[Senate Hearing 117-95]
[From the U.S. Government Publishing Office]
S. Hrg. 117-95
WHO WINS ON WALL STREET? GAMESTOP,
ROBINHOOD, AND THE STATE OF RETAIL
INVESTING
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE PRACTICES THAT ENCOURAGED THE VOLATILE ACTIVITY IN
STOCKS, HOW IT AFFECTS OUR ECONOMY IN THE LONG TERM, AND WHO BENEFITS
AND WHO LOSES FROM THIS ``TECH-INDUCED'' STOCK MARKET VOLATILITY
__________
MARCH 9, 2021
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: https: //www.govinfo.gov /
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
46-082 PDF WASHINGTON : 2022
-----------------------------------------------------------------------------------
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
SHERROD BROWN, Ohio, Chairman
JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey RICHARD C. SHELBY, Alabama
JON TESTER, Montana MIKE CRAPO, Idaho
MARK R. WARNER, Virginia TIM SCOTT, South Carolina
ELIZABETH WARREN, Massachusetts MIKE ROUNDS, South Dakota
CHRIS VAN HOLLEN, Maryland THOM TILLIS, North Carolina
CATHERINE CORTEZ MASTO, Nevada JOHN KENNEDY, Louisiana
TINA SMITH, Minnesota BILL HAGERTY, Tennessee
KYRSTEN SINEMA, Arizona CYNTHIA LUMMIS, Wyoming
JON OSSOFF, Georgia JERRY MORAN, Kansas
RAPHAEL WARNOCK, Georgia KEVIN CRAMER, North Dakota
STEVE DAINES, Montana
Laura Swanson, Staff Director
Brad Grantz, Republican Staff Director
Elisha Tuku, Chief Counsel
Dan Sullivan, Republican Chief Counsel
Mark Uyeda, Republican SEC Detail
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
(ii)
C O N T E N T S
----------
TUESDAY, MARCH 9, 2021
Page
Opening statement of Chairman Brown.............................. 1
Prepared statement....................................... 36
Opening statements, comments, or prepared statements of:
Senator Toomey............................................... 4
WITNESSES
Gina-Gail S. Fletcher, Professor Of Law, Duke University School
of Law......................................................... 6
Prepared statement........................................... 37
Rachel J. Robasciotti, Founder and Chief Executive Officer,
Adasina Social Capital......................................... 8
Prepared statement........................................... 47
Teresa Ghilarducci, Bernard L. and Irene Schwartz Professor of
Economics, The New School...................................... 10
Prepared statement........................................... 49
Michael S. Piwowar, Executive Director, Milken Institute Center
for Financial Markets.......................................... 11
Prepared statement........................................... 53
Responses to written questions of:
Senator Sinema........................................... 64
Senator Crapo............................................ 65
Senator Hagerty.......................................... 66
Senator Daines........................................... 68
Andrew N. Vollmer, Senior Affiliated Scholar, Mercatus Center at
George Mason University........................................ 13
Prepared statement........................................... 61
Responses to written questions of:
Senator Daines........................................... 70
Additional Material Supplied for the Record
``Price Improvement: Core of Retail Execution Quality'',
Bloomberg Intelligence, Larry R. Tabb.......................... 74
Letter submitted by Center for Capital Markets Competitiveness... 76
Letter submitted by CATO Institute............................... 91
Letter submitted by SIFMA........................................ 97
Letter submitted by Citadel Securities........................... 100
Letter submitted by FINRA........................................ 104
Letter submitted by the SEC...................................... 121
Letter submitted by Robinhood.................................... 127
(iii)
WHO WINS ON WALL STREET? GAMESTOP, ROBINHOOD, AND THE STATE OF RETAIL
INVESTING
----------
TUESDAY, MARCH 9, 2021
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m., via Webex, Hon. Sherrod
Brown, Chairman of the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN SHERROD BROWN
Chairman Brown. The Banking, Housing, and Urban Affairs
Committee will come to order. This hearing is in the virtual
format. A few reminders as we begin. Sorry to those of you who
have to hear this every hearing.
Once you start speaking, there will be a slight delay
before you are displayed on the screen. To minimize background
noise, please click the mute button until it is your turn to
speak or to ask questions.
You should all have a little box on your screens labeled
``Clock'' that will show you how much time is remaining. For
witnesses, you will have 5 minutes for opening statements. For
Senators, the 5-minute clock still applies to your questions.
At 30 seconds remaining for your statements and questions,
you will hear a bell ring to remind you your time has almost
expired. It will ring again when your time has expired.
If there is a technology issue, we will simply move to the
next witness or the next Senator until it is resolved. And,
fortunately, because of Cameron and Charlie's work, we rarely
have technical problems, but one never knows. To simplify the
speaking order process, Senator Toomey and I have agreed to go
by seniority for this hearing.
Last February, as the world came to the collective
realization that we were confronting a global pandemic, the
U.S. stock market suffered its fastest drop in history,
plummeting, as we recall, 34 percent in 33 days.
This was followed by the fastest stock market rebound in
history, recovering all of those losses by mid-August.
It was clear what most working people had suspected for a
long time: The stock market is detached from the economy and
the reality of most Americans' lives.
The coronavirus was spreading, widespread testing was not
available, and we did not know if the hope of a vaccine was
months or, for that matter, years away.
Unemployment soared, reaching 23 million jobs lost by
April. Almost a year later, only about half of those jobs have
been recovered. Families and small businesses had no certainty
about what their lives would look like in a few weeks, let
alone next year.
But the stock market continued to go up and up. Those lucky
enough to own investments reaped the profit.
To some, this looked like a new development. But to
millions of Americans, to millions of workers who have watched
the stock market reach new heights while their own paychecks
never kept up, it looked pretty familiar.
Families have not been too surprised by this state of
affairs. A whole lot of them never recovered from foreclosure
or from losing their savings during the last crisis, but they
watched Wall Street pocket its bailout and go on to record
highs just a few short years later.
That is because when you look at who truly benefits, it is
clear that the stock market's gains funnel wealth to a tiny
sliver of people, often at the direct expense of American
workers. We discussed this last week in our hearing ``Wall
Street vs. Workers.''
According to Federal Reserve data, the wealthiest 1 percent
hold 53 percent of stock and mutual fund investments. The
bottom 90 percent own less than 12 percent.
The bottom 90 percent own less than 12 percent.
Between workplace retirement accounts and personal
investments, about half of American households have at least
one financial account tied to the market, but only one in six
directly own stocks.
None of this reflects the actual makeup of the country.
Only 31 percent of Black families and 28 percent of Hispanic
families own any stock investment.
The wealthy are far more likely to have these accounts, of
course, than middle-class families, who in turn are far more
likely to be in the market than working-class families or poor
families.
So when the stock market soars, most people barely notice.
They are just trying to keep up with the cost of living within
their paychecks.
In recent years, the growth of fintech in financial
services has given rise to trading platforms that offer free
stock trades. Firms like Robinhood and others claimed to
``democratize'' stock trading with flashy marketing and easy-
to-use features.
And in one sense, it worked. They attracted millions of
customers, many of them young and new to investing.
The frenzied stock trading this January, when shares of
GameStop went from $18 to over $400 in a matter of weeks,
showed how millions of retail investors could engage with each
other and create a sort of sensation.
But it also lays bare serious risks.
There are real people who got caught up in the frenzy who
suffered real consequences. If the people who are busy working,
watching their kids, or living their lives cannot make sense of
the stock market's booms and busts, they will continue to lose
faith in the market. And hedge funds and insiders will continue
to reap the vast majority of the profit.
That is really bad for everyone in the long run.
Robinhood tried to blame its decision to cutoff its
customers from being able to purchase GameStop and other stocks
on industry-wide standards for processing stock purchases. Of
course, the SEC and others should examine and consider how to
reduce risk in the financial system by cutting the time it
takes to complete stock purchases. Everyone would benefit from
that.
But it has become clear that firms like Robinhood were
founded on a model that exploits small investors by encouraging
fast and loose trading, and then sells their trades to big
market players.
In a few short years, Robinhood violated the law, failed to
respond to customers when they needed help, and when it got in
trouble, cutoff customers to save itself. Robinhood attracted
new customers to investing, encouraged them to trade, profited
off of them, and then broke their trust--precisely when they
needed the company to have their backs.
It is also obvious that the David versus Goliath story--to
mix metaphors, perhaps--we first heard in January was not the
whole picture. Well-funded, sophisticated hedge funds made big
profits alongside the people trading at home. We know they
always had better access and information than any of us ever
will. No one thinks that is fair.
Some have tried to blame the small-time investors. They
scold people just trying to make some extra money in the worst
job market we have seen in most of our lifetimes.
Because of the Robinhood business model and other reasons,
we have all learned the new term ``gamification.''
But let us be clear: We have seen Wall Street treat the
markets as a game for decades--a game they always win, at the
expense of pretty much everyone else.
Wall Street has never been friendly to the little guy.
Surely this time is no different.
Yes, some regular people have had success. But,
fundamentally, the system is set up to funnel more wealth to
the already wealthy. Just like in Las Vegas, the house always
wins.
The economy and the markets should work for everyone, not
just the well-connected. They should reflect the economy we all
want--with broadly shared prosperity and a growing middle class
that all workers have the opportunity to join.
When that happens, people will have confidence the markets
can actually work for them, not just Wall Street. We will see
more Americans save and invest for the future.
This hearing will examine not only the volatile activity in
a dozen stocks early this year, but also the practices that
encouraged that activity. We will see how it affects our
economy in the long term. We will see who benefits and who
loses from this ``tech-induced'' stock market volatility.
I look forward to the testimony from all five of our
witnesses.
Senator Toomey.
OPENING STATEMENT OF SENATOR PATRICK J. TOOMEY
Senator Toomey. Thank you, Chairman Brown. Welcome to all
of our witnesses.
This January's volatility in the stock market
understandably captured everybody's attention. We saw
extraordinary trading volumes in GameStop and other stocks, and
we also saw some brokers limit stock purchases during this
period of volatility. So it is entirely appropriate to examine
these events and try to understand what happened and whether
any response is needed.
However, I urge my colleagues and regulators to avoid any
knee-jerk reaction to impose unnecessary restrictions and
burdens on investors. We have yet to see any evidence of
wrongdoing or that the regulatory regime failed to function as
intended. And Congress and regulators should avoid new laws and
regulations that could end up limiting investors' access to and
choices in the stock market.
One reason to tread cautiously is that new developments
have made it a great time to be a retail investor. Today a
person of modest means can invest in the stock market at zero
or minimal cost. Two developments particular stand out: zero
commission trading platforms with no minimum account balance
required, and a user-friendly trading technology such as mobile
apps. Zero commission trading is the culmination of a decline
in investor costs since the SEC abolished fixed commissions in
1975 and forced brokers to compete against each other.
In the 1980s and 1990s, it could cost you close to $100 to
buy several thousand dollars worth of stock. By the 2000s,
online trading sites offered lower costs, but they could still
cost you $30 for a trade. Competition from market makers allows
brokers under their best execution obligation to obtain a
better price for investors than current market price, even
after receiving a payment for order flow, and they can charge
zero to investors.
Similarly, new technology like app-based trading platforms
make it easier to access the market, including buying through
fractional shares. And it is not just Robinhood attracting new
investors. The Wall Street Journal reported that 2020, despite
the volatility, was a record year for new individual accounts,
and these developments have, of course, contributed to broader
investment in the stock market.
According to the Federal Reserve, in 1989, less than one-
third of U.S. households owned stocks. Three decades later, in
2019, a majority of American households did. And the most rapid
growth is among low- and middle-income households. Now, let us
not forget about the millions of others, including police
officers, firefighters, teachers, and other workers indirectly
invested through pension funds.
This allows everyone to share in the tremendous wealth
gains generated by the stock market, which used to be available
only to wealthy individuals and institutional investors.
Despite these positive developments, some see the state of
retail investing only in negative terms. Rather than
celebrating the fact that it is cheaper and easier for average
Americans to invest in the stock market, some claim that the
market is somehow rigged against retail investors.
So to my colleagues who say that, I would like to hear why
they believe that. Does the retail investor not receive
dividends like institutional investors do? Is the retail
investor not entitled to best execution on trade like
institutional investors? When a stock goes up in value, does
the value of a retail investor's share not go up like wealthy
individuals?
Of course, the answer to all of these questions is
obviously no. And if the market is rigged, then why did some
hedge funds lost their shirts shorting GameStop while some
retail investors hit pay dirt for buying it?
I am also incredulous at the idea that it somehow hurts
retail investors to have access to investing technologies that
are inexpensive and pleasant and easy to use. Retail investing
does not need to be expensive and miserable and difficult to
experience, nor should we want it to be. I would like to see
more U.S. households have the opportunity to benefit from the
financial gains that are available through the stock market.
Your average American does not need Big Government coming
in to limit her access to and choices in the stock market. The
fact is risk is a fundamental part of investing. All investors,
whether they are small retail investors or big hedge funds, can
gain or lose money by investing. But what we know is for sure
over time long-term investors investing in U.S. stocks, it is
the exact opposite of going to the casino. Investors win, and
when you go to the casino, you lose. Investors in GameStop and
a few other stocks took a lot of risk, but they represent a
very, very small fraction of retail investors. And investors
should understand that if they make a very risky investment,
they might lose money. Those who bought GameStop at its high
very likely lost money. I certainly hope they did not invest
money they could not afford to lose, but it is not the
Government's job to tell people which stocks they can and which
they cannot buy.
In my view, there is one action that regulators should
pursue, and Chairman Brown alluded to this, and that is to
finish the work that it started in 2004 for a faster settlement
cycle, including same-day cycle or maybe even real-time
settlement. A faster settlement cycle will reduce risks for
clearing agencies because there will be fewer unsettled trades
and a reduced time period of exposure. And a faster settlement
cycle will also require less collateral for clearing agencies,
which may reduce margin charges and other fees that are
inevitably passed on to investors.
When the SEC moved to T+2 back in 2017, the SEC said it
wanted to make settlement even faster, and last month, Ranking
Member McHenry from the House and I wrote to the SEC asking
that they follow through on this longstanding objective.
Let me close by just repeating: I think Congress and the
regulators should tread very cautiously here. We should want to
make sure that all parts of American society can participate
and share in the gains of the stock market, and we should avoid
taking actions that would undermine that goal.
I look forward to today's testimony.
Chairman Brown. Thank you, Ranking Member Toomey.
I will introduce today's five witnesses. Gina-Gail
Fletcher, professor of law at the Duke University School of
law. Professor Fletcher is a scholar of complex financial
instruments and market regulation. Her research focuses on the
interplay of public regulations and private ordering in
enhancing market stability and integrity. Welcome, Professor
Fletcher.
Rachel Robasciotti is the founder and chief executive
officer of Adasina Social Capital, an investment firm that
seeks to serve as a bridge between financial markets and social
justice movements. Welcome, Ms. Robasciotti.
Dr. Teresa Ghilarducci is an economist, nationally
recognized expert in retirement security. Dr. Ghilarducci holds
the Irene and Bernard Schwartz Chair in Economic Policy
Analysis in the Economics Department at The New School for
Social Research. She directs the Schwartz Center for Economic
Policy Analysis that focuses on economic policy research and
outreach. Welcome, Dr. Ghilarducci.
Commissioner Michael Piwowar is the executive director of
the Milken Institute Center for Financial Markets. Commissioner
Piwowar served as a Commissioner at the U.S. Securities and
Exchange Commission from August of 2013 to July of 2018 and was
Acting Chair from January to May 2017. Previously, he was the
Republican Chief Economist for the
U.S. Senate Committee on Banking, Housing, and Urban
Affairs under Senators Crapo and Shelby. Welcome back,
Commissioner Piwowar.
Andrew Vollmer is a senior affiliated scholar with the
Mercatus Center at George Mason university. From 2014 to 2019,
he taught securities regulation. He is the director of the John
W. Glynn, Jr. Law & Business Program at the University of
Virginia School of Law. Prior to that, Mr. Vollmer was a
partner in the securities litigation and enforcement practice
at Wilmer Cutler Pickering Hale and Dorr, and he also served as
Deputy General Counsel at the SEC from 2006 to early 2009.
Welcome, Mr. Vollmer, to our Committee.
Professor Fletcher, would you begin your testimony,please,
for 5 minutes? Thank you.
STATEMENT OF GINA-GAIL S. FLETCHER, PROFESSOR OF LAW, DUKE
UNIVERSITY SCHOOL OF LAW
Ms. Fletcher. Chairman Brown, Ranking Member Toomey,
Committee Members, thank you for inviting me to testify today.
I am a professor of law at Duke University, where my research
focuses on capital markets, financial regulation, and market
manipulation.
Our capital markets exist to channel investors' capital
into its best uses, ideally forming companies to increase sales
and create jobs, but also providing investors with reasonable
returns, allowing them to save for retirement or to send their
children to college.
We are here today because we are seeing trading activity
that seems to be divorced from this essential purpose. Since
the start of the year, GameStop's stock has gone through quite
a bit of volatility. It started at a little under $20 a share
at the beginning of the year, went up to $400, down to $40, and
now as of yesterday was a little bit under $200 per share, all
of this occurring over just a few weeks.
As the company's stock price yo-yos back and forth, it is
clearly not a good-faith reflection of the fundamental value of
a company with real stores, employees, and sales. The
volatility in GameStop's stock is just one of a growing number
of examples of market price gyrations which seem to be
impacting not only meme stocks but also some penny stocks,
special purpose acquisition companies, and even
cryptocurrencies.
Financial innovation has made it easier than ever for
retail investors to trade more complex, leveraged, and risky
assets than ever before. These developments have generally
expanded retail participation in the markets, and in some ways
this is great. For example, a recent study has estimated that
the racial gap in individual stock ownership has been halved in
less than 5 years because of greater lower-cost market access.
However, recent market events have raised questions about the
integrity and long-term stability of the markets.
Now, while my written remarks cover several topics, I wish
to highlight a few key points here.
First, to the extent that asset values are subject to wild
swings and are divorced from any semblance of fair market
values, market participants will increasingly view the markets
as rigged and unreliable. This will in the long run deter
investment and harm our economy.
Second, Congress and regulators should act to ensure that
those who deliberately distort prices may be subject to
regulatory or prosecutorial discipline.
Third, Congress and regulators should address the
incentives and market structures that have created the modern
trading markets. This includes the proliferation of payment for
order flow practices, the segmentation of retail orders, and
the overall impact on trading costs for all investors, not just
retail investors but pension funds and other institutional
investors. It is clear that retail brokers and market makers
are making quite a bit of money from these practices, but it is
also increasingly clear that retail and institutional investors
are paying the price.
Fourth, Congress and regulators should review whether and
how investors should access complex leveraged products, such as
call options. Opening options trading accounts used to take
weeks, and still does with some brokers. Yet it may take just a
few minutes with other brokers. It should not take a suicide
for us to realize that many investors in current markets do not
fully comprehend the products that they are trading or the
risks that they are taking.
Fifth, finally, and perhaps most importantly, Congress and
regulators must acknowledge that events like what we are seeing
with GameStop and other assets are no longer outlier events,
but are instead regular features of our current system. Unless
action is taken, these events will continue to expand and
evolve. This means that brokers need to be better prepared to
stand behind their customers' risky trading, and to the extent
brokers cannot, the answer ought not to lie with limiting
retail participation, as seems to have happened recently when
some broker-dealers suspended trading in highly volatile
stocks.
Additionally, regulators should consider shortening the
settlement cycle so that fewer things can go wrong between the
time of trade execution and when parties match up securities
and cash.
Today it is easier, cheaper, and faster to trade more
complex and leveraged financial products than ever before. This
new market reality requires that we rethink the risks that
accompany these developments and in so doing consider how to
create a market that is fair, accessible, and stable for
investors and the rest of the economy.
Thank you.
Chairman Brown. Sorry, I was having trouble with the mute.
Thank you, Professor Fletcher.
Welcome, Ms. Robasciotti. Speak for 5 minutes. Thank you.
STATEMENT OF RACHEL J. ROBASCIOTTI, FOUNDER AND CHIEF EXECUTIVE
OFFICER, ADASINA SOCIAL CAPITAL
Ms. Robasciotti. Mr. Chairman Brown, Ranking Member Toomey,
and Members of the Committee, good morning, and thank you for
inviting me to testify before this Committee. It is my great
honor.
