidence and that will
increase retail investors.
Mr. Garcia of Illinois. Thank you for that. Ms. Goldstein,
in your testimony, you mentioned that the GameStop incident
revealed more than just volatile stock prices. You mentioned
that the rise of retail trading and the dominance of certain
hedge funds like Citadel could threaten the stability of our
financial system. What do you think that regulators such as
FSOC should do to keep the volatility that we saw in January
from affecting our whole financial system, and what can
Congress do to help our regulators do their job?
Ms. Goldstein. Thank you for the question, Congressman
Garcia. I think there used to be a hedge fund working group at
the FSOC, that was shut down under the Trump Administration.
And before they created it, one of the things that they noted
in a report was that there was no single regulator that had all
of the information that they needed to look at a complete risk
profile of hedge funds.
And so, I think an easy thing for Secretary Yellen to do
would be to restart the hedge fund working group, to look at
risks to the system that hedge funds possibly contribute.
I also think that Citadel Securities is a particular thing
that they should look at closely. I want to flag that almost 10
years ago, when Citadel tried to start an investment bank,
there was a lot of reporting at the time that people were
confused about how they were going to have success in
investment banking, because they were known as a business
partner who charged their clients more than most funds did. And
I feel like that reputation perhaps may have followed them into
electronic trading.
But Citadel has talked a lot about their importance in the
marketplace. My question is, are they systemically important?
Congressman, you, I think, have an important bill, to make sure
the FSOC has the tools that they need to identify systemic
risk, and I think Congress should continue to ask the question,
is there more legislation that is required to make sure that we
do have the tools we need to identify systemic risks in the
system? And I think the regulators should ask themselves the
same question.
Mr. Garcia of Illinois. Thank you very much, and given that
I have to go vote, Madam Chairwoman, I yield back.
Chairwoman Waters. Mr. Rose is now recognized for 5
minutes.
Mr. Rose. Thank you. Thank you, Madam Chairwoman, and thank
you to Ranking Member McHenry, and thanks to our witnesses for
your testimony and participation today.
One month later, the committee investigation is barely
underway, and I view any policy proposals so far as premature.
At the core of market regulation is transparency, providing
investors information and giving them the opportunity to make
informed choices. We should not be adding regulatory barriers
to keep people from participating in our capital markets.
Instead, we should be opening up our markets to everyday
investors and providing them with the information and
transparency to participate in an informed way.
Despite the intense volume and exposures presented in the
market, the broader infrastructure of our financial markets has
performed well. My concern, like many of my colleagues, is that
forging ahead with new regulations or ideas like the financial
transaction tax, at this point, would be harmful and would have
unforeseen consequences.
Dr. Piwowar, you highlight the importance of a
comprehensive economic analysis as part of the rulemaking
process, as it allows us to evaluate tradeoffs. I agree with
you. Will you detail the implications of a knee-jerk reaction
to the events that occurred in January?
Mr. Piwowar. Thank you, Congressman, for that question.
Yes, the SEC is well-equipped to do economic analysis, and, in
fact, is required by law to do so. When it comes to market
structure issues, as I said in my written testimony, there are
no solutions; there are only tradeoffs. And the reason for that
is multidimensional. One is that our market structure is very
complicated. It is a consequence of dozens, if not hundreds of
decisions that have been made over the course of decades.
And so, any change in one area will necessarily have likely
effects in another area. That doesn't mean we shouldn't go
forward and make changes. What that means is that when we do
think about making changes, we need to think about what the
likely effects are. What are the tradeoffs? What are the costs?
What are the benefits? What are the expected changes in
behavior? And then evaluate all of those, but also explicitly
look at alternatives to the possibility that is there.
For example, payment for order flow, we could look at the
existing situation. One alternative is to ban it and look at
that, and Ms. Goldstein has brought up a couple of other sort
of in-between steps in there, and explicitly look at all of
those, and then based upon that analysis, you can do a
reasoned, rational approach to come out with which of these is
the best path forward.
Mr. Rose. So if we were to review and reform payment for
order flow, Dr. Piwowar, what reforms do you think the SEC
could implement to increase transparency for retail investors?
Mr. Piwowar. Thank you, Congressman. I think, as I
mentioned, there are these things called 605 reports, which is
just a fancy SEC rule on that, and they give a little bit of
information in terms of execution quality for retail investors.
And the SEC has revised them over time, and some of my fellow
witnesses have pointed out some of the problems and holes in
it. The National Best Bid or Offer doesn't necessarily include
all of the odd lots, and there are some other things that we
should do to that.
I think what the SEC should do is consider looking at those
605 reports that firms like Citadel have to do, so we get a
better sense of what the execution quality is, not just price
improvement, but speed of execution, what is the real MBBO.
Separately, there are different types of reports that firms
like Robinhood have to do, which are called 606 reports. They
are not very granular at all, and I think that we could do a
lot to provide some more transparency into the 606 reports and
the 605 reports so that we can find out, for particular
customers, at particular brokers, that send their trades in
particular stocks, to particular wholesalers, how well are they
doing. I think that would help shed a lot of light in terms of
public transparency of best execution.