My name is Rachel Robasciotti, and I hold leadership
positions at two SEC Registered Investment Advisory firms. I am
the founder and CEO of Adasina Social Capital, where we manage
an exchange-traded fund with the ticker symbol JSTC. It holds
over 800 stocks and is accessible to everyday investors at a
price of about $16 per share. I am also the director of
advocacy and engagement for Abacus Wealth Partners, which is a
firm with $3.8 billion in assets under management but no
minimum account size for its clients.
I serve hardworking, everyday Americans, so your
constituents and my clients are the same people.
I have worked in financial services for almost 22 years, so
I take the long view of market events, and I have seen
everything from the ill-fated dot-com boom of 2000 through the
Great Recession and the most recent GameStop-Robinhood episode
in January and February. So I understand the players in the
market, and in this most recent situation, there are really
three groups for us to consider.
First is the hedge funds. These are institutions that
primarily manage money for the wealthy, accredited investors,
and they are known for their risky strategies and high returns.
Two, the Redditors, these tech-enabled young people who use
commission-free trading and banded together to outwit the hedge
funds they felt had an unfair advantage.
Third--and these are the folks that I am here for today--
are the everyday Americans, hardworking people with long-term
retirement savings invested in the stock market. These people
rely on Government institutions and financial professionals to
look out for them.
When the GameStop-Robinhood episode occurred in January, I
was immediately reminded of the MIT Blackjack Team of the
1990s, when a group of students banded together to break the
bank at several large casinos. They realized that if they
worked together, they could win substantially more money than
the average gambler. So using their math skills and their
technology, they coordinated to quickly and strategically place
large bets against the house.
It is pretty easy to see the obvious similarities between
the two situations. Like the MIT students, the Redditors in
January were young, knowledgeable people with high appetites
for risk who chose to collectively speculate by making quick
bets against a larger player with a perceived advantage.
On the other hand, like the casino owners, the hedge funds
are these large institutions with specialized knowledge about
the game who some say routinely use their size to tip the odds
in their favor.
What is not obvious, whether in the casino or in the stock
market, is what the wealthy institutions and upstarts have in
common. They are all fast-moving, high-risk speculators with
more skills and tools than the average person.
But there is a problem here for the stock market, which is
supposed to be a place where a person can grow wealth by
investing in companies that have good prospects. But when fast-
moving, high-risk speculators dominate, we have a classic
recipe for market disruptions. What we saw in January with
GameStop and Robinhood is what we saw during the Great
Recession with Wall Street churning out subprime, mortgage-
backed securities.
Market disruptions like this are a problem because, as
stated by SEC Commissioners in January, `` . . . extreme stock
price volatility has the potential to expose investors to rapid
and severe losses and undermine market confidence.''
Now, unfortunately, this volatility does not impact
everyone equally, and let me paint the picture of what the
everyday investor experienced. Imagine a two-job household with
a couple of kids, adults working hard to make ends meet and
save enough for the future. They do not have a pension to fall
back on for retirement because so few pensions now exist. They
know that Social Security benefits their parents receive are
not enough to cover most retirees' basic needs. And for several
decades now--and this is key--the economy has only offered
these savers historically low interest rates, which means that
putting their money in low-risk savings accounts, CDs, or bonds
barely makes them enough to keep up with inflation.
This leaves investing in the stock market as their only
option. It is the only way their savings can grow enough to
provide for the future. So they are forced into the ``stock
market casino'' with their life savings. And they are required
to play against armies of sophisticated, high-risk hedge funds
and Redditors duking it out for dominance. For everyday
Americans with smaller amounts that represent all that they
have to invest, sustaining significant losses--or even the
perception of losses--is devastating. It makes them lose
confidence and want to opt out altogether. But we know they
cannot leave the casino.
As an investment professional who works for everyday
investors, and as Senators with these same people as your
constituents, we must fix the system for them. We need to
maintain fair, orderly, and efficient markets that serve as a
reasonable place for the average American to invest their life
savings. And we have a duty to protect these investors from the
crossfire of fast-moving, high-risk speculators.
Chairman Brown. Thank you, Ms. Robasciotti.
Ms. Ghilarducci.
STATEMENT OF TERESA GHILARDUCCI, BERNARD L. AND IRENE SCHWARTZ
PROFESSOR OF ECONOMICS, THE NEW SCHOOL
Ms. Ghilarducci. Hello. Thank you for inviting me, Chairman
Brown and Ranking Member Toomey, and hello to the Members of
the Committee.
I am a professor of economics at The New School. I teach
behavioral finance and labor markets. I also taught at the
University of Notre Dame for 25 years. I received my Ph.D. from
UC Berkeley, and I have published four books on how workers
acquire wealth. The latest one was ``Rescuing Retirement'' with
my co-author Tony James.
I also am a court-appointed trustee overseeing $60 billion
of the retiree health care trust fund money for auto workers,
and that money is invested to last over 80 years.
Now, as a professor, my office hours are typically quiet
moments huddled over equations and numbers. But over the past
few years, I have seen another trend. Students are coming to me
bubbly because they want to know about trading on their phone
app, Robinhood. Now, the young are told to buy stocks and they
are told to hold them, but these students have absorbed the
first point but they have not absorbed the second.
Trading on Robinhood is a game, and it has psychologically
powerful intermittent rewards. The trading is disconnected from
long-term wealth accumulation. Phone apps makes trading easy,
and they are cheaper, and superficially they seem to open
securities markets to many more people. But trading apps do not
produce wealth.
I welcome today's hearing seeking to protect retail stock
buyers, seeking to protect my students. And I am here to
testify where Americans really get their wealth.
So I am going to huddle over a few numbers in the next few
minutes, and I draw my data from the gold-plated data from the
University of Michigan, the Health and Retirement Survey, and I
am looking at households where people are still working, they
are over the age of 52. They have gone through their life
cycle. They have accumulated their wealth, and we are going to
take a snapshot of what their wealth looks like.
So averages hide differences, so I am going to report my
numbers in terms of the bottom half of the wealth distribution,
the middle class and the next 40 percent, and what the top 10
percent of the wealth distribution have.
Now, you probably have already guessed that home equity,
the net wealth from their homes, and retirement wealth,
including Social Security, are by far the largest component of
wealth for everybody. Those components make up 88 percent of
the wealth held by households in the lower half of the wealth
distribution, 78 percent for the middle class, and 43 percent
for those in the top 10 percent.
I am going to make a side track note to note what Social
Security means to households. I am always surprised to see that
Social Security is the most important source of wealth for
households nearing retirement.
In contrast to home equity, retirement wealth, and Social
Security, directly owned stocks and bonds make up a small share
of these households' wealth. The average is only 8 percent.
Only 24 percent of older households own stocks directly,
outside of their retirement accounts, and that ownership, that
24 percent, is concentrated way at the top. Only 10 percent of
people below the median own stocks directly, and it is a small
amount, and less than a third of the middle class owns stocks
directly.
And the wealthy, 70 percent of them do own stocks directly
outside of their retirement wealth. But it is only 13 percent
of their wealth.
As Nobel Prize winner Robert Shiller the economist's recent
book just points out, stock trading feeds a narrative. It feeds
a story about wealth. Stories about getting rich on stocks
produce a fiction that stock trading creates wealth, when, in
fact, retail investors fuel bubbles, as the witnesses have
testified to.
Defenders of Robinhood and widespread trading have purchase
because the COVID recession has produced wealthy people who
have gotten wealth. Their gains heighten the fear of missing
out, or FOMO. The reality is that most Americans are being left
out because they do not have access to retirement accounts,
which is where most of us who own stocks. Retirement accounts
are invested in diversified portfolios managed by institutional
investors and professionals. It is those professionals that can
handle the complex instruments for investments, and it is those
professionals that accumulate savings, hard-earned savings by
workers, and invest them in diversified portfolios.
We need innovations in public policy to give more Americans
access to what we know works: professionally managed retirement
coverage that allows everyone to benefit from the stock markets
the same way you and I do in the Thrift Savings Plan, in
private or public defined benefit plans--as Senator Toomey
mentioned, the firefighters and the teachers--or in my pension
plan, the Teachers Insurance Annuity Association. We all need a
piece of diversified, well-managed, professional accounts.
Thank you very much.
Chairman Brown. Thank you, Dr. Ghilarducci.
Commissioner Piwowar, please proceed for 5 minutes.
Thank you.
STATEMENT OF MICHAEL S. PIWOWAR, EXECUTIVE DIRECTOR, MILKEN
INSTITUTE CENTER FOR FINANCIAL MARKETS
Mr. Piwowar. Good morning. Thank you, Chairman Brown,
Ranking Member Toomey, 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. I had the
pleasure of serving on this Committee's staff as Republican
Chief Economist for Senator Shelby and Senator Crapo. I also
served as a Visiting Academic Scholar, Senior Financial
Economist, Commissioner, and Acting Chairman of the Securities
and Exchange Commission.
I am glad you called this hearing today on the state of
retail investing. As we have heard, on the one hand, retail
investors have never had it better. They enjoy more choices and
face lower costs when investing their hard-earned savings than
ever before. They can invest directly in securities through
brokerage accountable, and competition among brokers has led to
commission-free trading. Competition among exchanges,
alternative trading systems, and market makers has led to the
best market quality environment for publicly traded securities
in history. Transaction costs are low, market depth is high,
and execution speeds are fast. Retail investors can make their
own investment decisions, or they can seek the advice of well-
regulated investment professionals through a broker-dealer or
investment adviser.
Alternative, they can achieve low-cost diversification and
professional management by indirectly investing in the stock
market through passively and actively managed mutual funds and
exchange-traded funds. Competition among these funds has
brought fees and expenses down to their lowest levels in
history. The availability of retirement savings accounts such
as 401(k) plans and individual retirement accounts also allows
low-cost access to the stock market.
Now, retail investors have taken advantage of these
beneficial trends over the past few decades. As Senator Toomey,
mentioned, the percentage of U.S. households that own stocks--
directly or indirectly--increased from 32 percent in 1989 to 53
percent in 2019. Now, low-income households saw the biggest
gains over the period, but they still lag high-income
households in public stock ownership rates.
Now, as we have also heard, on the other hand, the January
trading frenzy in GameStop and other meme stocks and the
related difficulties faced by some brokerage customers
highlighted a few areas that require the SEC's and this
Committee's immediate attention.
Now, the SEC 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 has also
said they are investigating whether abusive or manipulative
trading activity prohibited by the Federal securities laws
occurred during this episode.
Having worked at the Commission for the better part of my
career, I have complete confidence that the Commission and the
staff will identify and pursue any evidence of noncompliance or
wrongdoing. Accordingly, I focus my testimony on the market
structure and infrastructure policy issues that have been
raised in the aftermath of the January trading.
In summary, I 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; three, evaluate various alternatives to
increase regulatory reporting and public transparency in
securities lending; and, four, consider amending the accredited
investor definition to achieve more equitable access to
investing in private companies across all income levels.
Now, 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 for bringing attention to these critical issues
and for the opportunity to testify here today.
Chairman Brown. Thank you, Commissioner Piwowar, and
welcome back again to the Committee.
Mr. Vollmer, you are recognized for 5 minutes. Thank you
for joining us.
STATEMENT OF ANDREW N. VOLLMER, SENIOR AFFILIATED SCHOLAR,
MERCATUS CENTER AT GEORGE MASON UNIVERSITY
Mr. Vollmer. Well, thank you for inviting me, Chairman
Brown, and to you and Ranking Member Toomey and the Members of
the Committee, good morning.
My written statement makes three points, and I end with my
view that what we know so far about the events surrounding the
GameStop trading does not provide a sufficient basis for new
legislation or regulation.
So the first topic I cover is the trading in GameStop by
the users of the WallStreetBets social media forum. Based on
the public information I have seen, misconduct probably did not
occur in the trading of GameStop. The SEC is investigating, but
my understanding is that the main group of individuals trading
GameStop did not make material false or misleading statements
to the securities markets and were not deceived by others.
Another concern has been whether a securities manipulation
occurred. The leading definition of securities manipulation,
which comes from the Supreme Court, is securities trading that
is artificial or not genuine. The traders using the
WallStreetBets site actually bought GameStop and the other
stocks and, therefore, did not engage in a manipulation.
Let us look at the effects of the GameStop trading on the
larger secondary markets for securities. At the moment, those
effects do not appear to be widespread or severe. The trading
activity in GameStop, AMC, and the other securities was limited
to a few companies and was short term. Some investors made
money in GameStop, and some lost money.
Overall, at least so far, we have not seen strong evidence
of securities violations or harm to the markets for buying and
selling equities on stock exchanges. There have been some
questions about short sales, and I hope we are able to get into
that topic during the questioning.
My second point in my written statement, I discuss the role
of the broker-dealer Robinhood. It has come under scrutiny
because of the WallStreetBets traders using it and because it
has certain features that make buying and selling securities
easier and more attractive, like commission-free trades or
accounts with no minimum dollar amounts.
The criticisms of Robinhood fail to give appropriate weight
to the benefits of its business model. The Robinhood brokerage
service is innovative, and it makes significant positive
contributions to society and the economy. It reduces costs for
consumers, makes securities trading simpler and easier. It
increases consumer choice and lowers barriers to participation
in the market for the common stock of companies listed on stock
exchanges. It, therefore, opens the securities markets and
equity securities ownership to a much larger part of the
population and to people with less income and wealth than are
typically associated with participation in the equity markets.
That is all to the good and serves a variety of goals that I
have heard from everyone who is participating in this hearing.
My final point is that the information currently available
has not revealed a problem of sufficient severity to justify
Congress imposing new regulations in these areas. New
information could change that, but any deliberations about
possible additional legal restrictions Congress should give
weight to and respect the personal liberty interests involved.
I have not heard individual civil liberty mentioned as a factor
so far today, but I think individual liberty is an important
tradition in our country, and Congress should not restrain
personal freedom unless it has a strong reason.
That is a summary of my written statement. I would be happy
to answer questions.
Chairman Brown. Thank you very much, Mr. Vollmer. I thank
all five witnesses.
I will start with Ms. Robasciotti. Why do people get
discouraged even as some stocks are going up? Do people think
the market is fair? What are you hearing from your clients?
Ms. Robasciotti. You know, we hear from our clients
regularly. They ask us literally the casino question, like is
it actually the best way for me to save long term? And what you
and I know is that they do not have any other options if we are
going to outstrip inflation. And so I do see, particularly in
the younger generation, an increasing set of people that do not
want to participate in financial markets specifically because
they do not see them as fair or efficient.
Chairman Brown. OK. Thank you.
Professor Ghilarducci, the research on stock ownership
shows, as you pointed out--and those numbers were helpful--that
half of U.S. households are investing in the market; many are
not. I appreciated your recounting where people's wealth--how
people hold their wealth and home equity and Social Security,
and that is the preponderance of wealth for most people. How
does the fixation on Wall Street and stock market performance
distract us from the actual economic reality for most families?
Ms. Ghilarducci. As I said, I teach behavioral economics,
and psychologically, we are wired to look at the most recent
events, and when people get rich around us, who are much
richer, we see them through the lens of the media, we feel that
we are afraid, and fear actually causes anxiety and might cause
pulling back. It might cause coming back in. And it fuels
bubbles. And as Robert Shiller's great new book says, it
produces a narrative about economics and a narrative is a
fiction. Stockholdings, direct stockholdings, does not create
wealth, and I really appreciate what Rachel said, that we wish
we had a better option. I wish everybody could be in the kinds
of funds that we are in. But they will not get that by directly
trading stocks.
I hope I answered your question.
Chairman Brown. You did. Professor Fletcher, Robinhood and
others brokers' business models based on selling customers'
orders to large trading firms and receiving so-called payment
for order flow, if these intermediaries are willing to pay
brokers and provide them a service, it suggests they are
getting a better deal than the broker's customers, the retail
customers.
Explain why these conflicts are so problematic.
Ms. Fletcher. Thank you, Senator Brown. So payment for
order flow, just as you explained, allows some brokers to say
that they are operating zero-commission trading to retail
investors, and these commissions are then being subsidized by
wholesalers. But the payment for order flow model undermines
the relationship between a broker and their client because it
pits the broker's primary revenue source directly against the
clients to whom they owe a duty of best execution.
So under the payment for order flow model, brokers are
incentivized to put their own profit-seeking interests above
their clients' in deciding where to route orders, and this
greatly undermines the broker-investor relationship, likely
leaving retail investors in a worse position.
Chairman Brown. Thank you, Professor Fletcher.
Commissioner Piwowar, I appreciate your work at the SEC in
2017 with Commissioner Stein to reduce the time it takes to
complete stock transactions, reduce risk in the system. Ranking
Member Toomey commented on that, too. Robinhood has suggested
real-time settlement as a solution to the difficulties it had
in January.
Is that realistic? What other changes would be necessary?
Comment on that, if you would.
Mr. Piwowar. Thank you, Senator Brown, for that question.
And as you pointed out, the move toward shorter trade
settlements, like in 2017 from T+3 to T+2 was overwhelmingly
bipartisan at the time. There were two of us at the
Commission--Commissioner Kara Stein, who used to work for
Senator Reed, who is on this, and myself. It was one that we
viewed as a slam dunk to move to T+2.
For reasons I stated in my testimony, I think the SEC
should absolutely consider moving to T+1. I am happy to go into
these details. But you asked me about real-time settlement. I
think that is a bridge too far at this particular point in
time. As we shorten the trade settlement cycle, we reduce risks
like market risk, liquidity risk, and systemic risk, but we
also have the opportunity--or we have the challenge of
increasing operational risk.
In order for real-time settlement to work, everything has
to work perfectly all the time, and it is important to remember
that the trade settlement cycle for securities does not operate
in isolation. We also have to make sure the cash gets there,
and that brings into account banking payment systems; it brings
into account foreign exchange settlements systems for cross-
border transactions; and all of those have to be calibrated to
make sure that it works perfectly.
And so at this point, I think absolutely the SEC should
look at shortening the trade settlement cycle, perhaps as one,
but I think real-time settlement is just a bridge too far at
this point.
Chairman Brown. Thank you, Commissioner.
Ranking Member Toomey.
Senator Toomey. Thank you, Mr. Chairman.
Dr. Piwowar, you know, when I graduated from high school in
1980, the Dow Jones Industrial Average had a low that year of
759, and it traded at a high of about 1,000. The last time I
checked this morning, the Dow was at 32,000. And I guess my
question for you is: If a retail investor took whatever amount
of savings he or she could and regularly invested in a broadly
diversified portfolio through whichever mechanism, and did that
over these last 40 years, is it likely that that investor would
have earned very substantial returns on those investments? Or
is it more accurate to think of the stock market as a zero-sum
casino where that middle-income American is going to lose
because there is a hedge fund out there somewhere that wins?
Mr. Piwowar. Yeah, thank you for that question, Senator. As
Andy Vollmer pointed out in his testimony, the returns that
retail investors get from long-term investing is exactly the
same as an institutional investor who invests in the exact same
securities. And what we know for long holding periods is that,
you know, on average, the stock market tends to go up.
There are daily fluctuations, there are minute-by-minute
fluctuations in individual securities, but what we know is that
retail investors who hold diversified positions in low-cost
mutual funds and other mechanisms over long periods of time
will do quite well in increasing their wealth.
Senator Toomey. And those low-cost options are lower in
cost and more available today than ever before. Isn't that
true?
Mr. Piwowar. That is correct. You know, since the time that
you graduated in 1980, not only do investors have the
opportunity to invest in open-end mutual funds, but a new
innovation, exchange-traded funds, has entered the landscape
and has brought incredible competition to this industry and
brought fees and expenses to their lowest rates in history.
Senator Toomey. Right. A quickly follow-up on the faster
settlement cycle. I understood you to say that there might be
some challenges, technical challenges, in real-time settlement.
But would you distinguish between real-time settlement and
same-day settlement? And do you think that it is feasible to
move to same-day settlement? Or do you think we really should
be happy with T+1 rather than the T+2 we have today?
Mr. Piwowar. Thank you for that question. First of all, I
think what the SEC should do, which is what we did when we
evaluated moving from T+3 to figure out should we go to 2, to
1, or real-time settlement, was we took a look at the way the
world existed in terms of the markets and technologies 4 years
ago, and we said let us look at it on a cost-benefit analysis.
And we said, all right, in terms of moving from 3, do we get
any benefits? And what are the costs from going to 2 to 1 or
real-time settlement?
At that time, 2 was the clear winner. What we heard from
the industry was that the cost would be low. It would be pretty
much speeding up existing back-office products. Then we heard
from buy side, sell side, the clearinghouse, exchanges, even
retail investor brokers and securities traders.
Moving to 1 had additional challenges. Not only the costs
were higher, but as I mentioned in answer to Chairman Brown,
you have to get the bank regulators involved to make sure that
all the bank payment systems also line up so that you make sure
that they settle correctly.
Moving to zero, you know, at that time, whenever we asked
people, said, ``Well, how do you get to real-time settlement?''
and the answer was always, ``Blockchain.'' And we said, ``Well,
can you explain how that workers?'' And they would just repeat
back louder, ``Blockchain.''
And so we may get to a point where blockchain technology or
digital ledger technology gets us to a point where we can
achieve real-time settlement, but I do not think we are there
just yet. That is just my opinion.
What I think the SEC should do is put out for public
comment a rule proposal proposing to move to a shorter trade
settlement cycle and put it out for public comment and evaluate
the costs and benefits.
Senator Toomey. Thanks. And, Mr. Chairman, if I have time
for one more quick question?
Chairman Brown. Yes, proceed.
Senator Toomey. Mr. Vollmer, recently the CEO of Robinhood
testified that the restrictions that they imposed on purchasing
GameStop and a few other stocks were driven by margin
requirements required by the DTCC in compliance with the SEC's
capital rule. So two questions.
One, is that a plausible explanation in your mind for the
restrictions they put in place? And, two, is it really optimal
to have the opacity about how those capital rules work that
prevent us from knowing clearly in advance exactly what they
are?
Mr. Vollmer. Thank you, Senator Toomey. I think the
explanation that I heard from the CEO sounded reasonable. The
collateral call from DTCC was sudden and in a large amount.
That took Robinhood by surprise and caused them to impose
trading restrictions. By the way, the trading restrictions were
only one way, only on buys, not on sells. So customers could
sell. They entered into the discussions. They talked to DTCC.
They reduced the collateral call because they had imposed these
trading restrictions.
The SEC is in a position to look at these areas to see if
the process could be improved and smooth, because I agree with
the theme in your question, and that is, I do not think either
Robinhood or the customers should have been taken by surprise
quite as much as they were, and if there is a way that we could
smooth that out, I think that would be better for the broker-
dealers and better for the markets.
Senator Toomey. Thank you very much.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Toomey.
Senator Menendez is recognized.
Senator Menendez. Thank you, Mr. Chairman.
Dr. Fletcher, I want to follow up on the questions that the
Chairman raised with you in terms of order flow issues. Doesn't
it create a conflict of interest or at least an appearance of a
conflict when a broker receives a payment from a third party--
in this case, a market maker--to fulfill their customers'
orders?
Ms. Fletcher. Thank you for that question, Senator. Yes, it
absolutely creates that conflict of interest because brokers
are now--with this payment for order flow model, brokers are
incentivized to put their own profit-seeking interests above
the interests of customers when deciding where or how to route
these orders.
This also should raise concerns for us in terms of
customers being able to get the best execution from their
brokers. And so, yes, I agree with your question that this does
raise these questions for us.
Senator Menendez. And so how does an investor know that
their broker is working to find the best execution quality for
their investor, not simply working with the market maker that
pays them the most?
Ms. Fletcher. So currently under SEC rules, there are some
disclosure out--there are disclosure obligations on retail
brokers to state what their price improvement is from having
routed their orders through different--to different wholesalers
or market makers. But the retail investor really has very
little information in terms of knowing the price at which their
order is executed or what exactly that price improvement was.
So retail investors do have less information, and so we do need
more or better disclosure for retail investors to be able to
evaluate this information.
Senator Menendez. Are there other costs that payment for
order flow imposes on investors?
Ms. Fletcher. One of the things that we want to probably be
thinking about with regards to payment for order flow is
whether or not retail investors are truly receiving a best
execution when they are trading, meaning if there are quotes
that are--so, for example, there are quotes that are available
that are odd lot quotes that are typically not included when we
think about what the best price is available for an order. And
right now one of the things that I would recommend is that the
SEC think about amending some of their rules to include these
odd lot quotes such that truly the best price available is
included when we think about the execution of more retail
investor orders.
Senator Menendez. Thank you. I would like to turn our
attention to racial inequity in the stock market. Historically,
stock ownership has been dominated by white Americans.
According to the Federal Reserve, in 2019, only 34 percent of
Black families and 24 percent of Hispanic families owned any
equities compared to nearly 61 percent of white families. This
disparity only grows larger when you look at the value of
equities held. Among families with equity, the typical white
family has over $50,000 in holdings compared to just over
$14,000 for a typical Black or Hispanic family.
These equities represent funds that families can tap into
in emergencies such as the pandemic. We have ample data showing
that the pandemic is having a disproportionate effect on
minority families, and the lack of savings is one reason why.
Dr. Ghilarducci, what are the consequences of
disproportionately low participation in the stock market by
Black and Hispanic families? And what are some of the
challenges holding back minority families from owning equities?
Ms. Ghilarducci. Thank you so much for that question. A lot
of my research at Notre Dame has been on non-white families
with anthropologists exactly exploring that question.
What holds non-white families, Blacks and Hispanics, from
having wealth is not having access to a retirement plan at
work. Wherever these families have significant holdings,
meaningful holdings in stocks and bonds and private equity and
the kind of wealth that we have because we are workers who have
a retirement plan at work, they do not have because of their
workplaces. So if we worked to expand retirement coverage to
all workers through an innovative pensions-for-all plan, they
would have less.
Senator Menendez. One last question, Dr. Ghilarducci. Is
the lack of stock ownership among minority families an
impending factor in their ability to build wealth?
Ms. Ghilarducci. Absolutely. They need Social Security,
they need home equity, and they need access to financial
instruments, but through professionally managed funds, not
through trading on their phone.
Senator Menendez. OK. Thank you very much.
Chairman Brown. Senator Shelby from Alabama is recognized
for 5 minutes.
Senator Shelby. Thank you, Mr. Chairman.
I want to take a second here and welcome again Dr. Piwowar
back to the Committee where he spent a number of years before
he was a member of the Securities and Exchange Commission
itself. Thank you for being here with us today.
I have a question for you following up on the area that
Senator Toomey was involved in. I have always asked about cost-
benefit analysis, how important that is when you are dealing
with a new regulation or a proposed regulation. What has the
SEC adopted a number of years ago and what do they do today
when they are looking at a regulation, Dr. Piwowar?
Mr. Piwowar. Thank you, Senator Shelby, for that question,
and thank you for your warm welcome back to the Committee. It
is great to see you and the other members of the Committee
again.
I think you are referring to the current guidance in
economic analysis----
Senator Shelby. Absolutely.
Mr. Piwowar. ----that the Commission adopted in 2012. So
then-SEC Chairman Mary Schapiro decided to enhance the role of
economic analysis at the Commission. It was due in response to
a couple things.
One, the Commission had lost some well-publicized cases in
the courts for not following--doing proper cost-benefit
analysis in accordance with the Administrative Procedures Act
and some of their own statutory requirements. And, two, part of
it was your leadership in terms of making sure that as the
regulator implemented the various Dodd-Frank provisions, that
they were doing cost-benefit analysis to evaluate how they were
going to move forward.
What the guidance did was essentially give the Chief
Economist at the Commission more authority over the rulemaking
process, got the economists involved earlier in the rulemaking
process to help standardize how they think through the rules.
And so what it does is it forces the Commission to go through a
very important exercise of saying, all right, what is the
justification of why you are thinking about going forward? It
could be a mandate from Congress, or it could be a
discretionary choice based on the fact that markets change. It
forces them to adopt a baseline for the status quo, and then to
look at various alternatives and evaluate each of those
alternatives in terms of the costs and benefits, and that will
then point them in the direction in terms of which is the most
appropriate way for the Commission to move forward.
That guidance has been followed by every Chairman, both
Republican and Democrat, and I was heartened to see in response
to your question at the nomination hearing last week that Gary
Gensler, if confirmed, would also continue to follow that
guidance.
Senator Shelby. Would you give us just a thumbnail sketch
of if there is a proposal to come forth with a regulation, a
mandate by the SEC dealing with the current problems, you know,
order placement and so forth, what would be the steps to do
this? How would you go about that if you did?
Mr. Piwowar. Yeah, thank you for that question. That is one
of the great things about the regulatory process that we have,
is it provides for valuable input from the public. So, first of
all, the SEC would decide whether they want to put a rule
proposal out; or maybe they are not there yet, maybe they are
still contemplating whether to put out a formal rule proposal,
so they could do a request for comment. And then what the SEC
does is it puts out and provides to the public their own
economic analysis in terms of what they think the costs and
benefits are, and then they ask explicit questions of the
public and ask them questions like: Did we get this right? Do
you have any other numbers that would support or contradict our
finding? Or do you have any other numbers that would help us
make this decision?
It is a very public process. They go through open meetings.
The public can participate. It is on their website. Anybody can
submit comments to this process. And then the procedures and
the statutes that the SEC has to follow, they have to take into
account those public comments. Then they go back and
reformulate their economic analysis with this new information,
and they can choose to either move forward, not move forward,
or move in a different direction. So it is a very robust
process.
Senator Shelby. One question to Mr. Vollmer. Mr. Vollmer,
in your opinion, did Robinhood perform in a rational,
thoughtful way in dealing with their situation when everything
was a little frenzied?
Mr. Vollmer. Senator, they certainly reacted in a rational
way, and they were as thoughtful as time permitted them. But
they were under a great deal of time pressure with the sudden
collateral call. And so they reacted quite well, and they did
impose the trading restrictions, which they did not want to do,
but they tried to relieve those when they could. But they
collected collateral that they could put up to DTCC very
rapidly.
Senator Shelby. Mr. Chairman, thank you very much.
Chairman Brown. Senator Tester from Montana is recognized.
Senator Tester. Well, thank you, Chairman Brown, and I want
to thank you and Ranking Member Toomey for holding this
hearing. And I want to thank everybody who has testified. I
appreciate all of your time, and thanks for being here.
We have known for a long time that there are perverse
incentives in our systems and that those systems influence
where companies make investments, and sometimes more
importantly whether to make cuts. Many of us here agree that
there would be benefits to a system where companies focus on
the long term and helping their communities and their workers
not just on short-term profits.
Now, I want to be clear. I do not feel bad for those who
have lost money trying to game the market. But I am worried
about those regular folks who saw this and tried to get in on
something like this and then get hurt.
The recent market volatility presents an opportunity to
take a really hard look at our securities regulations and the
systems that we have in place. Investing in companies in the
stock market should not be something that can only be gamed by
the wealthy. I think we all agree with that. So it is my view
our system should work for everybody that is trying to invest
in their future.
So it seems to me that something is not working here for
companies and communities, and especially the retail investor.
So this question is for all of you, and I will ask you to
try to make it short. Some of you have already addressed part
of this. But if you were able to make any changes and were in
charge of all of the decisions, whether that is in Congress or
at the SEC and SROs everywhere, what would you do to approve
how our system works for retail investors? And you can just go
in the order that you presented your testimony.
Ms. Fletcher. Thank you so much, Senator, for that
question. So the thing that I would want to make our system
work better for retail investors is better information for our
investors as to what the true costs are for their trades and
for the transactions that they are engaging in. Too many
investors see this zero commission model and think that it
truly is zero commission, and I think that there is information
that they would need to truly evaluate the costs and the risks
of these transactions.
Senator Tester. Thank you.
Ms. Robasciotti. Thank you for your question, Senator. If I
could do one thing, it would be to impose a financial
transaction tax. I believe that that is a very negligible cost
to the everyday investor, and it is something that would stop
the high-frequency traders from dumping gasoline onto the
already roiling fires of mistakes or other market disruptions
that come about.
Senator Tester. OK. Just to be clear, the tax would be put
on for the purpose of stopping the high-volume folks, correct?
Ms. Robasciotti. Yes, I believe the tax--the purpose of the
tax is to add an additional cost, and that additional cost
would be an invitation for deliberation, which I believe is
something that investment decisions always benefit from.
Senator Tester. Thank you. Next?
Ms. Ghilarducci. Three things. The economic analysis should
include behavioral economic analysis at the SEC. They should
look at the way that the phone app looks like and to cut out
the obvious addictive aspects of the games. Economists should
be smart about that.
Second, I agree with Dr. Fletcher that there should be a
revelation just like we do in professional investing, what the
true costs are.
And, third, Nobel Prize economists back up what Robasciotti
just said, that sand in the works, slowing down the trading
with a securities tax would help make the market work better.
Senator Tester. OK. Next?
Mr. Piwowar. Thank you, Senator Tester, for that question.
So a few things.
One, we already talked about, I think, shortening the trade
settlement cycle would help everyone, allow retail investors to
get access to their funds quicker, but also take risk out of
the system.
Second, amending the accredited investor definition to
achieve more equitable access to private companies across all
income levels.
And, third, just a general one: better disclosures for
investors. As you know, the SEC is a disclosure regulator, and
so one of the most important things that the SEC can do is
provide--is arm investors with information to make informed
choices. And so one example of that, you know, Professor
Fletcher had mentioned better information about order routing
and best execution. I wholeheartedly agree. In my written
testimony, I attempted to look to see whether Robinhood
customers in particular, how their order executions were done,
and, unfortunately, with the publicly available information, I
could not do that directly. So I think better, more granular
information about how and why brokers are routing their trades
and the outcome from that could go a long way to protecting
investors.
Senator Tester. Mr. Vollmer.
Mr. Vollmer. Thank you, Senator. I will be quick. Two
things.
First, reduce the cost and complexity of public offerings.
Second, I am in broad agreement with Mike Piwowar. In
private transactions, the difference between accredited
investors and nonaccredited investors should be eliminated, and
instead in certain private offerings, there should be required
short-form core disclosures.
Senator Tester. Thank you all.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Tester.
The Senator from North Carolina, Senator Tillis, is
recognized.
Senator Tillis. Thank you, Mr. Chairman. And thank you all
for being here. I have been in and out of this Committee. I
have got two other committee meetings going on at the same
time, so I am sorry I have not been here for all of your
testimony.
I was here after Senator Shelby's and Senator Tester's
questions, so I want to get right to the financial transaction
tax. I know that that has been something that has been offered
up in the wake of the Robinhood/GameStop saga. But there seems
to be--I am trying to understand how we can avoid what appears
to have been the consequence for financial transaction taxes
that have occurred in other jurisdictions and then some
countries have thought about it and backed off of it based on
these experiences.
Reputable studies indicate that the FTT would actually
reduce the value of a typical investor's 401(k) and maybe as
much by 8.5 percent in the lifetime of savings. That looks like
people may have to work an extra 2-1/2 years to make that up,
to realize the same amount of savings.
So do you disagree, Professor Ghilarducci, that it would
have that effect on potential savings?
Ms. Ghilarducci. Thanks a lot for bringing up that
research, Senator Tillis. It is really pertinent. That data is
a bit out of date, and it also is distorted. If 401(k) traders
or pension funds traded all the time, the tax would reduce
their savings. Also, that study was done on a tax that was much
higher than the kinds of taxes that are produced now.
It is well known in the economic research that if you get
the tax low enough, you do not hurt long-term investors, but
that you slow down the high-frequency trading. So it has to be
done right, but it is backed--the good effect is backed by
many, many studies, not just that one study you are citing.
Senator Tillis. Thank you. I know that CBO projects the FTT
would result in a $43 billion, almost $44 billion first-year
net loss of tax revenues and would immediately lower the value
of financial assets. Are you just saying that these studies
have set the mark too high? And so, in your opinion, what is
the sweet spot that you think would actually affect the high-
volume investors but not affect the individual investors that
now a substantial number are in the market?
Ms. Ghilarducci. I just read a dissertation that had that
number, that sweet spot--that is a really excellent question--
meaning I will have to get back to you with what that number
is, but there is a number. And the CBO study looks at the
short-term effects. People will not be trading and realizing
those capital gains, but we actually do not want them to. We
want them to hold those gains longer. So I will get back to you
with that number.
Senator Tillis. Thank you.
Mr. Piwowar, thank you for being here, and I am sorry our
time is limited. I will not be able to ask questions of all of
the witnesses. But am I correct that the act of frontrunning
that some worry market makers could engage in is already
illegal?
Mr. Piwowar. That is correct.
Senator Tillis. So should the discussion be more around
enforcement of what we already have on the books, or do you
think we need to go further than that?
Mr. Piwowar. No, I think you are absolutely right. I think
it is enforcement of what we already have on the books, right?
And so if I may just go into a little more detail on that,
there is an inherent conflict of interest when--in the presence
of payment order flow, and the SEC explicitly recognizes that,
and that is why we have best execution requirements, and that
is why the SEC actively enforces those best execution
requirements. And also, if I may, if the SEC works a band
payment for order flow, we would likely go back to commission
trading. It would cost to trade. And what that does is it does
not eliminate a conflict of interest; it just changes it.
So when I was in the private sector, I worked for an
economic consulting firm, and we provided expert witness
testimony on behalf of plaintiffs in the FINRA arbitration
context where brokers were churning the accountable of their
customers. And so simply, you know, getting rid of payment for
order flow just moves the conflict of interest, and, again, it
has to be done through enforcement.
Senator Tillis. Thank you very much.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Tillis.
Senator Warner of Virginia is recognized.
Senator Warner. Well, thank you, Mr. Chairman, and I want
to pick up where my friend Senator Tillis left off, and I want
to start with Professor Fletcher, but I would like to hear from
Michael on this as well.
On this question around payment for order flow, I think,
you know, we have now seen evidence that about $6 billion of
payments to brokers and others within the payment for order
flow, I remember, gosh, it has probably been 7 or 8 years ago,
the Royal Bank of Canada had a chart that kind of blew me away
about the bespoke nature of all this order flow payment. I
think it is extraordinarily not transparent. I think $6 billion
generates an awful lot of profits, I think particularly when
you have got only a few major firms that are on both sides of
the trade around payment for order flow, and I want Michael to
comment on this, but it really seems out of whack to me. And
the argument that says payment for order flow is to increase
liquidity, it just does not seem to be the case. I mean, if you
look at the fact that of the 9,000 securities that are traded,
the top 10 percent, less than 1,000 of them, account for about
77 percent of all that liquidity, it would say to me that, you
know, you do not need that payment for order flow to increase
liquidity because you have already got liquidity.
And I guess I would start with you, Professor Fletcher. I
think you have raised these issues as well. You know, we see
large enterprises with Fidelitys and Vanguards that do not make
payment for order flow, has that decreased liquidity? Why
wouldn't we--if we need liquidity payment, why wouldn't we pay
for, say, the bottom--payment for order flow for the bottom 90
percent but not the top 10 percent? And have we seen in
countries like the U.K. and Australia, which have banned
payment for order flow, any decrease, significant decrease in
liquidity? Why don't we start with you, Professor Fletcher? I
have worked with Michael in the past around here. I know he has
got a different view. But, Professor Fletcher, would you start?
Ms. Fletcher. So thank you so much for that question,
Senator. So in terms of the impact of payment for order flow on
liquidity, I do not think that payment for order flow is needed
for us to achieve liquidity. We have a deep financial market
that we have had before payment for order flow, and just as you
noted, there are jurisdictions, such as United Kingdom and
Australia, which have banned payment for order flow. And
research that I read from the United Kingdom recently has not
indicated that there has been any meaningful decline in their
liquidity.
Indeed, what that research has demonstrated is that there
has been better execution for retail investors at the best
price in the absence of payment for order flow. So that would
indicate that there is less conflict and investors are able to
get better price execution in the absence of payment for order
flow.
Senator Warner. And we have not seen--by the way, if you
are a Fidelity or Vanguard customer where they are not paying
payment for order flow, are they getting less good execution
terms than other retail investors?
Ms. Fletcher. So the problem with that, Senator, is that we
do not have information to even know that, right? And so one of
the--this is something that I believe that we have some
consensus about in this hearing, is that we do not have enough
information to know whether or not retail investors like
Fidelity that does not do payment for order flow have a better
or worse execution than our retail investors with other brokers
that do have payment for order flow. And so that is a point at
which we do need more and better information.
Senator Warner. And I would say that I fear--I have talked
to our friends at Robinhood, and I have spent some time looking
at this. I really do fear--and I am all for democratization of
our market system, but increasingly I fear that oftentimes
these retail investors are, frankly, not customers. I think
they are the product, a la many of us being the product for
Facebook. And I think we are--oftentimes that product is
manipulative.