Mr. Rose. Thank you. In the challenging global economy, the
strength of our capital markets is vital to long-term economic
growth, yet regulatory burdens and increasing amounts of red
tape prevents small businesses from thriving, and stifles
American innovation. The advances we have seen over the last
decade in technology have improved the way Americans and our
businesses perform financial activities. Due to these
advancements, we are seeing more investors, who have
historically been left out, active in the markets, and we
should not stand in their way.
With that, Madam Chairwoman, I yield back.
Chairwoman Waters. Thank you. The gentlewoman from
Pennsylvania, Ms. Dean, is now recognized for 5 minutes.
Ms. Dean. Thank you, Madam Chairwoman, and I thank all of
our witnesses today for shedding light on these important
questions and issues.
I am thinking back, Madam Chairwoman, to our hearing a
month ago. At that hearing, I questioned, and we all did, Mr.
Tenev of Robinhood, and he acknowledged mistakes or failures by
his company about actions that the company took to inform
customers, but he struggled to tell us what he was
acknowledging or what he was apologizing for. We did not
receive a clear, direct answer about when and how customers
were notified, and whether customers had the ability to contact
a customer service representative with any concerns about their
positions and holdings. He was simply unable or unwilling to
express what he was apologizing for.
Ms. Goldstein, I have had the chance, my office has had the
chance to discuss with you servicing failures in other
industries. What failures--and I am a former professor of
English, and I just want plain English here--what servicing
failures or failures or mistakes by Robinhood on January 28th
would you observe?
Ms. Goldstein. Congresswoman, thank you for the question. I
think that they probably--I don't have a crystal ball and I
don't have insight, but I think they may have failed to manager
their internal risk. My understanding, anecdotally, is that
major brokerages typically have very large teams of people who
model the capital requirements that they will likely need to
give to their clearinghouse on any given day. I would be very
curious to know how many employees at Robinhood were dedicated
to that task. Was it 10? Was it 20? Was it 5? Was it 0?
I also think that, at least historically, they have not
done a great job of disclosing to their customers how they make
their money, although I don't think--to speak to your
question--that was true on that day in January.
Ms. Dean. I am wondering, what should we now consider new
best practices or best practices going forward, to avoid what
we saw on January 28th?
Ms. Goldstein. Congresswoman, I think we need the
regulators to do an investigation, and get all of the
information. I think we need to make sure that there aren't
data gaps. One of the big questions I have is not what was the
retail footprint, but what was the footprint of institutional
players, and were institutional plays exacerbating the
volatility because they were watching what was happening on
Reddit and deciding to go along for the ride and maybe make
GameStop shoot up higher or come back down lower in the days
that followed?
And I think one of the questions that I have is, are there
regulatory gaps in the reporting of what are called over-the-
counter options, which are options that are not traded on
exchanges but are traded between big Wall Street players,
between themselves, and could that kind of trading, which is
often counterbalanced or hedged with stock, have contributed to
the volatility? And that is one of the questions that I have.
Ms. Dean. That is really interesting.
Dr. Bogan, I know I have very limited time, but could you
tackle the same question? What were the failures? And I would
also like to hear more about how these servicing practices
nudge user behavior.
Ms. Bogan. I will start with the last one first. I think
when we think about these online brokers that use gamification,
I think, just to be clear, access is a great thing for users to
have. But developing techniques that push retail investors to
trade a particular way or elicit particular behaviors, is not
beneficial for retail investors.
Some of the practices they have that have been mentioned,
that are encouraging trading behavior to the detriment of the
investor, are things like having lists of 100 popular stocks,
which draw attention to particular stocks, which causes people
to trade even though it may or may not be in their best
interest, and there are push notifications which elicit this
kind of response of fear of missing out, which encourages
people to trade, because it is triggering a particular
behavioral bias.
Additionally, I know people have talked about kind of the
confetti and it looks like a game. Yes, that does make it fun,
but it does belie the real risks that investors are taking on.
Another important point, too, that I don't think has been
brought up, is that some of these investors are targeting the
younger market, which is great to encourage new people into the
markets, but they are specifically targeting a segment that is
less financially literate, according to every survey, and less
likely to be sophisticated. And so, I think those are concerns
as well.
Ms. Dean. Certainly, those are concerns. And quickly, with
the time remaining, Dr. Bogan, you talked about clear, concise
disclosures about customer risk. Can you point to any examples
of those?
Ms. Bogan. I'm sorry.
Ms. Dean. I will yield back. I will submit questions.
Chairwoman Waters. Thank you. Thank you so very much. The
gentleman from South Carolina, Mr. Timmons, is now recognized
for 5 minutes.
Mr. Timmons. Thank you, Madam Chairwoman, and Ranking
Member McHenry, for convening this hearing today, and to our
witnesses for their time and expertise.