Michael, I want to give you a chance to respond to this. It
just seems to me that--and I know the excuse is always the way
you get to no-cost, you know, lack of brokerage fees, but,
obviously, some of the large enterprises were able to do this
without that payment for order flow, and I think there are
inherent conflicts. In that last 10 seconds, do you want to
give a bit of a rebuttal to my point?
Mr. Piwowar. Yes, thank you, Senator, for giving me 10
seconds to respond to that. I would start with agreeing with,
again, Professor Fletcher, that this is an empirical question,
right? The concerns that you have raised on the payment for
order flow side are the same concerns that people have raised
on the churning side when in the presence of commission-based
trading. And it is ultimately an empirical question, and,
unfortunately, right now we just do not have the data for that.
And so that is why I think it is important for the SEC to
consider getting better data, getting better transparency in
this so we can actually evaluate what the proper policy
alternatives or policy choices are.
Senator Warner. I know my time is up, but, Mr. Chairman, I
hope we would look at some of the questions around best
execution, because I think I actually frankly have seen some
evidence that there is some manipulation going on there, and it
would be a subject that would be well worth this Committee
looking into.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Warner.
Senator Hagerty from Tennessee is recognized for 5 minutes.
Senator Hagerty. Chairman Brown, Ranking Member Toomey,
thank you for holding this hearing today.
As noted, this hearing is an important part of Congress'
oversight of our capital markets, and it is also a great
opportunity to reaffirm support for retail investors'
participation in United States capital markets and for
maintaining our markets' fairness, our order efficiency, and
global competitiveness.
Before turning to the specific market events that led to
this hearing and the potential areas for improvement, we must
not lose sight of the fact that our financial markets are the
envy of the world, and for a very good reason. They are the
most robust, most efficient, and they deliver the greatest
liquidity and funding at the lowest cost of capital. They
finance our great economic opportunities by connecting retail
and institutional investors with American individuals and
families that are looking to achieve the American dream,
including higher education, homeownership, and financial
security in their retirement, and with our great businesses
that need capital to thrive.
Our vibrant capital markets play a vital role catalyzing
the economic growth of communities across America. We must not
forget that, particularly as our economy is recovering from a
pandemic-induced recession. Now is certainly not the time to
impose unnecessary constraints on our capital markets and
market participants that would only slow America's recovery
from the pandemic.
Mr. Piwowar, I want thank you for your testimony. Today may
be the golden age of investing for retail investors. I say
``may'' only because with the pace of our financial technology
innovation, who knows what tomorrow will bring? Major
brokerages now offer zero commission trading, but they must
continue to follow all legal obligations to serve their
customers.
Reams of financial and trading data can be immediately
accessed at the touch of an app, and while stocks may not
always go up, our major indices have repeatedly hit record
highs over the past 4 years, in large part due to solid pro-
growth policies.
So, Mr. Piwowar, having said that, many investors were
caught off guard when Robinhood temporarily halted trading of
certain shares. As a result, a lot more people now know about
short selling, margin trading, clearinghouse deposit
requirements, and settlement times.
Do you agree that the SEC, again, working together with the
private sector, can accomplish more by focusing on investor
education rather than engaging in just simply more Government
paternalism?
Mr. Piwowar. Thank you, Senator Hagerty, for that question.
I think in terms of the SEC's authority, I think the SEC
already has all of the regular authority it needs to address a
number of the issues that I identify in my testimony.
In terms of investor education, yes, it is extremely
important. As I mentioned, the SEC is a disclosure agency, and
one of the things--you know, as being one of the non-lawyer
Commissioners at the SEC--that I worried about what that, you
know, a lot of the disclosures were written by securities
lawyers and only understandable by securities lawyers. So that
is why I spent a lot of time with our Office of Investor
Education and Advocacy to make sure that we are getting the
word out to investors.
I also spent a lot of time working with our team that was
given the authority--or clarified the authority in Dodd-Frank
that the SEC could engage in investor testing and actually go
out and do focus groups and surveys to make sure that the
information that the SEC was giving to investors was
understandable and digestible.
And then, finally, I would just add that when I was Acting
Chairman, one of the major personnel changes I made was to add
a position specifically focused on military outreach. One of
the things that had happened during that time was that the
military was moving from the old pension system to a defined
contribution program, the TSP program that Professor
Ghilarducci mentioned. And I had the opportunity to meet with
some of the sailors on the USS Carl Vinson, and some of these
sailors were fantastic at, you know, launching and catching
planes landing on the aircraft carrier, but they did not know
the first thing about investing for their future. And so we
embarked on a specific initiative to make that information
available to them and talk to them about the power of
diversified, low-cost savings for the long term, the matching
services and saving for their retirement, and I am happy to say
that that has been a very successful initiative.
Senator Hagerty. In the minute we have left, are there any
specific actions that you would suggest for our retail
investors today as you look at the evolving markets that we are
in and the challenges ahead of us? Any specific guidelines that
you would propose or suggest for our retail investors?
Mr. Piwowar. Yes. It would be the same advice that I gave
when I was a professor of finance, which is: Do your homework.
There is an incredible amount of information that is out there
for investors that we have never had before, whether it is on
the Internet or whether it is through educational institutions
and the like. And if I may talk a little bit about
gamification, I am not a Robinhood customer. I have never seen
the app. I do not know what type of gamification is involved
there. But I do know that using games and simulations is a very
effective way of educating students. I note that many business
schools are moving away from the traditional case method and
lecture method to move toward simulations in trading, and even
in cybersecurity, training the next generation of folks working
in cybersecurity, it is all through games.
So in terms of gamification, I urge caution in throwing the
baby out with the bath water and that gamification could be
used for effective education.
Senator Hagerty. You got it. Thank you very much.
Chairman Brown. Senator Warren was having technical issues.
Is she able to join us?
We will come back to her. Senator Van Hollen of Maryland is
next.
Senator Van Hollen. Thank you, Mr. Chairman, Ranking Member
Toomey. And to all our panelists, thank you for your testimony
today.
We know that Wall Street has made an art of high-frequency
trading and rank speculation that has fattened the wallets of a
few while putting everyday investors at greater risk, and the
market events of last January brought attention to Robinhood's
practice of selling user data to hedge funds that do high-
frequency trading.
As has been mentioned today, one way to deal with that and
cut down on high-frequency trading and its risks to market
stability would be to place a small fee, say 0.1 percent, on
these Wall Street transactions. It would generate billions of
dollars that we could invest in greater opportunity for other
Americans. It would reduce wealth and economic inequality and
reduce volatility in the market. That is why Senator Brian
Schatz and I plan to shortly reintroduce our bill to impose a
financial transaction fee, a high-roller fee, and let me start
with Ms. Robasciotti. I know you mentioned this. Could you just
elaborate a little bit more on, first of all, the risks of
high-frequency trading; and then, second, how a financial
transaction fee of the kind I am talking about could reduce
that and be a benefit?
Ms. Robasciotti. Certainly. Thank you so much for the
question, Senator. I am happy to hear that you will be
reintroducing that legislation.
In terms of the risks, I mostly see them as systemic. When
we have that classic recipe for market disruptions, what we
have seen time and time again, whether it is the Great
Recession or the flash crash, is that high-frequency trading
simply exacerbates that.
In terms of how the financial transaction tax actually
shows up for regular Americans, if you will allow me, I would
like to use myself as an example. I was born into rural poverty
in a segregated town. I grew up in an all-Black family. We were
very poor. I have been homeless multiple times as a child.
Thankfully, I graduated at 15, went to college. Any of the
extra money that I have made in my entire working career has
gone either to my extended family or back into my business. But
at the age of 42, I have managed to save $100,000 in my
retirement account.
I was looking at my average trades, and my average trade
size is about $9,000 on my own account. If the financial
transaction tax that you are talking about of 10 basis points
or 10 percent of 1 percent were to come about, that would cost
me about $9 per trade, and I have about 20 trades per year. And
this is very similar to the situation that is true for most of
my clients; $9 is less than the $9.95 that the discount brokers
were charging when they were actually charging and trading--
when they were charging the commissions for trades. And so to
me, that seems very reasonable as a small amount of insurance
for the price that I pay as a participant in an orderly, fair,
and efficient market. And one of the ways that I know that that
is happening is because it is significantly slowing down the
non-human algorithmic high-frequency trading that has caused so
much damage.
Senator Van Hollen. Well, I appreciate that. As you say, it
really would create a disincentive, a financial disincentive
for that high-risk conduct that puts other people in the market
at risk.
Professor Ghilarducci, you also mentioned this. Could you
just elaborate a little more? Because this is going to be a big
debate. I think as we consider different options for revenue,
this will be an attractive one because, in addition to raising
revenue, it has these other benefits. Could you just talk a
little bit more about that?
Ms. Ghilarducci. Right. I think the economic research has
been done. It is an idea whose time has come, especially if you
reintroduce your bill. The costs and benefits have been
evaluated since James Tobin at Yale in the 1970s proposed it.
And economist after economist have rerun the numbers, and if it
is too high, it will have bad effects on long-term savings. If
it is too low, it will not have any effect. If you get it just
right--and, actually, 0.1 percent is about right; thank you for
reminding me of that--what it does is it shifts from high-
frequency trading--it changes behavior--towards more long-term
holdings, exactly where all of us want people to be with their
stocks.
So I think you are on very solid ground in terms of the
academic research, that the costs are too high of a tax, and
the benefits of just the right one encourages wealth
accumulation.
Senator Van Hollen. Well, thank you. I look forward to
following up with you and others on the panel as we shape this
and have the debate. Thank you all very much.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Van Hollen.
Senator Cramer of North Dakota is recognized for 5 minutes.
Senator Cramer. Thank you, Mr. Chairman. And thank you to
our witnesses. Like Senator Tillis and several of us, I
apologize for coming in and out of the hearing while we cover
other hearings, but I am grateful, so bear with me if you have
answered this several times.
Dr. Ghilarducci, I wanted to get real basic with you if I
can. In your testimony you stated the following, and I am going
to read you the quote: ``We need innovations in public policy
to give more Americans access to what we know works--
professionally managed retirement coverage that allows everyone
to benefit from the stock markets the same way you and I do in
[TSP] . . . in a defined benefit plan . . . [TIAA]'' and so on.
Just so I am really clear, do you believe that all
Americans should be required to pay for investment advice?
Ms. Ghilarducci. Investment advice. I think all Americans
should be in a retirement account--oh, I see, and so if you are
in a retirement account----
Senator Cramer. Should they have to pay for it?
Ms. Ghilarducci. ----you are paying for investment advice.
You know what? Americans should have access to investment
advice that is worth it. A lot of investment advice they get is
from conflicted investors, and that is not good. But if we are
going to hold our pension fund money in stocks, the advice
about where to put it should be high value.
Senator Cramer. And high value being high price, I assume.
Ms. Ghilarducci. No, well, just that the cost--the benefits
from the cost, you know, outweigh it.
Senator Cramer. Sure. All right. In some sense, this whole
hearing is obviously fundamentally about the level of access
that retail investors should have to own shares of companies,
right?
Ms. Ghilarducci. Yeah.
Senator Cramer. Some of your positions is that the system
is rigged, that it is a casino. We have heard all the terms.
Investors should have to rely upon professional advice for a
fee to have access.
Let me ask you, Mr. Vollmer and Mr. Piwowar, do you believe
retail investors in the marketplace benefit from direct retail
investor access to the market? And if so, why?
Mr. Vollmer. Shall I go first, Mike?
Senator Cramer. Go ahead.
Mr. Vollmer. I think that retail investors benefit hugely
from direct access to direct ownership of the equities of
operating companies, but they should do it with their eyes
open, as Mike Piwowar said, and accept responsibility for the
consequences. It is not a casino. The securities markets are
not a casino. They have risk. There is significant risk to
them. But as people have pointed out, stock markets in the
medium and long term produce positive returns. Casinos, if you
are in the medium or long term, you will lose money.
So, yes, they ought to have direct access, but they ought
to be smart about it and recognize their limitations. And,
clearly, investing in mutual funds or index funds is by far the
better approach for nearly all retail investors.
Senator Cramer. Including me, by the way.
Mr. Piwowar, would you have anything to add to that?
Mr. Piwowar. Sure, I agree with everything that Mr. Vollmer
talked about. What I would add to that is it is important for
investors to have the choice to do both, right? They have
access to indirect investments through low-cost, professionally
managed funds, and then investors have the opportunity to
invest some of their money on their own, do their own homework,
do their own due diligence on the firms. And over time what
that does is, whether it is through wins or losses in the stock
market, they learn. It gets them more engaged in the stock
market.
You know, as I mentioned, in business schools we do--back
when I was teaching, we even started doing some simulations in
terms of, you know, paper money portfolios. And it is amazing
how much students get involved in terms of the stock market and
learning about companies when there is, you know, pretend money
or real money on the line. So I think it really provides the
opportunity for people to learn over time about the financial
system.
Senator Cramer. I appreciate that. I appreciate all of you,
really. Every time I participate in one of these, I keep
thinking, speaking of schools, several of you are professors or
at least have been or get to be on an adjunct basis every now
and then. I just think every business school ought to take some
Senate hearings like this and just play them for students,
because I think there is a lot to be learned. So I am grateful
to all of you.
Thank you, Mr. Chairman. I yield back the rest of my time.
Chairman Brown. Thanks, Senator Cramer.
Senator Warren from Massachusetts is recognized for 5
minutes.
Senator Warren. Thank you, Mr. Chairman.
So in recent weeks, I sent letters asking questions of
those at the center of the GameStop market chaos, and I have
received responses from the SEC, FINRA, Robinhood, and Citadel,
the giant hedge fund. I ask that those responses or lack of
responses, Mr. Chairman, be entered into the record. Without
objection? Mr. Chairman?
Chairman Brown. I am trying to unmute. I did not see that
coming, Senator Warren. Without objection, so ordered.
Senator Warren. All right.
Neither side advertised it publicly, but Citadel Securities
was Robinhood's go-to partner for handling retail trades. At
the height of the GameStop trading mania, Citadel alone was
handling more volume than all of Nasdaq. And while Citadel was
raking in cash from executing GameStop trades with one hand,
its hedge fund affiliate was bailing out another fund on bad
GameStop bets with the other hand.
So I asked questions about Citadel and its relationship
with Robinhood because this gets at the heart of what is wrong
with Wall Street. It is riddled with conflicts of interest that
allow the giants to win every single time.
Here is some of the information that Citadel would not
provide: how much money Citadel made from GameStop trades; what
information on trades Citadel receives from Robinhood about
GameStop and about millions of other trades; and then how
Citadel uses that information it gets, whether it passes it
along to its affiliates, to make even more money.
Professor Fletcher, is this information important for
understanding the role that Citadel played during the recent
GameStop volatility? If, say, Citadel has executed the
overwhelming majority of GameStop trades during the turmoil or
had been receiving an information advantage from executing
Robinhood orders, could that potentially hurt retail investors?
Ms. Fletcher. Thank you, Senator Warren, for the question.
Yes, so to just go right to your question, yes, this
information about Robinhood and other retail brokers' customers
trading is definitely essential to our understanding of these
recent market events.
One of the things that we know is that Citadel does receive
lots of information about customers' orders from Robinhood, but
it would also be important to know whether and how that
information is being used by Citadel and others in order to
have a clearer understanding of the recent volatility and any
role that they may play in the swings, in the price swings that
the stock price experienced.
Senator Warren. Thank you. You know, Robinhood gets more
than half of its revenue from collecting fees for pushing its
customers' orders to outfits like Citadel, and Citadel makes
its money off the spread. They pocket the small difference
between the buy and sell price of the trade, and--this is
important--Robinhood also receives a percentage of the spread
on each trade.
So, Professor Fletcher, both the number of transactions
goes up and the spread tends to widen during periods of market
turmoil. So am I understanding correctly that when share prices
for GameStop or any other company undergo extreme swings,
Citadel and Robinhood both stand to make more money while
investors pay more to trade?
Ms. Fletcher. Yes, Senator Warren. This is generally what
happens in times of stress, and so it is also important to keep
in mind that market makers like Citadel are both in the
exchange trading markets and executing huge volumes of orders
off the exchanges. So while pension funds and other
institutional investors generally cannot interact with retail
customers and retail customers are siphoned off and prevented
from interaction with institutional investors, Citadel sits in
the middle and is able to interact with all of them. And this
benefits Citadel by being able to segment the markets in this
way, which dilutes the number and quality of orders that we see
on the exchanges. And the profitability is there for Citadel
for doing so.
Senator Warren. Right, and this is why the SEC needs to
investigate the GameStop run-up. The stock market is supposed
to be about capital formation creating long-term value for
companies so they can grow and create jobs. This is good for
the American economy and for American families. But when big
sharks like Citadel and Robinhood come out ahead no matter what
happens and when the information they gather is not disclosed
and when it is secret how that information is used, it is
easier for these giants to skim off the top at the expense of
small investors and working families.
The SEC's job is to provide transparency about these
companies' market tactics and make sure they do not rip off
customers. They could start by following up on my questions to
Citadel and Robinhood.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Warren.
Senator Cortez Masto from Nevada is recognized for 5
minutes.
Senator Cortez Masto. Thank you, Mr. Chairman. Thank you,
everyone, for being here. This is a great conversation.
First of all, let me just say I recognize that the SEC is
undergoing an investigation as well, and I look forward to the
results of that investigation. And then as the Senator from the
great State of Nevada, born and raised in Las Vegas, I am
listening to all of the comparisons with the casinos
particularly across this country, but knowing one thing, our
casinos do not allow anybody that is under the age of 21 to
gamble, and there is a reason. We want to protect our youth.
So let me ask you this, because I am concerned about the
gamification of the market and what we are seeing with some of
these apps. It is clearly looking to target a particular area,
I think, of our youth who are now more engaged in gaming apps
than we have ever seen before.
So let me ask Professor Fletcher, should the design
features of trading apps because regulated?
Ms. Fletcher. At a minimum--so thank you very much for that
question, Senator. I think at a minimum they have to be
studied, right? Because one of the things, as Professor
Ghilarducci has noted, is that there are certain behavioral
economics at play here. And so when we have things like
confetti raining from the skies for having done a trade, this
raises concerns about the types of encouragement that we are
giving traders for just doing trades, which may be problematic
as we think about trying to encourage appropriate behavior
within the capital markets.
Senator Cortez Masto. Thank you. So let me also ask this
then: Particularly for young adults, do retail broker-dealers
provide enough education and disclosure to individual consumers
or should there be more?
Ms. Fletcher. Currently it does not seem I would be able to
say--it does not seem as though these broker-dealers provide
that type of education to retail investors. I know that this is
a focus of Professor Ghilarducci's research, and so currently I
do not believe that they provide this level of education for
retail investors, which then allows them to profit right off
retail investors engaging in risky behavior that is not wealth-
maximizing for these investors.
Senator Cortez Masto. So let me ask then, Ms. Robasciotti,
do you think that anybody under the age of 21 should be allowed
to engage in the stock market, particularly what we have seen
with Robinhood, a young man who was only 20 years of age
committing suicide because he felt he overextended himself?
Ms. Robasciotti. Thank you very much for the question, and
it was very sad what happened with that particular young man. I
do believe that, given that we have all transferred
responsibility for our retirement from these defined benefit
plans and pensions down to us all being responsible for
ourselves, we need to get as early a start as possible. So,
yes, I would recommend that people under 21 be able to invest,
yet it is incumbent upon as a society in that transfer of
responsibility for our long-term financial security, we need to
also transfer the education. Right now it is just happening
within families, mostly from father to son and wealthy
families, and I believe that is a big underpinning reason for
why there is such concentration of wealth where it is in the
country.
Senator Cortez Masto. Do you think that the payment for
order flow models should be banned?
Ms. Robasciotti. I do, absolutely. I do, absolutely, and
specifically because I tell my clients this constantly, that if
you do not see what you are paying, you are probably paying
more than you would be comfortable with. And payment for order
flow is doing exactly that. The customer never sees it, and yet
they are paying for it in terms of the price that they
ultimately get.
One of the reasons that our markets are orderly, fair,
efficient, one of the ways that they remain so is by ensuring
that as much information and data is disclosed as possible, and
that just seems like a huge gap.
Senator Cortez Masto. Does anybody on this panel believe
that it should not be banned?
Mr. Piwowar. If I may, I do not think it should be banned
without proper study. As I mentioned in my testimony, if you
ban payment for order flow, you are highly likely to go back to
commission-based trading, and it just shifts the conflict of
interest from best execution requirements to churning accounts,
and then that is the best interest requirement in terms of
customers. So we have to be careful in these things. It is best
left for the SEC to study the issue. I agree with Professor
Fletcher on that. The SEC absolutely should study it in a zero
commission environment, you know, look at all the costs and
benefits, and then make a decision based on that.
Senator Cortez Masto. OK. Thank you.
And, Mr. Vollmer, you raised your hand, so you believe the
same thing. Is that correct?
Mr. Vollmer. I start with Mr. Piwowar and Professor
Fletcher--we need to look carefully, we need to proceed
cautiously here. Start from the proposition that every
participant that provides services in the market deserves some
reasonable, fair compensation--the broker-dealers, the
wholesale broker-dealers who also act as internalizers, like
Citadel Securities, and the exchanges. They all provide
important services to our capital markets. They all deserve
compensation.
Payment for order flow is a method of compensation. If you
remove it, you need to find another mechanism. That is why Mr.
Piwowar says you are going to reinstitute commissions on
trades. So everything is interrelated here. All of these
relationships are connected. So I think we need to proceed
cautiously, and I strongly agree with let us look and gather
evidence and data. But I do not like the payment for order flow
because it is disruptive and it is not obvious to investors.
Senator Cortez Masto. Thank you. Thank you all.
Chairman Brown. Thank you, Senator Cortez Masto.
Senator Ossoff from Georgia is recognized. His camera is
not on, and he can proceed with or without it. Senator Ossoff,
are you there?
Senator Ossoff. Thank you, Mr. Chairman. I appreciate that.
On Saturday, with overwhelming bipartisan support, the Senate
passed the American Rescue Plan, and unlike traditional
monetary expansion which subsidizes investment banks and unlike
other recent fiscal measures that have subsidized corporations
and wealthy donors, zero percent of the stimulus checks and tax
credits in this bill goes to the top 1 percent. And I would
like to point out for colleagues on this panel who oppose the
bill that, following Senate passage, the OECD has revised its
growth forecast for the U.S. economy, doubling it from 3.2
percent to over 6 percent this year. And the OECD projects that
this legislation will boost global growth by a full percentage
point this year.
Ms. Robasciotti, the title of this hearing is ``Who Wins on
Wall Street?'' We just passed an ambitious fiscal measure in
the Senate. Given that the bottom 50 percent of American
households by wealth possess just 1 percent of total national
wealth held in the stock market, what, in your view, are the
benefits of economic policy that gets cash directly to low-
wealth households by fiscal measures versus economic policy
that adds liquidity to financial markets via the banking sector
like traditional monetary policy?
Ms. Robasciotti. Thank you very much for the question,
Senator Ossoff. The way that it actually occurs, when you give
money to people who come from the kind of background that I
have, they are more likely to spend it. We learned about this,
you know, in economics textbooks as the marginal propensity to
consume. But it is just true that if you give money to those
who are more in need, they are going to be more likely to spend
it and circulate it throughout the economy, and so it does not
just help them. It is not just something that we want to do to
help the vulnerable. It is actually something that creates a
multiplier effect throughout the entire economy. So I believe
it just makes good economic sense.
Senator Ossoff. Thank you. And what, in your view, are the
costs, Ms. Robasciotti, of economic stimulus like traditional
monetary expansion, which adds liquidity to financial markets
by allowing investment banks to access credit at
extraordinarily low rates or just transfers cash to financial
institutions' balance sheets by processes like quantitative
easing?
Ms. Robasciotti. Again, thank you for the question. Those
who are doing well at this point with their outsize gains,
particularly during the pandemic, do not need any more help.
What it actually does is just sequesters that money in the
hands of those who are most wealthy and are not going to put it
back necessarily into the economy. You know, we had that
argument of trickle-down economics, and we can kind of see from
where we all are that that is not actually what happened. And
so it actually harms all of us to make sure that those types of
economic stimulus are going to the wealthiest in the country
rather than going where it is going to actually do us all some
good.
Senator Ossoff. Thank you, Ms. Robasciotti. Professor
Fletcher, you opened your testimony by rightly noting, ``A core
purpose of the financial markets is to facilitate the efficient
allocation of capital.'' I am curious for your perspective on
this. Over the last 15 years, U.S. investment banks have
required multi-trillion-dollar bailouts to avoid insolvency,
and even after the acute credit crisis in 2007-08, central
banks and the Federal Reserve have continued to grant
investment banks access to credit at record low rates and
engaged in sustained quantitative easing, adding trillions of
dollars to financial markets. Do you believe, Professor
Fletcher, that the U.S. financial system in its current
configuration facilitates the efficient allocation of capital?
Ms. Fletcher. Thank you so much for that question, Senator.
I think that the U.S. capital markets are among some of the
best capital markets in the world, but there are significant
issues with the market structure that we have currently in that
we have retail investors that are better able to make risky
decisions without fully appreciating the cost of those
decisions. Within our capital structure, we also have
questionable valuations for some companies that may not be
fully reflective of an efficient market. So do I believe that
our markets are fully efficient, no, not quite; but do I
believe that they are among the most efficient in the world,
absolutely.
Senator Ossoff. Thank you, Professor. Thank you, Mr.
Chairman. I yield back.
Chairman Brown. Thank you, Senator Ossoff.
Thank you to the witnesses for being here today, for your
really incisive testimony. Thank you for that.
I will just make a brief announcement. For Senators who
wish to submit questions for the record, these questions are
due 1 week from today, Tuesday, March 16th. For witnesses, you
have 45 days, if you would, to respond to any of those
questions from me or from my colleagues. Thank you again for
that.
A couple of comments. I appreciated Professor Ghilarducci
making it clear that the stock market is not the economy.
Making the markets fair is important, but equally important is
remembering that half the country does not have any stocks at
all. Most Americans get their money from a paycheck. Growing
those paychecks, not growing stock prices, is the most
important thing we can actually do to improve American
families' lives. And when people's hard work pays off, the more
they are able to put a little aside at the end of the month and
invest for the future. We are never going to have fair markets
or an economy that reaches its full potential until our economy
and its rules reflect the dignity of work.
With that, the hearing is adjourned. Thank you all so much.
[Whereupon, at 11:55 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN SHERROD BROWN
Last February, as the world came to the collective realization that
we were confronting a global pandemic, the U.S. stock market suffered
its fastest drop in history, plummeting 34 percent in 33 days.
That was followed by the fastest stock market rebound in history,
recovering all of those losses by mid-August.
It was clear what most working people had suspected for a long
time: that the stock market is detached from the economy and the
reality of most Americans' lives.
The coronavirus was spreading, widespread testing wasn't available,
and we didn't know if the hope of a vaccine was months or years away.
Unemployment soared, reaching 23 million jobs lost by April. Almost
one year later, only about half of those jobs have been recovered.
Families and small businesses had no certainty about what their lives
would look like in a few weeks, let alone next year.
But the stock market continued to go up and up, and those lucky
enough to own investments reaped the profit.
To some, this looked like a new development. But to millions of
workers who have watched the stock market reach new heights while their
own paychecks never kept up, it looked pretty familiar.
Families haven't been too surprised by this state of affairs--a
whole lot of them never recovered from a foreclosure or losing their
savings during the last crisis, but watched Wall Street pocket its
bailout and go on to record highs a few short years later..
That's because when you look at who truly benefits, it's clear that
the stock market's gains funnel wealth to a tiny sliver of people,
often at the direct expense of American workers. We discussed this last
week in our hearing Wall Street vs. Workers.
According to Federal Reserve data, the wealthiest one percent hold
53 percent of stock and mutual fund investments, and the bottom 90
percent own less than 12 percent.
Between workplace retirement accounts and personal investments,
about half of American households have at least one financial account
tied to the market, but only one in six directly own stocks.
And none of this reflects the actual makeup of the country. Only 31
percent of Black families and 28 percent of Hispanic families own any
stock investment.
The wealthy are far more likely to have these accounts than middle-
class families, who in turn are far more likely to be in the market
than working-class or poor families.
So when the stock market soars, most people barely notice. They're
just trying to keep up with the cost of living within their paychecks.
In recent years, the growth of fintech in financial services has
given rise to trading platforms that offer free stock trades. Firms
like Robinhood and others claimed to ``democratize'' stock trading with
flashy marketing and easy-to-use features.
And in one sense, it worked--they attracted millions of customers,
many of them young and new to investing.
The frenzied stock trading this January, when shares of GameStop
Corporation went from $18 to over $400 in a matter of weeks, showed how
millions of retail investors could engage with each other and create a
sensation.
But it also lays bare serious risks.
There are real people who got caught up in the frenzy who suffered
real consequences. If the people who are busy working, watching their
kids, or living their lives can't make sense of the stock market's
booms and busts, they'll continue to lose faith in the market. And
hedge funds and insiders will continue to reap the vast majority of the
profit.
That's bad for everyone in the long run.
Robinhood tried to blame its decision to cut off its customers from
being able to purchase GameStop and other stocks on industry-wide
standards for processing stock purchases. Of course, the SEC and others
should examine and consider how to reduce risk in the financial system
by cutting the time it takes to complete stock purchases. Everyone
would benefit.
But it's become clear that firms like Robinhood were founded on a
model that exploits small investors by encouraging fast and loose
trading, and then sells their trades to big market players.
In a few short years, Robinhood violated the law, failed to respond
to customers when they needed help, and when it got in trouble, cut off
customers to save itself. Robinhood attracted new customers to
investing, encouraged them to trade, profited off of them, and then
broke their trust--precisely when they needed the company to have their
backs.
It is also obvious that the David versus Goliath story we first
heard in January was not the whole picture. Well-funded, sophisticated
hedge funds made big profits alongside the people trading at home, and
we know they always had better access and information than any of us
ever will. No one thinks that's fair.
Some have tried to blame the small-time investors. They scold
people just trying to make some extra money in the worst job market
we've seen in most of our lifetimes.
Because of the Robinhood business model, we've all learned the new
term ``gamification''.
But let's be clear: We've seen Wall Street treat the markets as a
game for decades--a game they always win, at the expense of pretty much
everyone else.
Wall Street has never been friendly to the little guy. Surely this
time is no different.
Yes, some regular people have had success. But fundamentally, the
system is set up to funnel more wealth to the already-wealthy. Just
like in Las Vegas, the House always wins.
The economy and the markets should work for everyone, not just the
well-connected. And they should reflect the economy we all want--with
broadly shared prosperity, and a growing middle class that all workers
can join.
When that happens, people will have confidence the markets will
actually work for them, not just Wall Street. And we'll see more
Americans save and invest for the future.
This hearing will examine not only the volatile activity in a dozen
stocks early this year, but also the practices that encouraged that
activity. We will see how it affects our economy in the long term, and
who benefits and who loses from this ``tech induced'' stock market
volatility.
I look forward to our witnesses' testimony.
______
PREPARED STATEMENT OF GINA-GAIL S. FLETCHER
Professor Of Law, Duke University School of Law
March 9, 2021
Chairman Brown, Ranking Member Toomey, Members of the Committee:
Thank you for inviting me to testify at this hearing. I am a Professor
of Law at Duke University, where my research focuses on financial
regulation, market manipulation, and corporate law. Before becoming an
academic, I practiced law at Gibson, Dunn, & Crutcher LLP, in the areas
of securities regulation, banking, and mergers and acquisitions.
Introduction
A core purpose of the financial markets is to facilitate the
efficient allocation of capital. \1\ When functioning efficiently, the
markets allow for capital to be put to its most profitable use, which
enables firms to access capital and improves the allocation of finite
resources within the markets and the economy. When the fundamental
operation of the markets is undermined, there are far-reaching effects
that extend beyond the capital markets, affecting consumer savings,
investments, retirement plans, and the rest of the real economy. \2\
---------------------------------------------------------------------------
\1\ Gina-Gail S. Fletcher, ``Legitimate Yet Manipulative: The
Conundrum of Open-Market Manipulation'', 68 Duke L.J. 479, 489 (2018).
\2\ Id.; see Benjamin P. Edwards, ``Conflicts & Capital
Allocation'', 78 Ohio St. L.J. 181, 184-85 (2017).
---------------------------------------------------------------------------
The recent market volatility stemming from trading in ``meme
stocks'', most notably GameStop, \3\ has raised concerns as to the
integrity, stability, and overall health of the markets. Over the
course of a few weeks in early 2021, GameStop--a struggling retailer of
video games--saw its share price increase 1,500 percent, crash, and
then spike again. \4\ In the wake of the volatility of GameStop's stock
price, many investors (both large and small) have been left with
significant losses \5\ and some market participants and members of the
public wonder whether the GameStop volatility is the ``new normal'' for
the markets.
---------------------------------------------------------------------------
\3\ John Hyatt, ``How GameStop (GME) Is Creating Volatility--and
Opportunities--for Investors'', NASDAQ (Jan. 29, 2021, 1:54 PM),
https://www.nasdaq.com/articles/how-gamestop-gme-is-creating-
volatility-and-opportunities-for-investors-2021-01-29.
\4\ Reuters Staff, ``Timeline: The GameStop Battle--How It
Unfolded for the Key Players Testifying'', Reuters (Feb. 18, 2021, 1:20
AM), https://www.reuters.com/article/us-retail-trading-gamestop-
timeline/timeline-the-gamestop-battle-how-it-unfolded-for-the-key-
players-testifying-idUSKBN2AI0IQ.
\5\ Harry Robertson, ``Short-Sellers Are Nursing Estimated Losses
of $19 Billion in 2021 After Betting on GameStop's Stock To Plunge'',
Markets Insider (Jan. 30, 2021, 2:31 PM); Drew Harwell, ``As GameStop
Stock Crumbles, Newbie Traders Reckon With Heavy Losses'', Washington
Post (Feb. 2, 2021, 5:34 PM), https://www.washingtonpost.com/
technology/2021/02/02/gamestop-stock-plunge-losers.
---------------------------------------------------------------------------
The recent market events have raised questions as to the long-term
health of the markets, specifically the effects of such extreme
volatility and the conduct that drove it on public perception of the
markets. Additionally, these market developments have brought to the
fore some issues related to how the markets function and are regulated,
such as efforts to promote market integrity and prevent market
manipulation; the costs and impacts of conflicted brokers' routing
practices, including payment for order flow (PFOF); and the impact of
larger numbers of small-dollar, higher risk trading in the markets. \6\
---------------------------------------------------------------------------
\6\ See, e.g., William Watts, ``GameStop Saga Illustrates Rising
`Noise-Trader Risk' That Could Feed Market Volatility, Warns
Quantitative Analyst'', Marketwatch, (Feb. 26, 2021, 1:55 PM), https://
www.marketwatch.com/story/gamestop-saga-illustrates-rising-noise-
trader-risk-that-could-feed-market-volatility-warns-quantitative-
analyst-11614365724.
---------------------------------------------------------------------------
I. Market Integrity and Stability
A. Market Integrity: The Importance of Public Perception
Market integrity is key to the functioning of healthy capital
markets. \7\ Market integrity is a broad term that refers to notions of
market fairness, investor protection, and the absence of misinformation
and market abuse. To the extent the public believes the markets are
fair, investors are likely to participate in the markets. Conversely,
if the markets are viewed as unfair, investors may refrain from
participating in the markets altogether or, should they participate,
discount all transactions to reflect the risk of dealing in an unfair
market. \8\ Public perception of the fairness (or unfairness) of the
market, underlies market integrity and, in turn, is crucial to the
efficient allocation of capital.
---------------------------------------------------------------------------
\7\ Fletcher, supra note 1, at 493.
\8\ Id. at 492-93.
---------------------------------------------------------------------------
The GameStop incident has highlighted public perception of the
unfairness of the markets, on the one hand, and raised new concerns
about the integrity of stock prices. As trading in GameStop gained
momentum, a narrative of David vs. Goliath coalesced, with the
individual, Reddit-led investors being cast as David against the short
selling, hedge fund Goliaths. \9\ Many of these individual investors
expressed the viewpoint that the markets were ``rigged against the
little guy'' and saw their GameStop trades as a way to right the wrongs
of the past.
---------------------------------------------------------------------------
\9\ See, e.g., Associated Press, ``GameStop Soars as Swarming
Small Investors Face Down Hedge Funds'', L.A. Times (Jan. 25, 2021,
1:39 PM), https://www.latimes.com/world-nation/story/2021-01-25/
smaller-investors-face-down-hedge-funds-as-gamestop-soars; Edward
Helmore, ``How GameStop Found Itself at the Center of a Groundbreaking
Battle Between Wall Street and Small Investors'', Guardian (Jan. 27,
2021, 5:00), https://www.theguardian.com/business/2021/jan/27/gamestop-
stock-market-retail-wall-street; ``All Things Considered: Reddit Users
Vs. Wall Street Giant in Fight Over GameStop Stock Value'', NPR (Jan.
27, 2021, 4:14 PM), https://www.npr.org/2021/01/27/961279048/reddit-
users-vs-wall-street-giant-in-fight-over-gamestop-stock-value.
---------------------------------------------------------------------------
While the realities of who was trading in which directions, how
much, and when will take time to decipher, the views echoed in the
GameStop incident are reflective of a larger narrative about the
integrity and fairness of the markets. In recent years, an increasing
view is that the markets are regulated for the benefit of Wall Street
and to the detriment of Main Street. \10\ During the 2008 crisis, for
example, banks received bailouts while ordinary citizens lost their
jobs and homes, struggling to recover years later. Likewise, with the
COVID-19 pandemic millions of Americans lost their jobs and their
health, but public corporations earned unprecedented profits and the
stock market continued to soar. The disparate impact of these two
significant financial crises on ordinary citizens versus the economic
elite, especially when coupled with the (seeming) lack of enforcement
against corporate wrongdoing, have fomented the strong perception that
the markets are titled in favor of the wealthy, the banks, and the
hedge funds.
---------------------------------------------------------------------------
\10\ See, e.g., Alexis Goldstein, ``Opinion, The Trouble With
GameStop Is That the House Still Wins'', N.Y. Times (Feb. 1, 2021),
https://www.nytimes.com/2021/02/01/opinion/gamestop-biden-wall-street-
reddit.html; Zachary Karabell, ``How the GameStop Trading Surge Will
Transform Wall Street'', Time (Jan. 28, 2021, 8:44 PM), https://
time.com/5934285/gamestop-trading-wall-street.
---------------------------------------------------------------------------
The proliferation of these views indicates that many investors do
not view the markets as honest, fair, or accessible. Increasingly,
seemingly freed by this recognition of the apparent ``unfairness,''
many investors appear to be engaging in transactions that undermine
capital allocation and distort asset prices to (attempt to) tilt the
markets in their favor.
Yet, even for those who did not previously believe the markets are
inherently rigged to favor insiders, the extreme volatility associated
with meme stocks may nonetheless cause them to be concerned with the
integrity and stability of the markets. This is particularly true if
regulators and lawmakers fail to act-either by not addressing the
underlying cause for the volatility or by not holding someone
accountable for wrongdoing.
To safeguard the integrity of the markets, therefore, it is
important that lawmakers and regulators undertake efforts to repair the
market's reputation and bolster investor confidence. Research has shown
that when investors question the integrity of the markets, they
withdraw from the markets, reducing the amount of capital available in
the market in general. \11\
---------------------------------------------------------------------------
\11\ Emilios Avgouleas, ``The Mechanics and Regulation of Market
Abuse'' A Legal And Economic Analysis 212 (2005).
---------------------------------------------------------------------------
Thus, failure to address the issues that GameStop trading
highlights may, ultimately, weaken the markets.
While addressing these issues is neither simple nor
straightforward, this ought not dissuade Congress and the SEC from
investigating how to minimize the likelihood and impact of a future
iteration of the volatility we witnessed earlier this year.
B. Market Manipulation: Was GameStop Stock Manipulated?
A common theme accompanying discussions about GameStop's stock
price was market manipulation. Many questioned whether the coordinated
trading of Reddit-inspired investors constituted market manipulation
from a legal standpoint and what if anything the SEC should or could do
in response.
Among the initial motivators behind the adoption of the securities
laws was the prevention of market manipulation. Although the purpose of
financial market regulations and laws has since been extended,
proscribing and punishing market manipulation remains one of primary
goals of the SEC. Market manipulation imposes significant social and
financial costs on the financial markets. Furthermore, it undermines
the efficient allocation of capital by distorting prices and by
contributing to the perception that the markets lack integrity.
Despite its centrality to securities laws, market manipulation is
undefined in the securities laws. \12\ Instead, the laws and associated
regulations prohibit specific, named conduct such as price
artificiality, fictitious trades, and fraud. Some have commented that
the absence of a statutory definition is the reason that this area of
the law is confusing and contradictory. But, as others have noted,
given the unexpected ways in which the markets may develop, tying
regulators to a fixed definition of manipulation may do more harm than
good. \13\
---------------------------------------------------------------------------
\12\ Fletcher, supra note 1.