Since the first hearing in the series, I have continued to
research and attempt to understand the root causes of trading
halts, retail investors, the dynamics of trade settlement, and
the other issues in this hearing. While these topics can be
overly technical, it remains imperative that our financial
markets continue to function effectively while not limiting the
increased market participation of investors of all income
levels. We also should not rush to any rash decisions that
could have unintended consequences further down the line.
My first question is for Mr. Piwowar. As you have stated,
you were involved in the transition from settlement going from
T+3 to T+2. In your opinion, what roadblocks will market makers
and participants face in the transition from T+2 to T+1, and do
you believe that this can be achieved earlier than the initial
timeline?
Mr. Piwowar. Thank you, Congressman. I don't think there
are any roadblocks from the market participant side. In fact,
when we went from T+3 to T+2, we worked very closely with--
there was an industry coalition that came together called the
T+2 Coalition, that was buy-side/sell-side exchanges, the
clearing agencies, even a group representing retail investors.
And what they did was they were able to tell us what a
reasonable timeline was for all of them across the industry.
And I think, similarly, they could start that group again, call
themselves the T+1 Coalition, and talk about particular
challenges.
One of the things I will note is that 4 years ago, when we
went through this, the big challenge of 2 versus 1 was that,
with few exceptions, going from 3 to 2 was just taking existing
back office processes, which are very complicated, and for many
of the firms, it was just effectively speeding those up. They
didn't have to retool and set up new systems. Once you start
going to 1 or 0, the costs go up, because you are going to have
to retool some of the systems.
Now, the benefits may outweigh those costs, and so that is
what the SEC should go through, from a public policy
perspective, and look at those.
I wouldn't say those are roadblocks but those are the
challenges that they would face.
Mr. Timmons. Sure. Thank you. Do you believe this can be
done by the industry without any government or limited
government involvement beyond cheerleading the effort?
Mr. Piwowar. The SEC has to make it real. The industry came
to us and said, ``Could you please make this real, and here is
why.'' So yes, they could do it, but what would happen is, it
is a collective action problem. If you get one holdout or a
couple of holdouts, then you can't do it as a voluntary effort.
So what they did was they did a lot of the work in terms of
how they were going to get it done. They went out and got
third-party thoughts and did timeframes and all of this sort of
stuff. This is the one thing I think government can be very
helpful in doing, is solving the collective action problem, and
then explicitly looking through the costs and benefits.
The other thing I will note, as I have mentioned before, is
the SEC can't do this alone. Once you go to 1 or 0, because you
have to get the bank regulators involved to make sure that the
bank payment systems, the cash gets there too. So, it is a
little bit more difficult going to 1 or 0 than it is going to
2.
Mr. Timmons. Sure. Thank you. Mr. Grujic, what would be the
tradeoffs if we were to eliminate the credit investor standard?
Mr. Grujic. There is an obvious benefit to allowing more
investors to access private markets, and as I previously said,
I think this is a very important part of where investors should
put their money. So, there are a lot of benefits on the side of
concern about education and understanding. We have to see where
we want to land on those, if we want to explore qualifications
as a substitute for wealth, in terms of access is appropriate.
I just want to say, I think we have to take the lessons of
history. About 20 years ago, when we talked about electronic
communication networks (ECNs) and the fragmentation of the
dominant few market exchanges, there were these sorts of
similar concerns. What we wound up with is a far better
marketplace. We had to enact regulations to solve the issues of
fragmentation, but where we landed was something much better.
The post-ECN world is vastly better than what it was before.
We should take the same approach here now with private
markets, with PFOF, with gamification, where we recognize that
innovation is good, and innovation and regulation are yin and
yang. And so, when you look at gamification, building habits
like regular savings, regularly looking at education, rewards
for things that are healthy are clearly good. How to regulate
that is challenging, but that is on a natural path forward. We
should open up the private markets. We should open up
gamification in healthy ways. We should innovate and regulate
in lockstep.
Chairwoman Waters. Thank you very much.
Mr. Timmons. Thank you for that answer. I yield back, Madam
Chairwoman. Thank you.
Chairwoman Waters. Thank you. The gentleman from
Massachusetts, Mr. Auchincloss, is now recognized for 5
minutes.
Is Mr. Auchincloss on the platform?
If not, the gentleman from Guam, Mr. San Nicolas, is now
recognized for 5 minutes.
If not, the gentleman from Indiana, Mr. Hollingsworth, is
now recognized for 5 minutes.
Mr. Hollingsworth. Good afternoon, and I appreciate all of
our witnesses being here today, and I certainly appreciate the
dialogue that we have had.
I have touched on this several times in previous hearings
but wanted to touch on it yet again. Again, none of my comments
should be construed as being in favor of or opposed to dark
pools or LIT trading or exchanges. I certainly believe in an
even playing field where all competitors can compete for flow,
but I wanted to really specifically dial in on some of this.
[Pause.]
Chairwoman Waters. Mr. Hollingsworth?
Mr. Hollingsworth. Can you hear me?
Chairwoman Waters. Yes, I can hear you.
Mr. Hollingsworth. Okay, great. Sorry. I think it cut out
there for a second. Sorry about that.
Mr. Blaugrund, you mentioned in your testimony that 30
percent of market volume is artificially constrained by this,
``penny-wide regulatory requirement'' on exchanges. Can you
expand on that a little bit? What are some examples of how tick
size restrictions can affect liquidity in the nearly 8,000
stocks that trade above $1.
Mr. Blaugrund. Thank you very much for the question.
As I mentioned in my testimony, there are effectively two
regimes functioning in parallel. On exchange, there is a rule,
Rule 612, that requires that exchanges accept and display
orders only in penny increments in stocks priced above a
dollar.
Mr. Hollingsworth. Right. And this doesn't apply in dark
pools, correct?
Mr. Blaugrund. Correct. Off exchange, they can trade at
100th of a cent increments. The implication is that price
discovery, particularly in very active, low-priced names should
occur within that penny-wide spread. As a result, public
investors on exchanges are restricted. They can only narrow the
spread to 1 cent wide when, in fact, there might be millions of
shares that trade in some of these names in that sub-penny
increment.
As a result, if you haven't been invited into that
particular dark pool or single dealer platform, that liquidity
is simply inaccessible.
Mr. Hollingsworth. Right. And there are some implications
here for both price discovery, as you said, right? The ability
for investors to be able to trade inside that increment, but
also challenges from a competitive footing between the two. Can
you talk a little bit about how volumes might be shifting to
dark pools versus exchanges on account of the current disparity
in regulatory regime?
Mr. Blaugrund. Yes. Thanks for the question.
So, as a number of the panelists have noted, in aggregate,
on-exchange trading is now its lowest proportion of the overall
market than it has ever been. And there were some days at the
end of last year where actually most trading happened in the
dark.
In retail names, and particularly in these lower-priced,
very active securities, 60, 70, sometimes 80 percent of trading
activity will occur off exchange in sort of private pools. So,
I think it is in the public interest in trying to ensure that,
one, the price discovery process is efficient, which goes to
questions we have been discussing previously about having good
benchmarks for measuring things like price improvement, and
also to encourage the broadest set of investors possible to
compete and offer one another the opportunity to interact with
their liquidity.
Mr. Hollingsworth. Certainly, there has been an abundance
of evidence that has shown the amount of savings retail
investors are achieving by virtue of payment for order flow and
other market makers that might lead to dark pools. However,
there might be some hidden costs associated with the increase
in volume on dark pools versus exchanges in price discovery or
price movement. Can you talk a little bit about that?
Mr. Blaugrund. I think you have two different regulatory
regimes. You have a regime with dark pools, which doesn't have
a fair access requirement, allows for privately negotiated
commercial terms, allows for customer accommodation should
there be some sort of dispute, and generally doesn't have any
sort of Reg SCI or sort of stability regulation.
We are not asking for those regulatory burdens to be
shifted to dark pools as well. We are simply hoping for a level
playing field. Let public investors who participate on
exchanges trade at the same price points.
Mr. Hollingsworth. And it certainly stands to reason that
retail investors and investors writ large would benefit from a
competitive platform that was agnostic between players?
Mr. Blaugrund. Correct. To the extent that there is another
public investor that is going to offer a more competitive
price, that accrues to the benefit of the investor.
Chairwoman Waters. Thank you very much.
The gentleman from Guam, Mr. San Nicolas, is now recognized
for 5 minutes.
Mr. San Nicolas. Thank you, Madam Chairwoman, and thank you
to our witnesses for being here today.
This hearing has been very, very informative, and your
background and expertise are very well-noted. And I am
absolutely interested in considering policy options as a result
[inaudible].
I wanted to circle back on the purpose of why we have
markets. I think we get so caught up on the trading aspect of
it and the volatility of it. But really, Mr. Kelleher, you, I
think in your opening statement, really captured the fact that
markets exist for us to be able to grow our commerce, grow our
private sector, and it is supposed to be providing environments
for those kind of activities to take place.
And when I dug deeper into the whole GameStop trade that
kind of precipitated all of these inquiries, one of the things
that really jumped out at me was the fact that at least on what
I was able to find as a layperson, the information on the short
interest on the GameStop stock was indicating that it was at
150 percent, and that really just kind of jumped out at me for
a number of reasons.
And Mr. Blaugrund, your testimony about the opacity of
short selling data really, really captured my attention as
well. And I wanted to kind of tie it all together before I get
into my questions by stating this.
When we have short selling in the market, it is intended to
kind of be a balancing component. But when you have 150 percent
of a stock's float short sold and the price compressed as a
result of that, you are inhibiting businesses from being able
to go out and raise equity at a higher price point.
And so, Mr. Blaugrund, can you expand on your testimony on
the opacity of the short selling that is going on and how that
potentially could be inhibiting businesses from being able to
go out and raise equity capital at a rate that would be more, I
think, reflective of the fair market value of the stock?