\13\ As one court opined: ``Congress' decision to prohibit
manipulation without defining it apparently arose from the concern that
clever manipulators would be able to evade any legislated list of
proscribed actions or elements of such a claim.'' In re ``Soybean
Futures Litig.'', 892 F. Supp. 1025, 1044 (N.D. Ill. 2015).
---------------------------------------------------------------------------
In identifying manipulative conduct, courts have typically looked
for evidence of willful misconduct, fraud, and/or an artificial price.
Academics have also tried to define manipulation through conduct that
has an improper effect on price or efforts to dominate supply and
demand to artificially distort prices.
Notwithstanding the lack of an agreed upon definition, the SEC,
FINRA, and the exchanges all have anti-manipulation provisions that
proscribe and punish abusive practices that distort asset prices. But
as decades of enforcement actions and litigation has demonstrated,
proving market manipulation as a matter of law can be very difficult.
Indeed, one person's manipulation can be seen as another person's
exuberance, even if irrational.
Whether the GameStop incident rises to the level of legally
recognized and punishable market manipulation is a fact-intensive
inquiry, which is ongoing. But, beyond the stark question of whether
this constitutes illegal manipulation, the GameStop incident highlights
the ways in which social media and technology have combined to push the
limits of market regulations. It also calls into question to what
extent existing understandings of manipulation can adequately respond
to and, ultimately, deter the type of misconduct that may have
occurred. Regardless of the outcome of the pending investigations into
possible market manipulation, there are two recommended actions
Congress and the SEC should consider.
First, Congress and regulators should hold traders accountable for
their words and actions, even in the absence of explicit fraud. Price
distortion can occur without explicit fraud and, when it does, someone
ought to be held accountable. \14\ There ought to be consequences for
using internet platforms and social media to encourage others to buy/
sell stock, if result is a price that is so distorted as to be
completely divorced from the company's fundamentals.
---------------------------------------------------------------------------
\14\ Fletcher, supra note 1.
---------------------------------------------------------------------------
Unfortunately, manipulation laws have become ossified, and courts
have been somewhat hostile to new interpretations and applications of
the law from regulators. This makes it somewhat challenging for
regulators to address novel forms of market manipulation using laws
that were written almost a century ago and long before most of the
things that are commonplace in today's markets were even conceivable.
The type of coordinated action among thousands of dispersed, small-
dollar investors that was seen during GameStop's rise was not
imaginable when courts and regulators first conceptualized the market
power needed to squeeze or corner the markets. However, in today's
markets this is not only plausible, but it can be just as disastrous as
traditional manipulation schemes.
As the markets evolve and the types of abusive trading tactics
evolve along with it, it becomes increasingly urgent that Congress
revisit and expand the antimanipulation authority granted to the SEC.
Congress and regulators should explore updating the laws and rules
against market manipulation to ensure regulators have the tools they
need to protect the integrity of the markets against intentional,
extreme price distortions.
Second, the SEC has traditionally relied on enforcement actions to
address market manipulation. Punishing traders ex post for their
conduct has been an understandable approach in the past, but it is not
as sound in the modern markets where herd behavior is swift and can be
disastrous. In today's markets, the SEC should explore the types of ex
ante guardrails needed to protect the markets from extreme price
distortion that will undoubtedly leave destruction in its wake.
As the volatility in GameStop and other stock persisted, the SEC
issued a statement that it was monitoring the situation, but failed to
take any action. The agency's refusal to act lead many to wonder why
trading in GameStop stock was not halted once it became clear that the
stock price was completely and unjustifiably divorced from the
company's fundamentals. Arguably, the SEC's failure to act created a
vacuum of authority, which resulted in a haphazard and uneven response
from market actors. While some brokers halted trading in GameStop,
others did not, causing public uproar. Leadership from the SEC
indicating what should have been done or, at a minimum, a statement of
recommended action would have had a better outcome for the markets and
less public furor.
It is not beyond the scope of the SEC's authority to proactively
consider how it will respond to certain indicators of price distortion
and manipulation in the markets. In light of the far-reaching
consequences of manipulation on today's interconnected markets, it is
imperative that the SEC consider how to address extreme volatility in
real time, particularly when such volatility may be borne from
manipulative and abusive trades.
II. Democratizing the Capital Markets
A. The Impact of Technology and Innovation on Retail Investors' Access
to the Public Capital Markets
The Federal securities laws were adopted to ensure that all
investors--not just sophisticated, wealthy, or connected insiders--have
access to essential information about companies and basic shareholder
rights. In many ways, the Federal securities laws exist to
``democratize'' the capital markets.
In recent years, financial innovation has further expanded the
availability of capital for firms and enhanced retail investors' access
to the markets. \15\ The creation and proliferation of discount
brokers, mutual funds, exchange traded funds, and 401(k) plans have
made investing available to a large segment of the population. Further,
the entrance of robo-advisors onto the financial scene has granted
investors access to model portfolios tailored to their risk profiles
and investment preferences, further increasing access for consumers
seeking low-cost financial advice. \16\
---------------------------------------------------------------------------
\15\ John V. Duca, Fed. Reserve Bank of Dallas, ``The
Democratization of America's Capital Markets'' 10-13 (2001).
\16\ Anne Tergesen, ``Robo Advisers Seen Exploding in
Popularity'', Wall St. J. (Dec. 11, 2015, 7:08 PM), https://
www.wsj.com/articles/robo-advisers-seen-exploding-in-popularity-
1449860367.
---------------------------------------------------------------------------
The democratization of the financial markets, therefore, has been
ongoing for decades, but it has undoubtedly exploded in measure and
kind in the past 5 years. \17\ Efforts to increase retail access to the
markets have resulted in greater participation in index funds, mutual
funds, etc., which rely on intermediaries to transact on consumers'
behalf. \18\ Recently, with the rise of zero-commission trading, retail
investors are choosing to directly participate in the markets at
unprecedented levels.
---------------------------------------------------------------------------
\17\ See Charlotte Gifford, ``Democratising Finance'', World Fin.
(Jan. 25, 2021), https://www.worldfinance.com/special-reports/take-
from-the-rich-give-to-the-poor.
\18\ Jay Clayton, Chairman, SEC, Speech at Temple University:
``The Evolving Market for Retail Investment Services and Forward-
Looking Regulation--Adding Clarity and Investor Protection While
Ensuring Access and Choice'' (May 2, 2018), https://www.sec.gov/news/
speech/speech-clayton-2018-05-02.
---------------------------------------------------------------------------
In the past year or two, many low-cost brokers have eliminated
explicit fees to buy and sell stocks, thereby opening up access to the
markets to those who may have been unwilling or unable to trade because
of what were once significant explicit commissions and fees. \19\
Additionally, the ability to trade in fractional shares has lowered
costs for investors who no longer need over $2,000 to buy a single
share of a company like Amazon, for example; instead, they can purchase
$100 of stock or 1/20th of the share. With technology, market
democratization has gone a step further--brokers allow trading through
apps, thereby making it easier for younger investors to access the
markets on their mobile devices. \20\ Today, it is not a stretch to say
that the markets are truly within reach of anyone.
---------------------------------------------------------------------------
\19\ For example, Schwab eliminated fees for stock purchases in
October 2019. See Alexander Osipovich and Lisa Beilfuss, ``Schwab Cuts
Fees on Online Stock Trades to Zero, Rattling Rivals'', Wall St. J.
(Oct. 1, 2019, 7:04 PM).
\20\ Alicia Adamczyk, ``Trading Apps Like Robinhood Are Having a
Moment. But Users Should Be Careful'', CNBC (Aug. 24, 2020, 3:49 PM),
https://www.cnbc.com/2020/08/21/robinhood-is-having-a-moment-users-
should-be-careful.html.
---------------------------------------------------------------------------
These developments have had a noteworthy and positive impact on
retail participation in the markets. A recent study has demonstrated
that the racial gap in individual stock ownership has been halved in
less five years. \21\ Similarly, a recent FINRA study found that the
majority of investors who opened their first account in 2020 were under
the age of 45, had lower incomes, and were more likely to be racially
and ethnically diverse. \22\
---------------------------------------------------------------------------
\21\ Aaron Brown, ``Opinion, Stock Investors Are Younger and More
Racially Diverse'', Bloomberg (Sept. 21, 2020, 6:00 AM), https://
www.bloomberg.com/opinion/articles/2020-09-21/stock-investors-are-
younger-and-more-racially-diverse.
\22\ News Release, Angelita Williams and Eric Young, ``FINRA, New
Research: Global Pandemic Brings Surge of New and Experienced Retail
Investors Into the Stock Market'' (Feb. 2, 2021), https://
www.finra.org/media-center/newsreleases/2021/new-research-global-
pandemic-brings-surge-new-and-experienced-retail.
---------------------------------------------------------------------------
In sum, technology and innovation have enabled a ``shift towards
more equitable investment participation,'' which is a laudable
achievement in the development of the markets. \23\
---------------------------------------------------------------------------
\23\ Id.
---------------------------------------------------------------------------
However, the rules for stock trading have generally not kept pace
with these rapid evolutions. Technology has made it easy to trade
incredibly complex, leveraged, and high-risk investments, with relative
ease. I urge Congress and the SEC to think clearly about what that
means not just for those investors, but for the millions who invest
through pension funds and mutual funds, as well as the businesses and
economy that rely on our capital markets.
If you wish to further democratize the capital markets, I would
urge you to begin by restoring the emphasis on the public markets, and
looking to reverse the proliferation of exemptions and exceptions from
the Federal securities laws.
B. The Private Capital Markets Are Not Suitable for Retail Investors
Because of the great strides retail investors have made in
accessing the public capital markets, there may be an inclination to
consider granting them access to the private capital markets. The
recent market events have exposed the growing discontent of retail
investors with the perceived unfairness of the public markets. As the
argument goes, institutional investors and high-net-worth investors
have access to a market that is brimming with greater returns on
investment that the public markets and it is to the disadvantage and
detriment of the retail investor to deny her access to these markets.
This argument, however, ignores key factors that would put retail
investors in a significantly worse position if they were able to invest
directly in private securities.
The public capital markets in the U.S. are based on a system of
regulation that is based fundamentally on mandatory and ongoing
disclosure from those offering securities to investors and the public.
Broadly, securities must be registered with the SEC prior to being
offered and sold on the public markets. \24\ There must be ``full
disclosure of the character of such securities,'' \25\ including basic
information about the company, its management, and its financials.
Further, after a company is ``public,'' it must share information with
the public fairly, and cannot selectively disclose information to
favored investors or other insiders.
---------------------------------------------------------------------------
\24\ Securities Act of 1933 5, 15 U.S.C. 77e (2018).
\25\ H. Rep. 73-85 (1933), at 2-3.
---------------------------------------------------------------------------
The mandatory disclosure regulatory regime of the U.S. public
markets is foundational to market democratization because it ensures
that all investors--regardless of size, influence, insider connections,
or wealth-have access to the same information on an ongoing basis.
Mandatory disclosure obligations for accessing the capital markets
levels the playing field as between retail investors with no access and
corporate insiders or sophistication, influential investors.
To grant retail investors access to the private capital markets
would place retail investors at a significant informational and
positional disadvantage because there would be considerable information
asymmetry. As a starting principle, it is important to keep in mind
that ``private'' markets refer to markets for which the mandatory
comprehensive disclosure and rights regime of the Federal securities
laws do not apply. \26\
---------------------------------------------------------------------------
\26\ See, e.g., Press Release, SEC, ``SEC Charges AT&T and Three
Executives with Selectively Providing Information to Wall Street
Analysts'' (Mar. 5, 2021), https://www.sec.gov/news/press-release/2021-
43#.YEOQlWUhHjk.twitter.
---------------------------------------------------------------------------
In contrast to the public markets where information is readily
available, the private markets are opaque and subject to little to no
disclosure requirements. \27\ This lack of disclosure means that
investors in the private markets must ascertain the value of securities
on their own and without the help of the public disclosures or readily
available information. Indeed, private securities typically have no
generally agreed upon ``market price'' as the company's valuation is
often determined separately with each new round of financing. Trading
prices in private market trading venues often have massive variations,
and comparatively high transaction costs. \28\
---------------------------------------------------------------------------
\27\ Elizabeth Pollman, ``Information Issues on Wall Street 2.0'',
161 U. PA. L. Rev. 179, 235-36 (2012).
\28\ Letter from Tyler Gellasch, ``Health Markets Ass'n. to Off.
Sec'y'', SEC, (Sept. 30, 2019), https://healthymarkets.wpengine.com/wp-
content/uploads/2019/09/SEC-Concept-Release-9-30-19-1.pdf.
---------------------------------------------------------------------------
Unsurprisingly, private company valuation is notoriously fraught
with complications and disagreement, resulting in valuations that may
be unsupported based on the company's undisclosed financial condition.
The case of WeWork provides a salient example. In January 2019, the
company was valued on the private markets at $47 billion. It's largest
shareholder SoftBank is an investment bank with significant experience
investing in private companies. Yet, shortly after WeWork filed its S-1
to initiate a public offering of its stock, the company's valuation
plummeted. Several months later, after a shelved IPO, WeWork was valued
at a little under $3 billion. \29\ But again, this valuation was based
on SoftBank's calculations, which are debatable given that WeWork is
still private and not subject to public disclosure of its financial
condition.
---------------------------------------------------------------------------
\29\ Bryan Pietsch, ``WeWork's Valuation Has Fallen From $47
Billion Last Year to $2.9 Billion'', Bus. Insider (May 18, 2020, 11:38
AM) https://www.businessinsider.com/wework-valuation-falls-47-billion-
to-less-than-3-billion-2020-
5#::text=WeWork's%20valuation%20has%20fallen%20to,said%20in%20its%20earn
ings%20report.
---------------------------------------------------------------------------
The alarming failure of SoftBank, an undeniably sophisticated
investor in the private markets, to value WeWork should raise serious
doubts as to whether a retail investor, even a sophisticated one, would
fare any better in valuing a private company.
Additionally, the absence of standardized and mandated information
dissemination means that retail investors will be at a severe
disadvantage relative to insiders and more powerful investors who can
demand information or negotiate disclosures from private issuers. With
no regulatory mechanism to force disclosures, there is no reason to
believe that private companies will voluntarily and on a timely basis
disclose information, even information material to the value or future
existence of the company, such as the loss of a major client, the
imposition of government sanctions, or pending bankruptcy.
Likewise, whereas in the public markets Regulation Fair Disclosure
prohibits selective disclosure of information, there is no corollary in
the private markets. Private companies can provide information to
institutional investors in compliance with contract-based information
rights but refuse to provide the same information to retail investors.
Retail investors, therefore, would be completely in the dark as to the
operation, profitability, future, and value of private companies if
allowed to invest in them. At a such a disadvantaged position, it would
be impossible for retail investors to make an informed decision as to
how to allocate their capital in the private markets.
C. Policy and Practical Considerations/Implications Regarding Greater
Retail Participation
While the public markets are more suitable for retail investors
versus the private markets, there are concerns that arise with regards
to greater retail participation in the public markets. To be clear,
these concerns do not equate with eliminating retail participation in
the markets, but they do signal the need to consider how to address the
ramifications on not only those investors, but also the overall
operation and structure of the market. There are three issues I would
like to raise.
First, retail investors seem to have very limited understanding of
the markets and products that they are trading. As a 2020 FINRA study
notes, there were ``low levels of investment knowledge among all types
of investors [in the study]-new and experienced . . . .'' \30\ The lack
of knowledge among retail investors indicates that there is likely an
underappreciation of the risks and costs of participating in the
markets. Specifically, approximately 38 percent of new investors self-
assessed their investment knowledge as low/very low. \31\
---------------------------------------------------------------------------
\30\ Id.
\31\ FINRA Inv. Ed. Found., ``Consumer Insights: Money &
Investing, Investing 2020: New Accounts and the People Who Opened
Them'' 15-16, https://www.finrafoundation.org/sites/finrafoundation/
files/investing-2020-new-accounts-and-the-people-who-opened-them-1-
0.pdf.
---------------------------------------------------------------------------
And, on the objective investment knowledge assessment, all investor
types scored poorly. \32\
---------------------------------------------------------------------------
\32\ Id. at 16.
---------------------------------------------------------------------------
Indeed, it is particularly noteworthy given that the investors are
participating in the public capital markets, where there is an
abundance of information on the corporations in which they may trade.
Yet, their understanding of the markets and their transactions were
concerningly low. As the FINRA study concludes, the low level of
knowledge among investors, particularly new investors, makes them
``potentially unprepared to make sound investment decisions . . . .''
\33\ Thus, while increased retail participation is laudable, it is
imperative to consider how to protect retail investors from unsuitable
investments that they neither understand nor appreciate the risks.
---------------------------------------------------------------------------
\33\ Id.
---------------------------------------------------------------------------
Second, with the proliferation of zero-commission brokers and
trading apps that ease access to the markets, there is the question:
what are retail traders able to access with these modern-day brokers? A
troubling aspect of the GameStop incident is that many traders were
trading call options on the stock. \34\ The widespread use of options
in GameStop trades reflects the ease with which retail investors are
now able to trade complex financial products on margin, which is
concerning for a few reasons.
---------------------------------------------------------------------------
\34\ Chris McKhann, ``GME Stock Options Trading Explained: The
Leverage of Long Calls Against the Volatility of GameStop'', Inv's.
Bus. Daily (Feb. 1, 2021, 3:08 PM), https://www.investors.com/research/
options/gme-stock-options-buyers-got-rich-now-looking-puts.
---------------------------------------------------------------------------
Options trading is complex and can entail significant risks for
traders. Options are leveraged transactions that can amplify the gains
and losses a trader experiences in the market. There are real policy
issues at play when we consider whether retail investors ought to be
able to trade on leverage-either at all or as easily as they currently
can through some retail broker-dealers. Given than a large number of
investors in a recent FINRA study stated that they were unaware of
whether their account charged fees, \35\ how can we expect retail
investors to appreciate the risks attendant with options trading and
other complex financial instruments. \36\
---------------------------------------------------------------------------
\35\ Williams and Young, supra note 22.
\36\ We have also seen retail investors not sufficiently
appreciate leveraged ETFs, where retail investors often believe that
their investment performance is simply going to be the returns of some
index multiplied by some factor, but that is not how those products
typically work. Div. Econ. & Risk Analysis, SEC, ``Economics Note: The
Distribution of Leveraged ETF Returns'' (2019), https://www.sec.gov/
files/DERA-LETF-Economics-Note-Nov2019.pdf.
---------------------------------------------------------------------------
Investor understanding of the risks, costs, and potential fallout
from options and leveraged trading is likely limited and, therefore, we
should be more thoughtful about what financial products are available
to retail investors. To be plain: democratization of finance cannot
mean that investors, regardless of their experience and sophistication
get access to options trading and margin accounts. This is not only
foolish, but dangerous. Indeed, we need not look any further than the
young man who committed suicide because he erroneously believed he had
a negative balance of over $700,000. \37\ There must be an awareness of
the limited knowledge and expertise of retail investors as they gain
access to increasingly complex products.
---------------------------------------------------------------------------
\37\ Maggie Fitzgerald, ``Robinhood Sued by Family of 20-Year-Old
Trader Who Killed Himself After Believing He Racked Up Huge Losses'',
CNBC (Feb. 8, 2021, 6:28 PM), https://www.cnbc.com/2021/02/08/
robinhood-sued-by-family-of-alex-kearns-20-year-old-trader-who-killed-
himself-.html (last updated Feb. 8, 2021, 9:26 PM).
---------------------------------------------------------------------------
I would urge Congress, the SEC, and FINRA to reconsider the ready
availability of complex financial products for retail investors.
Further, Congress, the SEC, and FINRA should inquire into how investors
are able to access margin accounts and options trading. Some reports
have stated that users on certain broker platforms are defaulted into
margin accounts, which raises significant concerns related to investor
protection. \38\
---------------------------------------------------------------------------
\38\ Letter from Tyler Gellasch, ``Health Markets Ass'n, to Maxine
Waters, Chairwoman, Comm. Fin. Servs.'', Patrick McHenry, Ranking
Member, Comm. Fin. Servs., Brad Sherman, Chairman, Subcomm. Inv. Prot.
and Bill Huizenga, Ranking Member, Subcomm. Inv. Prot. 17 (Feb. 17,
2021), https://healthymarkets.org/wp-content/uploads/2021/02/Letter-to-
HFSC-Hearing-2-17-21.pdf.