Mr. Blaugrund. Thank you very much for the question.
With respect to raising capital, you are certainly right
that if a stock price is depressed, then the cost of capital
for the company would be higher than it would otherwise be.
With respect to the short positions, that data is now
reported twice a month, and it certainly provides a lens into
the relative activity, but it is really not actionable. It
doesn't allow a market participant, whether they are hoping to
borrow the stock or whether they are considering lending their
securities, regulators or the insurers themselves, to
understand if there is risk developing, if there is this
potential for rehypothecation to introduce some significant
problem.
And so, our view, after discussing this issue with issuers
and investors, is that you really need to go one step upstream.
You have to look at the securities lending market itself, which
currently is relatively anachronistic. And there is an
opportunity for the SEC to promulgate rules that they were
directed to promulgate under the Dodd-Frank Act.
They have the authority today to bring transparency to this
marketplace, and we would urge that the SEC consider doing that
as a high priority.
Mr. San Nicolas. Mr. Kelleher, would you be interested in
offering some comments on this discussion?
Mr. Kelleher. Yes, I agree that kind of the upstream
disclosure increase for the securities lending part of these
activities needs to be addressed either through legislation or
through regulation. That is clear. But we also need increased
disclosure of the short activity that we currently have,
separate and apart from what we need for the securities
lending.
But for the short activity, we need greater disclosure on
the timing and frequency--increased disclosure on timing and
frequency of that disclosure. We need to expand the firms that
are subject to the disclosure. It needs to cover hedge funds,
broker-dealers, and everybody else engaged in those activities.
And it has to expand to cover all of the products that are
being used. It is not just puts and calls. You get equity
derivatives, total return swaps, synthetic exposure of all
sorts of ways.
So, multilayered increased disclosure and transparency will
benefit everybody in the market.
Mr. San Nicolas. Thank you, Madam Chairwoman, and I yield
back.
Chairwoman Waters. You are welcome. Mr. Steil is now
recognized for 5 minutes.
Mr. Steil. Thank you, Madam Chairwoman.
I also look forward to the day when we can be back in
person and not on Zoom. I know we have had some broadband
issues here in the House. It will be good to all be together
soon.
If I can dive in, in particular as it relates to settlement
times, Mr. Piwowar, you originally wrote an op-ed--we have
talked about it a little bit here today--supporting a move to
faster settlement. In the op-ed, you wrote that U.S. securities
markets may now be ready to really benefit from some of the
technology and operational advances in back office
administrative functions and a move to shorter settlement
cycles.
You oversaw the process of the SEC, in particular from T+3
to T+2, and during that process, the Commission looked at the
possibility to move to T+1. I know Mr. Davidson earlier brought
up the ability of blockchain and possibly being a solution. Can
we look back a little bit, in particular at what has been
changing since 2017 that may make the move to T+1 settlement
feasible as you kind of look at a broader picture?
Mr. Piwowar. Yes, thank you, Congressman.
One, technology costs decrease over time, and market
participants find greater efficiencies in their operations over
time. There is new innovators in this space. There are new
third-party providers that do a lot of things in the back
office things.
And you mentioned blockchain. So, 4 years ago, when we were
going through this, and we started the process 2 years before
that--so between 4 and 6 years ago--the advocates of a real-
time settlement, we would say, well, how do you get there? And
they would say, blockchain. And then we would say, well,
explain to us how exactly that happens. And they would just say
the word, ``blockchain'' louder.
And so, there was no--
Mr. Steil. We have some of that in Congress.
Mr. Piwowar. --thought process as to exactly how this would
work. What was that?
Mr. Steil. I said, we have some of that in Congress that
occurs when people--with lack of depth, they will just go
louder.
Mr. Piwowar. Yes, no comment. And what I learned in the
regulatory process is if somebody explains something back to
you louder and makes it imply that you don't understand what
they are saying, it really means they don't understand what
they are saying.
So, blockchain has a lot of promise to it. I really believe
that it can be transformative in the future. We weren't there
yet 4 years ago.
Now 4 years have passed, and there has been a lot of cool
innovation in this space. Again, some people just say,
``blockchain'' louder, but other people have actually come
forth with some interesting ideas. So, it is time for the SEC
to talk to those people and understand how feasible it is.
Mr. Steil. So to build on this, what do you see going
forward are the biggest obstacles we have to overcome to get
from where we are today to T+1, if we look at it from the other
direction?
Mr. Piwowar. Yes, thank you.
Again, I don't think they are really obstacles. I think the
biggest challenge that we didn't have to face going to T+2 is
the coordination with the bank regulators. Again, the cash has
to get there, not only securities.
I am not an expert in this, but some of my colleagues at
some of the other think tanks, for example, Aaron Klein at
Brookings, has written a lot about this, the antiquated bank
payment systems. And he has been doing it in the context of the
stimulus payments being so slow to get out there.