---------------------------------------------------------------------------
Third, as retail traders become more active and potent participants
in the market, it becomes necessary to consider how their presence and
behaviors impact the broader markets. It may be tempting to think of
the exuberance of retail investors for GameStop in January 2021 as a
one-off event, but this would be short-sighted. Indeed, in June 2020
retail investors piled into Hertz stock, even though the company was
going through bankruptcy, increasing the stock price tenfold. \39\
Additionally, even as GameStop's price began its descent from its
inexplicable highs, the stock price of other companies, such as AMC
Theatres and BlackBerry, also began to increase because of retail
investor interest. \40\
---------------------------------------------------------------------------
\39\ David Welch and Steven Church, ``What It Means To Buy Stock
in a Bankrupt Company Like Hertz'', Bloomberg (June 18, 2020, 5:00 AM),
https://www.bloomberg.com/news/articles/2020-06-18/what-it-means-to-
buy-stock-in-a-bankrupt-company-like-hertz.
\40\ Gunjan Banerji, Juliet Chung, and Caitlin McCabe, ``GameStop
Mania Reveals Power Shift on Wall Street-and the Pros Are Reeling'',
Wall St. J. (Jan. 27, 2021 6:46 PM), https://www.wsj.com/articles/
gamestop-mania-reveals-power-shift-on-wall-streetand-the-pros-are-
reeling-11611774663?mod=article-inline.
---------------------------------------------------------------------------
With significant reform, it is fair to believe that these wild
swings in stock prices owing to retail traders may become a recurring
feature of the markets. As was seen with GameStop, the fallout is not
limited to traders, but there are consequences for the clearinghouse
and for brokers as they try to keep pace with heavy transaction and
order flow. There may also be significant consequences on the companies
whose stock prices are gyrating. But perhaps even more concerningly,
these wild fluctuations may prove to be a significant deterrent for
future long-term investment.
Congress and the SEC should consider the extent to which the market
and incentives structure that currently exists (such as payment for
order flow, discussed below) contribute to the volatility accompanying
increased retail interest in certain stocks.
Further, as these peaks and troughs become more common in the
markets, I would encourage Congress and the SEC to explore whether the
existing framework can manage the risks and consequences that accompany
growing retail participation in the markets. To the extent it cannot,
the answer ought not to lie with limiting retail participation, as
seems to have happened recently when some broker-dealers suspended
trading in highly volatile stocks. Rather, the onus should be placed on
clearinghouses and brokers to do a better job of anticipating and
responding to potential market volatility. To this end, I encourage
Congress, the SEC, FINRA, and the DTCC to consider updates to broker
capital requirements, margin call processes, and settlement processes.
III. Payment for Order Flow
A contributing factor to the recent market volatility that raises
policy and regulatory concerns is payment for order flow (PFOF). PFOF
is the practice by which brokers are compensated for routing client
orders to third parties, such as wholesalers and market makers, for
execution. \41\ Through PFOF, retail brokers' commissions are
subsidized or substituted by payments received from third parties who
are able to profitably trade against those clients' orders.
---------------------------------------------------------------------------
\41\ Alex Rampell and Scott Kupor, ``Breaking Down the Payment for
Order Flow Debate'', Andreessen Horowitz (Feb. 17, 2021), https://
a16z.com/2021/02/17/payment-for-order-flow.
---------------------------------------------------------------------------
During a Congressional hearing last month, Robinhood's CEO
testified that over half of the firm's revenues came from PFOF. \42\
With brokers, wholesalers, and market makers earning such high profits
from PFOF, one is left to wonder if investors are truly better off
under this model.
---------------------------------------------------------------------------
\42\ ``Game Stopped? Who Wins and Loses When Short Sellers, Social
Media, and Retail Investors Collide'': Hearing Before the H. Comm. on
Fin. Servs., 117 Cong. (Feb. 18, 2021) (statement of Vladimir Tenev,
CEO, Robinhood Markets, Inc.), prepared remarks available at https://
financialservices.house.gov/uploadedfiles/hhrg-117-ba00-wstate-tenevv-
20210218.pdf.
---------------------------------------------------------------------------
PFOF is a concerning practice that has been allowed to continue in
the U.S. securities markets, although its costs to both retail
investors and the markets overall outweigh the supposed benefits they
receive. PFOF is innately conflicted, placing retail investors in an
inferior position vis-a-vis their broker. Further, claims that PFOF
results in price improvement are questionable at best and it is more
likely that retail investors are often paying higher prices for their
trades than they would if those orders were exposed to the exchanges.
Lastly, PFOF increases market segmentation and decreases liquidity,
which diminishes market stability and efficiency. Each of these is
discussed in greater detail below.
A. PFOF Is Innately Conflicted and Opaque
Broker-dealers are bound by a duty of loyalty to their clients.
This duty includes the duty to act in the best interests of their
clients and obtain the best terms for their clients when executing
trades. This duty of loyalty is delineated through SEC and FINRA rules,
and numerous cases. PFOF directly undermines this duty by allowing
brokers to route client orders based on agreements with third parties,
allowing these third parties to profit at the expense of clients.
Previously, broker revenue was primary earned from their customers
to whom they owe such a duty, aligning the interests of the brokers
with their clients'. PFOF undermines this relationship because it pits
the brokers' primary revenue source directly against the clients to
whom they owe the duty of best execution. Under the PFOF model, brokers
are incentivized to put their own profit-seeking interests above their
clients in deciding where to route client orders. This practice greatly
undermines the broker-investor relationship and leaves retail investors
in a worse position.
Additionally, it is questionable whether brokers are truly getting
the best execution for clients if they receive PFOF. To the extent
brokers are required to put clients' interests above incentives for
trade routing, as required by FINRA's rules regarding best execution,
\43\ PFOF is fundamentally at odds with this duty. Recent, separate
actions by FINRA \44\ and the SEC \45\ against Robinhood for failure to
achieve best execution, for example, would seem to bear this out.
---------------------------------------------------------------------------
\43\ Regulatory Notice 15-46: ``Guidance on Best Execution
Obligations in Equity, Options and Fixed Income Markets, FINRA'' (Nov.
2015), https://www.finra.org/rules-guidance/notices/15-46.
\44\ See, e.g., Letter of Acceptance, Waiver, and Consent No.
2017056224001 from Robinhood Fin., LLC., to Dept. of Enf't., FINRA
(Dec. 19, 2019), https://www.finra.org/sites/default/files/2019-12/
robinhood-awc-121919.pdf.
\45\ ``In the Matter of Robinhood Fin., LLC'', Admin. Proc. File
No. 3-20171 (Dec. 17, 2020), https://www.sec.gov/litigation/admin/2020/
33-10906.pdf.
---------------------------------------------------------------------------
Another related issue with the PFOF structure is the lack of
transparency. SEC rules require brokers to report their PFOF
statistics, including net payments received from market makers for
trade execution and the rate of PFOF per 100 shares. These disclosures,
which were recently amended in 2020, provide data in the aggregate that
make it impossible for individual retailers to know specific,
individualized information.
This lack of information makes it difficult for retail investors to
compare costs across brokers and to appreciate the true costs of their
trading activities.
Importantly, even though the SEC requires that these reports are
made available to customers, it can be nearly impossible to locate them
on the broker's website. \46\ And, there are questions as to whether
the reports some brokers provide even comply with the SEC regulations.
It is imperative that the SEC mandate additional disclosure around this
issue in order to make investors more informed about the costs of their
allegedly free trading accounts.
---------------------------------------------------------------------------
\46\ Letter from Tyler Gellasch, Healthy Markets Ass'n, to Brent
J. Fields, SEC, at 7-8, (Sept. 26, 2016), https://
healthymarkets.wpengine.com/wp-content/uploads/2018/04/09-26-16-HM-
letter-Order-Handling-Disclosure-rules.pdf; Annette L. Nazareth,
Gregory Rowland, Zachary J. Zweihorn, and Mark A. Sater, ``SEC Adopts
Enhanced Order Handling Disclosure Requirements5'', FINREG: Davis Polk
Insights on Fin. Reg. (Nov. 27, 2018), https://www.finregreform.com/
single-post/2018/11/27/sec-adopts-enhanced-order-handling-disclosure-
requirements.
---------------------------------------------------------------------------
Lastly, Congress should explore whether PFOF ought to be banned
given its inherent incompatibility with best execution and brokers
acting in the best interest of their clients. If a broker is able to
cover its trading expenses through receipt of fractions of a penny per
share from a third party, could it not simply charge its actual
customer a similar price?
A ban on PFOF is unlikely to result in the end of retail investor
participation in the market. But it can result in less conflicted order
routing and adoption of a more transparent pricing model. Other
jurisdictions, such as the United Kingdom and Australia, have banned
PFOF because it is innately conflicted and of questionable benefit to
investors. \47\ FINRA has begun an examination of PFOF and the zero-
commission business model because of their problematic incentive
structures. \48\ In light of the concerning features of PFOF, Congress
and the SEC should explore whether its continuation is truly in the
best interest of retail investors or in the best interest of brokers,
wholesalers, and market makers.
---------------------------------------------------------------------------
\47\ CFA Inst., ``Payment Order Flow: Internalisation, Retail
Trading, Trade-Through Protection & Implications for Market Structure''
2 (2016), https://www.cfainstitute.org/-/media/documents/issue-brief/
payment-for-order-flow.ashx (discussing the U.K. ban on PFOF).
\48\ ``Targeted Examination Letter on Zero Commissions'', FINRA
(Feb. 2020), https://www.finra.org/rules-guidance/guidance/targeted-
examination-letters/zero-commissions.
---------------------------------------------------------------------------
B. Price Improvement Is Questionable
One of the main arguments in favor of PFOF is that the third
parties to which brokers route orders purportedly provide retail
customers with ``price improvement.'' Often, market participants will
(somewhat misleadingly) claim that ``price improvement'' means that
retail customers are getting better prices than are available on
exchanges. For example, Robinhood's CEO testified: ``In fact, Robinhood
customers received more than $1 billion in price improvement-the price
they received compared to the best price on a public exchange-in the
first half of 2020.'' \49\
---------------------------------------------------------------------------
\49\ ``Game Stopped? Who Wins and Loses When Short Sellers, Social
Media, and Retail Investors Collide: Hearing Before the H. Comm. on
Fin. Servs., 117 Cong. (Feb. 18, 2021) (statement of Vladimir Tenev,
CEO, Robinhood Markets, Inc.), prepared remarks available at https://
financialservices.house.gov/uploadedfiles/hhrg-117-ba00-wstate-tenevv-
20210218.pdf.
---------------------------------------------------------------------------
But that is not what price improvement is often defined to
calculate. Rather, ``price improvement,'' as defined by SEC Rule 605 is
not measured from the best available prices on exchanges, but rather
the best available protected quote. \50\ Odd-lot quotes (i.e., buy/sell
offers for less than 100 shares) are generally not protected and,
therefore, they are not used to calculate price improvement, even if
they are a better price than the protected quote. Consequently, price
improvement claims are often overstated and fail to reflect that many
investors' executions were not at the best available prices, but were
instead at prices that were inferior to odd-lot quotes on the
exchanges.
---------------------------------------------------------------------------
\50\ SEC Rule 605, FINRA, https://www.finra.org/rules-guidance/
guidance/sec-rule-605 (last visited Mar. 7, 2021).
---------------------------------------------------------------------------
Studies have also raised questions as to whether retail investors
receive the best price when their orders are routed based on PFOF. A
study by the U.K. financial regulator found that in removing broker
payments for order routing, investor execution at the best available
price increased from 65 percent to 90 percent. \51\ A more recent study
based on U.S. transactions in GameStop during the January trading
frenzy estimated that price improvement estimates were cut in half when
odd lots on just Nasdaq were included in the calculations. \52\
---------------------------------------------------------------------------
\51\ CFA INST., supra note 47, at 2.
\52\ Robert P. Bartlett, III & Justin McCrary, Modernizing Odd Lot
Trading (on file with author).
---------------------------------------------------------------------------
To improve the calculation of price improvement and actually enable
investors to receive best execution, the SEC should immediately update
Rule 605 to reflect odd-lots in the calculation of price improvement.
There is little to no justification in the current market for excluding
odd-lot quotes from the calculation of price improvement. And, there is
even less justification for excluding it from determining the best
available price for trade execution when the aggregated available odd
lots are at least as great as a customer order.
It is also worth noting that it appears that different retail
broker dealers appear to negotiate different amounts of price
improvement for their customers. Further, the amounts of price
improvement seem to be, in many cases, inversely related to the amount
of payments received by the broker as part of its PFOF. It seems as
though it should be obvious, but if one retail broker is routinely
providing its customers with better prices than another, they can't
both be providing ``best execution.''
Lastly, as discussed below, even using a more accurate calculation
methodology, the ``price improvement'' statistic may still not reflect
an improvement over a price that could have been received if the order
had been routed to the lit markets. That's because if a retail order is
routed to an exchange, it is likely that the order could receive mid-
point trade executions that would offer far better prices than the
price improvement currently offered.
C. Price Discovery and Market Liquidity Are Reduced
Another consequence of PFOF is that it results in significant
market segmentation. Retail orders routed to a market maker, for
instance, are typically filled by the market maker without ever trading
on the exchanges. Given that retail trades account for an ever-
increasing segment of the markets, isolating retail transactions to
market makers with whom brokers have order routing arrangements reduces
liquidity and price discovery for the rest of the markets.
In adopting Regulation National Market System (''Reg NMS''), the
SEC sought to create a fair and transparent marketplace in which
investors could trade at the best price available across the different
venues trading a security. \53\ The reality, however, is that the
securities markets are more fragmented today than they were prior to
the enactment of Reg NMS. There are over a dozen exchanges and dark
pools, and hundreds of broker-dealers who fill customer order
internally or route them according to prior arrangements. \54\ Further
compounding this fragmentation, it is estimated that close to 100
percent of retail orders are internalized and, therefore, never
interact with the broader market in execution. \55\
---------------------------------------------------------------------------
\53\ Div. Trading & Mkts., Responses to Frequently Asked Questions
Concerning Rule 611 and Rule 610 of Regulation NMS, SEC, https://
www.sec.gov/divisions/marketreg/nmsfaq610-11.htm (last updated Apr. 4,
2008).
\54\ CFA Inst., ``Dark Pools, Internalization, and Equity Market
Quality'' 2 (2012), https://www.cfainstitute.org/en/advocacy/policy-
positions/dark-pools-internalization-and-equity-market-quality.
\55\ Id. at 16.
---------------------------------------------------------------------------
Over the past several years, the amount of exchange trading has
steadily declined as retail trading has increased. Over the past
several weeks, as much as half of all trading has been occurring off-
exchange. \56\ This means that those orders are not contributing to
price discovery. Pension funds, mutual funds, and other investors are
generally unable to interact with them. Further, as discussed above,
retail customers may not be receiving the best price available.
---------------------------------------------------------------------------
\56\ Alexander Osipovich, ``GameStop Mania Highlights Shift to
Dark Trading'', Wall St. J. (Feb. 12, 2021, 5:33 AM), https://
www.wsj.com/articles/gamestop-mania-highlights-shift-to-dark-trading-
11613125980.
---------------------------------------------------------------------------
Relatedly, segmentation of retail transactions has reduced market
liquidity, making it harder for institutional investors to trade. \57\
Retail trades are inaccessible sources of liquidity, which has a
significant effect on the cost to trade popular stocks that have a high
percentage of retail ownership. Apple, for example, has an estimate
retail share of 38 percent, which is unavailable to most institutional
investors because the trades are fulfilled internally. As a result,
institutional investors seeking to trade stock with high retail
ownership face significantly higher costs because of diminished
liquidity and increased volatility. \58\
---------------------------------------------------------------------------
\57\ ``Meme Stocks: Inaccessible Trading Share, Trading Cost, and
Risk'', Babelfish Analytics (Feb. 5, 2021), https://
www.babelfishanalytics.com/news/2021/2/4/meme-stocks-inaccessible-
trading-share-trading-cost-and-risk.
\58\ Id.
---------------------------------------------------------------------------
Conclusion
Today, it is easier, cheaper and faster to trade more complex and
leveraged financial products that ever before. This new market reality
requires that we rethink the risks that accompany these developments
and, in so doing, consider what types of markets we want to create and
encourage from a policy perspective. Promoting and strengthening market
stability and integrity is essential to the market fulfilling its
fundamental purpose: efficiently allocating capital to businesses,
driving the economy, and enabling investors to enjoy reasonable returns
on their capital. Recent events have highlighted concerns and
shortcomings in the existing market structure, which must be
comprehensively addressed in order to ensure that the markets remain
fair, stable, and accessible companies seeking capital and, most
importantly, all investors.
______
PREPARED STATEMENT OF RACHEL J. ROBASCIOTTI
Founder and Chief Executive Officer, Adasina Social Capital
March 9, 2021
Mr. Chairman Brown, Ranking Member Toomey, and Members of the
Committee: Good morning and thank you for inviting me to testify before
this Committee. It is my great honor. My name is Rachel Robasciotti and
I hold leadership positions at two SEC Registered Investment Advisory
firms. I am the Founder and CEO of Adasina Social Capital, where we
manage an exchange-traded fund with the ticker symbol JSTC. It holds
over 800 stocks, but is accessible to everyday investors at a price of
about $16 per share. I am also the Director of Advocacy & Engagement
for Abacus Wealth Partners, a firm with $3.8 billion in assets and no
minimum account size for its clients.
In both roles, I serve hardworking, everyday Americans. Your
constituents and my clients are the same people.
I have also worked in financial services for almost 22 years, so I
take the long view of market events. I have seen everything from the
ill-fated dot-com boom of 2000 through the Great Recession and the most
recent GameStop-Robinhood episode in January. I understand the players
in the market and, in this most recent situation, there are three
groups to consider.
1. Hedge Funds: Institutions that primarily manage money for
wealthy, accredited investors \1\ and are known for their risky
strategies and high returns.
---------------------------------------------------------------------------
\1\ Securities and Exchange Commission, Office of Investor
Education and Advocacy, ``Investor Bulletin: Hedge Funds'', SEC Pub.
No. 139 (February 2013).
---------------------------------------------------------------------------
2. Redditors: Tech-enabled young people, using commission-free
trading, who banded together to outwit the hedge funds they felt had an
unfair advantage.
3. Everyday Americans: Hard-working people with long-term
retirement savings invested in the stock market. These people do not
have time to be sophisticated investors and were mostly anxious,
confused, and frustrated.
But, as an investment professional, what happened here was familiar
to me.
When the GameStop-Robinhood episode occurred in January, I was
immediately reminded of the MIT Blackjack Team of the 1990s, when a
group of students banded together to break the bank at several large
casinos. \2\ They realized that if they worked together, they could win
substantially more money than the average gambler. So, using math
skills and technology, they coordinated to quickly and strategically
place large bets against the house.
---------------------------------------------------------------------------
\2\ Noah Goldman, ``How MIT Students Broke the Bank in Vegas'',
ABC News (January 6, 2006).
---------------------------------------------------------------------------
It is easy to see the obvious similarities between the two
situations. Like the MIT students, the Redditors in January were young,
knowledgeable people with high appetites for risk who chose to
collectively speculate by making quick bets against a larger player
with a perceived advantage.
On the other hand, like the casinos, the hedge funds are large
institutions with specialized knowledge about the game who some say
routinely use their size to tip the odds in their favor.
What is not obvious, whether in the casino or the stock market, is
what the wealthy institutions and upstarts have in common. They are all
fast-moving, high-risk speculators with more skills and tools than the
average person.
But there is a problem here for the stock market. When fast-moving,
high-risk speculators dominate, we have a classic recipe for market
disruptions. What we saw in January with GameStop and Robinhood is what
we saw during the Great Recession with Wall Street churning out
subprime, mortgage-backed securities.
Market disruptions like this are a problem because, as stated by
SEC Commissioners on January 29th, \3\ ``...extreme stock price
volatility has the potential to expose investors to rapid and severe
losses and undermine market confidence.''
---------------------------------------------------------------------------
\3\ U.S. Securities and Exchange Commission, ``Statement of Acting
Chair Lee and Commissioners Peirce, Roisman, and Crenshaw Regarding
Recent Market Volatility'', Public Statements, U.S. Securities and
Exchange Commission (January 29, 2021).
---------------------------------------------------------------------------
Unfortunately, this volatility does not impact everyone equally.