There is kind of a fight going on between the Fed and the
industry as to who gets to control that payment system. I hope
they figure out that fight, because that is actually probably
the biggest sticking point, and so that is why the SEC,
shortening it even further, has to coordinate with the bank
regulators.
Mr. Steil. Thank you very much. I know this is an important
topic for both myself and my colleague, Anthony Gonzalez, as
well.
Shifting gears to Mr. Blaugrund, if I can for a minute, I
think you really touched on the unequal footing between trades
that are placed on and off exchanges. You commented and we have
discussed a little about the limited price increments to a
penny on the exchange. Could you just go back and highlight
again what you think the attractiveness would be to on-exchange
trades if this was adjusted?
Mr. Blaugrund. Thank you very much for the question.
The way exchanges and, more specifically, the investors who
are trading on exchanges compete for order flow is they display
their prices. And in so doing, they signal to the market their
intent, they draw in counterparties, and the trade is
consummated.
If they are unable to display that interest at a
competitive price, one, they don't get the trade. So, they are
discouraged from doing so in the first place. And two, the
price discovery that ought to have occurred at that sort of
intermediate price is impossible.
We think that by permitting a level playing field in terms
of the price increments, a broader set of market participants
will be encouraged to participate. The price discovery process
will be more robust. That will result in equal or better
outcomes for the retail investors today, and that there is
generally a public interest in having an efficient price
discovery process.
Right now, about 30 percent of all market volume occurs
with securities that are pegged at 1-cent wide.
Mr. Steil. Thank you very much, Madam Chairwoman. I yield
back.
Chairwoman Waters. Thank you. Mr. Auchincloss, you are now
recognized for 5 minutes.
Mr. Auchincloss. Thank you, Madam Chairwoman.
I want to raise the issue of the wealth gap in this country
as it relates to what we have seen over the last few months.
The stock market overwhelmingly benefits higher-income
households, and for many middle-income or lower-income
households, the interaction they have with the stock market is
through retirement accounts, pension plans. Only 10 percent of
U.S. households own 87 percent of all stocks and mutual funds.
I don't think that is sustainable for us to have a form of
capitalism that works for everybody.
I want to tackle this question of wealth inequality from
two angles. First, with a question for Dr. Bogan. We have seen,
I think, in the last few months, examples of what does not work
in terms of FinTech and people psychology. I raised in the last
hearing my concerns about inducing people to trade options
through gamification on an app.
But I would welcome, Dr. Bogan, any thoughts from you about
what types of gamification, what types of FinTech actually
promote healthy wealth-building activities that are more
inclusive of the American population?
Ms. Bogan. First of all, thank you for the question,
Congressman. I appreciate it.
And I think that it is important to make a distinction when
we are talking about gamification between having a platform
that is accessible for all households to participate in
financial markets. And at the core, I think that is a good and
beneficial thing.
What I think we need to carefully think about is the way
people access those platforms and the user interface. We have
talked a lot about the evolution of technology, and that is how
people interface with financial markets. But the research on
sort of behavioral cues has advanced quite a lot over the past
decade, and there is a lot of information about how to set
defaults and push people to use it for good and for bad.
And I think where we need to take a careful look is at
these user interfaces. I think access is great, but are the
nudges in behavioral techniques being used for good or for bad
and to manipulate customers in a particular way? I think that
is a key area to investigate.
Mr. Auchincloss. To be looking at, as Cass Sunstein would
say, the nudge factor for default choices in terms of how
people save?
Ms. Bogan. Exactly right. Richard Thaler does a lot of work
with that, too, as well for retirement savings.
Mr. Auchincloss. The second question is for you, Mr.
Blaugrund, and it is about IPOs, which might seem like they are
not really related to FinTech or to wealth inequality. But my
concern is that over the last 20 to 25 years, IPOs have become
more rare. And when we have less private companies going
public, we have fewer Americans being able to access the value
creation that happens.
And increasingly, we have companies raising in the private
markets for valuations that are astronomical by the standards
of even in the 1990s or early 2000s, and a lot of that value
capture is happening for a smaller and smaller pool of
investors. Can you talk about things that the New York Stock
Exchange and other organizations are doing to make IPOs easier
and to democratize the access to the wealth that is being
created there?
Mr. Blaugrund. Thank you for the question.
It is an issue that we spend a ton of energy thinking about
and trying to influence in a positive way. As you know, public
companies are now larger and older when they have their IPO,
and so we are keenly interested in trying to find more
innovative ways to bring younger, faster-growing companies to
the public market.
Two of the ways that have been introduced recently or have
achieved more sort of interest recently--the first is a direct
listing. That is a mechanism that allows any investor to
participate in the IPO-ish first trade in a way that
democratizes access to the capital markets that we think is
ultimately going to be a very effective way for companies that
are interested in issues of equality to participate in the
market.
The second is the growth in special purpose acquisition
companies, or SPACs.
Mr. Auchincloss. Mr. Blaugrund, I apologize for
interrupting you, but our time is limited here. The SPACs are
not, though, really going to democratize access to the value
creation that is happening pre-IPO because these are still
private vessels, and the value is still being captured by a
small number of investors in the know. You have to explain to
me how that is going to democratize it?
Mr. Blaugrund. I think there is more work to do, but SPACs
offer in some ways a retail-oriented product that offers
exposure similar to private equities.
Chairwoman Waters. Thank you. The gentleman from Ohio, Mr.
Gonzalez, is now recognized for 5 minutes.
Mr. Gonzalez of Ohio. Thank you, Madam Chairwoman. Thank
you for holding this hearing and for all our participants.
This hearing is supposed to be about GameStop and
Robinhood, and I thought it was supposed to be about preventing
a halt in trading that we saw that day. It seems to have
morphed into something completely different, where many of the
ideas, unfortunately, that I am hearing from my colleagues on
the other side of the aisle would actually cut off access to
the markets for retail investors.
I spend a lot of time thinking about retail investors and
how to give them more access, in particular into the highest-
performing asset class net of fees, which is private equity.
One idea, and this is for Mr. Piwowar, that I have had is to
provide that access through closed-end funds.
What safeguards exist inside of the closed-end funds that
would help in this regard?
Mr. Piwowar. Thank you, Congressman, for that question.
Closed-end funds are regulated much in the same way that
mutual funds and other open-end funds like ETFs are regulated
by the SEC and are subject to the investment company and the
Investment Advisers Act. It is a well-established regulatory
framework that has been around since 1940.
I believe that private equity investments, private company
investments are particularly--it is particularly appropriate to
put them in the closed-end fund structure. The open-end funds,
either mutual funds have daily redemption, liquidity, or ETFs
have almost instantaneous liquidity. These are less liquid
assets, and so the closed-end fund structure, and in particular
a subset of them, the interval funds, which allow for periodic
redemptions rather than daily redemptions, would provide a nice
vehicle for that with all the protections that we just talked
about.
Mr. Gonzalez of Ohio. Thank you. And moving back to the T+2
versus T+1 debate, so one of the reasons or the reason why
Robinhood had to restrict their buys is because they didn't
have the capital. We uncovered that last time. They didn't have
the capital to make their deposit at the time it came in, and
so they stopped the order flow.
If we move from T+2 to T+1, what effect would that have had
on the amount that would have been required at that time? It
would have gone down, correct, Mr. Piwowar?
Mr. Piwowar. That is correct. It certainly would have gone
down. Now, I don't know the exact formula that DTCC uses, but
it is a function of the amount of days. So, it certainly would
have gone down. It would have been more than half or less than
half--I don't know--but it would have gone down.
Mr. Gonzalez of Ohio. But all else being equal, Robinhood
would have had a lower deposit number, and so, in theory, may
not have been forced to halt the buy side, which, again, I
thought was the point of this hearing. So, hopefully, we can
coalesce around a T+2 versus T+1 debate. I am in the T+1 camp.
Additionally, another way that they could have lowered the
risk is if they had stronger capital requirements potentially.
Do you have any thoughts on that? Because as you probably know,
Schwab did not have to halt buy orders. Robinhood did, and they
are under two different capital regimes and have two different
business models.
So, I am curious if you have any thoughts on the capital
side of this requirement as well?
Mr. Piwowar. Yes, thank you, Congressman.
I believe Mr. Tenev testified that they met all of their
SEC net capital requirements and were in compliance all that
time. Net capital requirements are one way that the SEC
protects customers. The other is the explicit customer
protection rule, where they have to segregate the assets and
the firms can't use them.
The SEC's net capital requirements were established in the
1970s. They have been revised over time. One of the areas of
concern for me is that those requirements aren't as transparent
as they should be, particularly for new entrants. If you are an
established entrant, you can hire broker-dealer lawyers who
have been around for a long time and know the intricacies of
this.
I think one thing the SEC should look at--I don't know
whether we have the right levels or whether the right
securities are given the proper haircuts and all those sort of
things, but at least make it more transparent so that new firms
like Robinhood know ahead of time whether they are complying
and whether they are safely above the minimum requirements.
Mr. Gonzalez of Ohio. Thank you. With my last 30 seconds,
what would have happened to Robinhood account holders had
Robinhood not been able to make their deposit requirement? What
is the downside of this?
Mr. Piwowar. Yes, thank you, Congressman.
Unlike banks, where failure is basically not an option,
built into the SEC's regime for broker-dealers, there is a
special bankruptcy provision called the Securities Investor
Protection Act (SIPA), and there is a group of people called
the Securities Investor Protection Corporation (SIPC), that
would take over--effectively, what would happen is they would
appoint a trustee and very quickly try to move those customer
assets over to another solvent broker-dealer.
There would be a disruption in trading. It could take days
or weeks. It just depends on whether customer assets were
segregated properly, all of those certain things, but there is
a regime that would have taken over to support that.
Mr. Gonzalez of Ohio. A bankruptcy regime. Thank you, and I
yield back.
Mr. Sherman. [presiding]. Thank you. I now recognize Mr.
Taylor from Texas.
Mr. Taylor. Thank you, Mr. Chairman.
Good news for everybody, I think I am the last guy. So, I
appreciate everybody waiting through this.
Mr. Piwowar, I really appreciated your testimony. I enjoyed
reading your editorial in the Wall Street Journal talking about
T+1 versus T+2. I think you have really shed a lot of light in
your perspective on that and I appreciated your input.
Mr. Grujic, my understanding is, you seem to be--basically,
in your written testimony, you seem to be okay with going to
T+0. Is that a fair characterization? Am I reading your
testimony correctly?
Mr. Grujic. I think what Dr. Piwowar said is fair. We have
to take a look at the state of the technology.
Mr. Taylor. Okay.
Mr. Grujic. I think that the technology has evolved a lot.
Blockchain has moved from proof of work to proof of stake,
things that make it faster. And we are rapidly accelerating,
and I think that very soon, T+0 benefits, in my view, will
substantially outweigh the costs.
Mr. Taylor. Okay. And then, Mr. Blaugrund, just as the COO
of the New York Stock Exchange, based on your written
testimony, you seem to be fine with going to a T+0 as well. Is
that a fair statement? Am I reading your testimony correctly?
Mr. Blaugrund. We are certainly comfortable and supportive
of moving to T+1. With respect to anything sort of narrower
than that, I think we would be hypersensitive to the
operational concerns as well as ensuring that netting is
preserved.
Mr. Taylor. Okay. Your written testimony kind of led to
that. But Ms. Goldstein, I think you had the most important and
sort of the deepest thoughts on this particular topic, and I
know it has been--we have talked a lot about it. And I am just
going to read what you wrote. You wrote, ``Losing the benefit
of netting would create significant new operational costs.''
Could you expand on that?
Ms. Goldstein. Sure, Congressman. Thank you for the
question.
If you execute a very large trade, say you trade a million
shares and perhaps you send it to some algorithm that tries to
break it up into chunks, you might have many, many transactions
across the million shares you are trying to trade. And if we
lose the ability to net those transactions, operationally, we
are going to have to look at every single one of those
executions instead of being able to combine them together.
And so, I think that this is one of the main challenges to
moving to what people call real-time settlement, which would be
even faster than T+0, right? I think there is T+0, and then
there is real time. I just don't know that the industry is
prepared to do that just yet, and I think that is why you hear
most folks, I think there is perhaps some consensus about T+1
and some hesitation about anything quicker than that.
Mr. Taylor. I appreciate it. Again, I think you, in your
written testimony, provided the greatest detail, giving me an
insight into what those reservations would be.
If I could shift to just your next written statement where
you are talking about, and I will just read what you wrote. You
wrote, ``The broker capital standards, as they are today, are
adequate to withstand periods of extreme market stress.''
And I guess my question is--when I was in the previous
hearing, when we were talking to the CEO of Robinhood, it
struck me, and I think you have heard a lot of my colleagues
talk about where it sort of came up over and over, hey, you
didn't have enough capital. There was a capital call and you
didn't have the money. You had to then shovel in the money, and
it wasn't enough. And so, you had to agree not to--you would
only buy--I can't remember. You can only do one action, but not
the other action with the securities of GameStop in order to
reduce this capital call.
I guess my question is, was this statement made with that
example in mind? Because at least with that example in mind, I
would think this statement is incorrect. But maybe I don't
understand it.
Ms. Goldstein. My belief is that whether it is the SEC net
capital rule and tweaking it, or perhaps it is just making sure
that brokerages have more capital preemptively than they need
to, I think this instance shows it wasn't just Robinhood who
had a little bit of trouble generating their capital. Maybe
funds are not modeling their own capital risk adequately and
should be holding more capital in the event of another big
volatile day like this.
That was the spirit in which I made that statement in my
written testimony. And to Dr. Piwowar's point, I do think net
capital rules by the SEC are important to look at.
Are there ways that we need to tweak them? I don't know
that he and I would agree with how we should tweak them. But
for example, right now firms are able to sort of use their own
internal models to determine their haircuts. I would advocate
that that might not be the right approach. But again, this is
an ongoing conversation.
Mr. Taylor. Sure. I appreciate your input, and I thank all
of the witnesses for your time and expertise.
Mr. Chairman, I yield back.
Mr. Sherman. Thank you. And Mr. Taylor, it appears as if
you were correct. I do not see any other Members who have not
had their chance to question the witnesses, who are to be
congratulated for their tenacity and endurance.
I would like to thank all of my colleagues who
participated, and thank our distinguished witnesses as well. I
look forward to exploring with my colleagues, and with experts
in the field, how to make our markets fairer for all retail
investors.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned.
[Whereupon, at 2:37 p.m., the hearing was adjourned.]
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