Let me paint the picture of what the everyday investor experienced.
Imagine a two-job household with a couple of kids, adults working hard
to make ends meet and save enough for the future. They don't have a
professionally managed pension to fall back on for retirement, because
so few pensions now exist. \4\ They know that Social Security benefits
their parents receive aren't enough to cover most retiree's basic
needs. \5\ And, for several decades now, the economy has only offered
these savers historically low-interest rates, which means that putting
their money in low-risk savings accounts, CDs, or bonds barely makes
them enough to keep up with inflation. \6\
---------------------------------------------------------------------------
\4\ Barbara A. Butrica, Howard M. Iams, Karen E. Smith, and Eric
J. Toder, ``The Disappearing Defined Benefit Pension and Its Potential
Impact on the Retirement Incomes of Baby Boomers'' Office of Retirement
and Disability Policy, Social Security Administration, Social Security
Bulletin, Vol. 69, No. 3 (October 2009).
\5\ Jan Mutchler and Yang Li, ``The Gap Remains: Social Security
Benefits Continue to Fall Short of Covering Basic Cost of Living for
Older Americans, 2015-2020'', Center for Social and Demographic
Research on Aging Publications, No. 48, University of Massachusetts
Boston (November 2020).
\6\ The Economist, ``The Savers Dilemma: Low Interest Rates Leave
Savers With Few Good Options'', Finance & Economics, The Economist
(October 15, 2020).
---------------------------------------------------------------------------
This leaves investing in the stock market as their only option. It
is the only way their savings can grow enough to provide for the
future. So, they are forced into the ``stock market casino'' with their
life savings. And they are being required to play against armies of
sophisticated, high-risk hedge funds and Redditors duking it out for
dominance. With smaller amounts, that represent all that they have to
invest, sustaining significant losses (or even the perception of
losses) is devastating. It makes them lose confidence and want to opt
out altogether. But we know they can't leave the casino.
As an investment professional who works for everyday investors, and
as senators with these same people as your constituents, we must fix
the system for them. We need to maintain fair, orderly, and efficient
markets that serve as a reasonable place for the average American to
invest their life savings. And we have a duty to protect these
investors from the crossfire of fast-moving, high-risk speculators.
______
PREPARED STATEMENT OF TERESA GHILARDUCCI
Bernard L. and Irene Schwartz Professor of Economics, The New School
March 9, 2021
Thank you for inviting me, Chairman Brown and Ranking Member Toomey
and Members of the Committee.
I am the Bernard Schwartz Chair of Economics at The New School in
New York City, coming to that faculty in 2007 after teaching at the
University of Notre Dame for 25 years. I received my PhD from UC
Berkeley and serve as a court-appointed independent trustee of the
Goodyear tire retirees' $900 million health care trust fund and the
autoworkers $60 Billion retiree health fund.
My office hours are typically quiet moments huddling over
equations. But over the past few years, students have been bubbly,
asking about their trades on the phone-friendly trading platform,
Robinhood. The young are told to buy stocks and hold them--but they
absorbed the first point and missed the second.
Trading on Robinhood is a game with psychologically powerful
intermittent rewards and is disconnected to long term wealth
accumulation. Phone Apps makes trading easy and cheaper and
superficially seems to open securities markets to many more people but
they do not produce wealth.
I welcome today's hearing seeking to protect retail stock buyers
from casino-type trades. And I want to emphasize that Americans' wealth
does not come from retail stock trading. I am here to testify where
Americans really get their wealth. \1\
---------------------------------------------------------------------------
\1\ Researchers at The New School, Michael Papadopoulos and
Siavash Radpour, constructed the wealth data and Owen Davis helped with
the Robinhood discussion.
---------------------------------------------------------------------------
As you might guess, home equity and retirement wealth including
Social Security \2\ are the largest components of wealth \3\--they make
up 88 percent \4\of the wealth held by near retiree households in the
lower half of the wealth distribution; 78 percent for the middle class,
and 43 percent for those in the top 10 percent (Table 2).
---------------------------------------------------------------------------
\2\ We add the shares in the net value of primary residence,
present value of expected Social Security benefits, value of DC plans
and IRAs, and present value of defined benefit benefits.
\3\ Half of near-retirement households (with members aged 52 or
over), those in the bottom half of the wealth distribution have less
than $296,000 wealth, including the value of their pensions and Social
Security benefits. The median wealth for the middle class--those in the
next 40 percent of the wealth distribution--is $1.02 million.
Households in the top 10 percent have a median net wealth of over $3.2
million (Table 1).
\4\ Adding 19%+58%+11%=88%
---------------------------------------------------------------------------
You might be surprised that Social Security is the most important
source of household wealth for half of all households with workers
nearing retirement. Social Security represents 58 percent of net wealth
for near retirees in the bottom half of the wealth distribution; 27
percent for the middle class; and 7 percent for the top 10 percent. \5\
---------------------------------------------------------------------------
\5\ A note about the racial wealth gap and Social Security.
Whites, on average, have 83 percent more net wealth (Table 3) that non-
whites. But the racial Social Security wealth gap is only 13 percent--
Social Security is the most equitably distributed source of wealth for
Americans nearing retirement. Whites have 8 times the wealth in
business, and 4 times the wealth in directly held stocks, 58 percent
more housing wealth and 2.4 times the retirement plan wealth compared
to non-whites
---------------------------------------------------------------------------
In contrast, directly owned stocks (and bonds) make up a relatively
small share of near retirees' wealth at 8 percent. Only 24 percent of
older households own stocks directly, outside of their retirement
account and that ownership is concentrated at the top. Only 10 percent
of those in the bottom half of the wealth distribution own stocks, less
than a third of the middle class.
And the wealthy are not rich because they directly own stocks.
Though 70 percent of the top 10 percent directly own stocks, it is only
13 percent of their wealth. (They own businesses (15 percent of their
wealth), other real estate (15 percent of their wealth), and have 25
percent of their wealth in retirement accounts and pension plans.)
As Nobelist Robert Shiller recent book points out stock trading
feeds a narrative, a story about wealth, trading is exciting because
stocks fluctuate. Stories about getting rich on stocks produce a
fiction that stock trading creates wealth, when, in fact, retail
investors fuel bubbles.
Defenders of Robinhood and widespread trading have purchase because
in the COVID recession people who own stocks have done well, which
heightens the fear of missing out for those not buying stocks. The
reality is they are being left out because they don't have access to
retirement accounts, which is where most of us who own stocks hold
them. Retirement accounts are invested in diversified portfolios
managed by institutional investors and professionals who can manage the
risks that come with investments in private equity, etc., and other
complex instruments.
But more than half of workers do not have a retirement plan at
work, which means many households do not have any investment in stocks
or are accumulate private wealth for their retirement. (Radpour,
Papadapoulos, and Ghilarducci 2021).
Any retail brokers' claims that trading democratizes access to
wealth only takes advantage of people's fears. I do not recommend
opening up high-risk and expensive alternative investments to the
retail investor it can make risk and inequality worse. \6\
---------------------------------------------------------------------------
\6\ Demand for lottery-like stocks increases during economic
downturns and is more prevalent among vulnerable groups: poor young
men, African Americans and Latinos. (Kumar 2009) Some types of retail
trading resemble gambling disorders. (Grall-Bronnec et al. 2017). New
technologies make stock trading more like gambling. Apps like Robinhood
make gambling stocks more accessible. Two to three percent of gamblers
become addicted. Trading can become an addiction, akin to gambling
addiction.
---------------------------------------------------------------------------
Robinhood founders frequently invoke their experience as part of
the Occupy movement to explain why they want to democratize finance.
But safe and professionally managed diversified investments, not
trading apps, are the path to economic security. Successful investors
know that ``time in the market'' and diversification, which are among
the many benefits of professionally managed retirement plans, are what
works. Unlike ``timing the markets,'' which does not work, yet is that
is what trading apps encourage.
We need innovations in public policy to give more Americans access
to what we know works--professionally managed retirement coverage that
allows everyone to benefit from the stock markets the same way you and
I do in Thrift Savings Plan, in a private or public defined benefit
plan, or in my pension plan Teachers Insurance Annuity Association.
Wealth Holdings
The typical household whose members are nearing retirement earn
about $65,000, their average wealth of over $1 million is barely
relevant since the very wealthy pull up the average beyond reality.
Because most Americans do not have significant wealth until their
fifties, I focus today on those nearing retirement age, defined as
households with one worker 52 or over.
The typical near-retirement household in the United Statesearns
between $55,000 to $75,000 per year and has an average net wealth of
$1.67 million. I don't report the income distribution tables, but am
reporting the wealth distribution. When dividing up the over near
retiree population This sounds like a large number, but--as you know--
averages hide important differences (as witnesses testified in your
March 3 hearing) and means and medians don't give you a complete
picture. So I am going to report wealth in terms of wealth
distribution, looking at the differences between those in the bottom 50
percent, the next 40 percent and the top 10 percent of the wealth
distribution. (These are categories recommended by French economist
Thomas Piketty (2015).
For those in the bottom half of the wealth distribution, the median
net wealth is $295,724; for those in the next 40 percent, it is
$1,019,239; and for those in the top 10 percent, median net wealth is
$3.19 million. You may be surprised that home equity in a primary
residence is not the largest share of wealth across all income groups.
It is only 12 percent of net wealth for those in the top 10 percent
(they own other real estate) and about 20 percent for the bottom 90
percent.
Social Security is the predominant source of household wealth for
near retirees. As a promised stream of income for the rest of your
life, indexed to inflation, Social Security represents 24 percent of
net wealth, which falls as income goes up. Social Security matters much
more for lower wealth holders who are likely lower earners: 58 percent
of total wealth is in Social Security for the bottom half of the wealth
distribution, 27 percent for the middle and 7 percent for those at the
top. Retirement savings in the form of defined contribution savings
plans and individual retirement accounts are next, representing 17
percent of households net wealth, only 8 percent on the bottom, 21
percent for middle and 16 percent for those on the top. Traditional
pensions, or benefits from a defined benefit plan, represent only at 8
percent because they have been replaced by 401(k)s, only 3 percent for
the bottom and 9 percent for the top half.
Policy Implications
Overall, I think the focus on broader wealth accumulation and
retirement assets is the right way to go. We need to add accrued Social
Security benefits to retirement wealth which helps reduce the
retirement wealth gap between low and high earners and keeps retirees
out of poverty, American workers still face a wealth crisis.
Policymakers need to strengthen and expand Social Security and mandate
employer-sponsored retirement plans to ensure universal coverage and
adequate retirement income. Policymakers need to pay attention to the
risks of student debt and home mortgages. We need better regulation of
Fin tech to be sure, the future generation depends on our stewardship.
The most important source of savings, though, is income, savings are a
residual from people's earnings. They can't buy a house and contribute
to a pension without decent earnings. This is not a rhetorical point,
it is rooted in economic research on savings. We need to increase
minimum wage and raise wages.
Social Security Wealth
Social Security reduces--but does not eliminate--retirement wealth
inequality. For typical workers age 51-56, accrued Social Security
benefits exceed employer-sponsored retirement wealth. Median Social
Security wealth amounts to $81,900 compared with $67,000 in employer-
sponsored retirement plans.
At ages 51-56, the typical low-wage worker (in the lowest 20
percent of earnings) has no retirement wealth. The typical high-wage
worker (in the highest 20 percent of earnings) has wealth equal to
almost two and a half times their earnings.
Adding accrued Social Security benefits to retirement wealth
decreases the retirement wealth gap between low and high earners from
two and a half times earnings to just over half a year's earnings (see
Ghilarducci, Radpour, and Webb 2020).
To calculate Social Security wealth for this testimony, I impute a
career earnings trajectory for each worker using two factors: (1)
current earnings in the survey year [2016] and (2) scale factors from a
Social Security Administration Actuarial Note published by Clingman and
Burkhalter (2016). This career earnings trajectory is then used to
calculate AIME and PIA, giving us the Social Security Retired Worker
benefit. We assume all workers claim the Retired Worker benefit. We
assume a worker collects benefits for 13 years, and therefore multiple
annual benefits by 13--the actuarial factor (Carlson 2020), giving us
an estimate for Social Security wealth.
Trading and Investment
It's well-known that individual investors underperform on average,
and app-based day-trading may be making this performance gap between
underperforming app trading and other portfolios worse. In general,
retail investors' returns are lower on average than returns to low-cost
index funds and certainly less rewarding in terms of risk--adjusted
returns to a professionally managed defined benefit portfolio. (Barber
and Odean, 2013).
Retail investors tend to sell good stocks too soon and hold bad
stocks too long--the endowment effect--and engage in myopic and salient
trading patterns (a recent event is viewed as more likely to happen
than it is) and they tend not to be diversified enough, professionals
with a broad information base have more holdings.(Barber and Odean,
2013).
Recent evidence using Robinhood data finds that frequently bought
stocks on the app seriously underperform due to what authors call
``extreme herding'' events (Barber et al., 2021). And a recent study
using data on German households found that switching from desktop
computers for investing to smartphone apps led investors to ``increased
purchasing of riskier and lottery-type assets and chasing past
returns'' (Kalda et al., 2021).
Fintech is not all bad--Apps like Betterment, Wealthfront, and
Acorns are geared more toward patient, long-term investing than
impulsive day trading. Owen Davis, graduate student at the New School
helped with this section.
References:
Barber, B.M., & Odean, T. (2013). ``The Behavior of Individual
Investors'', In Handbook of the Economics of Finance, Vol. 2, pp.
1533-1570.
Barber, B.M., Huang, X., Odean, T., and Schwarz, C. (2021). ``Attention
Induced Trading and Returns: Evidence From Robinhood Users''.
Available at SSRN: https://ssrn.com/abstract=3715077 or http://
dx.doi.org/10.2139/ssrn.3715077.
Carlson, B. (2020). ``How To Value Social Security''; Clingman, M.,
Burkhalter, K. (2016). ``Scale Factors for Hypothetical Earnings
Examples Under the 2016 Trustees' Report Assumptions''. Social
Security Actuarial Note 2016-3. https://www.ssa.gov/oact/NOTES/
ran3/an2016-3.pdf.
Ghilarducci, T., Radpour, S., and Webb, A. (2020). ``Social Security
Reduces Retirement Wealth Inequality'' Schwartz Center for Economic
Policy Analysis and Department of Economics, The New School for
Social Research, Policy Note Series.
Grall-Bronnec, M., Sauvaget, A., Boutin, C., Bulteau, S., Jimenez-
Murcia, S., Fernandez-Aranda, F., Challet-Bouju, G., and Caillon,
J. (2017). ``Excessive Trading, A Gambling Disorder in Its Own
Right? A Case Study on a French Disordered Gamblers Cohort''.
Addictive Behaviors, 64, 340-348. https://doi.org/10.1016/
j.addbeh.2015.12.006
Kalda, A., Loos, B., Previtero, A., and Hackethal, A. (2021). ``Smart
(Phone) Investing? A Within Investor-Time Analysis of New
Technologies and Trading Behavior'' (No. w28363). National Bureau
of Economic Research.
Kumar, A. (2009), ``Who Gambles in the Stock Market?'' The Journal of
Finance 64: 1889-1933. https://doi.org/10.1111/j.1540-
6261.2009.01483.x
Piketty, T. (2015). ``About Capital in the Twenty-First Century''.
American Economic Review 105 (5):48-53.
Radpour, S., Papadopoulos, M., and Ghilarducci, T. (2021) ``Trends in
Employer-Sponsored Retirement Plan Access and Participation Rates:
Reconciling Different Data Sources'', Schwartz Center for Economic
Policy Analysis and Department of Economics, The New School for
Social Research, Research Note Series 2021-01.
Shiller, R. (2020) ``Narrative Economics: How Stories Go Viral and
Drive Major Economic Events''. Princeton University Press.
Not referenced but relevant:
Federal Reserve (2020). ``Changes in U.S. Family Finances from 2016 to
2019: Evidence From the Survey of Consumer Finances''. Federal
Reserve Bulletin, Vol. 106.
Ghilarducci, T. (2020) ``Most Americans Don't Have a Real Stake in the
Stock Market'', Forbes.
______
PREPARED STATEMENT OF MICHAEL S. PIWOWAR
Executive Director, Milken Institute Center for Financial Markets
March 9, 2021
Good morning. Thank you Chairman Brown, Ranking Member Toomey, 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. \1\ I had the pleasure
of serving on this Committee's staff as Chief Economist for Senator
Shelby and Senator Crapo. I also served as a Visiting Academic Scholar,
Senior Financial Economist, Commissioner, and Acting Chairman of the
U.S. Securities and Exchange Commission (``SEC'' or ``Commission''). I
am testifying today on my own behalf.
---------------------------------------------------------------------------
\1\ The Milken Institute is a nonprofit, nonpartisan think tank
that promotes evidence-based research that serves as a platform for
policymakers, industry practitioners, and community members to come
together in catalyzing practical solutions to challenges we face both
here in the U.S. and globally. The Center for Financial Markets
conducts research and constructs programs designed to facilitate the
smooth and efficient operation of financial markets--to help ensure
that they are fair and available to those who need them when they need
them.
---------------------------------------------------------------------------
Now that the dust has settled after the January trading frenzy on
Gamestop and other so-called meme stocks, I am glad that you called
this hearing on the state of retail investing.
Retail investors enjoy more choices and face lower costs and
barriers when investing their hard-earned savings than ever before.
Retail investors can invest directly in securities through
brokerage accounts. Competition among brokers has led to commission-
free trading. Competition among exchanges, alternative trading systems
(ATSs), and market makers has led to the best market quality
environment--transaction costs are low, market depth is high, and
execution speeds are fast--for publicly traded securities in history.
\2\ Retail investors can make their own investment decisions or seek
the advice of a regulated investment professional through a broker-
dealer or investment adviser.
---------------------------------------------------------------------------
\2\ See, e.g., ``A Century of Stock Market Liquidity and Trading
Costs'', Charles M. Jones (May 23, 2002), available at https://
papers.ssrn.com/sol3/papers.cfm?abstract-id=313681; ``Equity Trading in
the 21st Century'', James J. Angel, Lawrence E. Harris, and Chester S.
Spatt, Quarterly Journal of Finance, Vol. 1, No. 1 (2011); and ``Equity
Trading in the 21st Century: An Update'', James J. Angel, Lawrence E.
Harris, and Chester S. Spatt (May 23, 2013), available at https://
www.q-group.org/wp-content/uploads/2014/01/Equity-Trading-in-the-21st-
Century-An-Update-FINAL.pdf.
---------------------------------------------------------------------------
Retail investors can achieve low-cost diversification and
professional management by indirectly investing in the stock market
through passively--and actively--managed mutual funds and exchange-
traded funds (ETFs). Competition among funds has brought fees and
expenses down to their lowest levels in history. \3\ The widespread
availability of retirement savings accounts such as 401(k) plans and
individual retirement accounts (IRAs) also allows low-cost access to
the stock market.
---------------------------------------------------------------------------
\3\ See, e.g., ``2020 Investment Company Fact Book: A Review of
Trends and Activities in the Investment Company Industry'', available
at https://www.ici.org/research/stats/factbook.
---------------------------------------------------------------------------
Retail investors have taken advantage of these beneficial trends
over the past few decades. The percentage of U.S. households that own
stocks--directly or indirectly through funds and retirement savings
accounts--increased from 32 percent in 1989 to 53 percent in 2019. \4\
Low-income households still lag high-income households in stock
ownership rates, but low-income households saw the biggest gains over
this period. \5\ \6\
---------------------------------------------------------------------------
\4\ See ``Federal Reserve Board 2019 Survey of Consumer Finances''
(Nov. 17, 2020), available at https://www.federalreserve.gov/econres/
scfindex.htm.
\5\ See ``Main Street Owns Wall Street, ICI Viewpoints'', Sarah
Holden and Michael Bogdan (Feb. 10, 2021), available at https://
www.ici.org/viewpoints/21-view-equityownership.
\6\ The Milken Institute Center for Financial Markets is actively
engaged in research, programs, and events to provide for more equitable
access to capital for job-creating businesses and more equitable access
to investments by retail investors.
---------------------------------------------------------------------------
However, the SEC could make regulatory changes to improve the
retail investing landscape. The January trading frenzy and the related
difficulties faced by some brokerage customers highlighted a few areas
that require the SEC and this Committee's immediate attention.
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. \7\ The Commission also said that they are
investigating whether abusive or manipulative trading activity
prohibited by the Federal securities laws occurred during this episode.
\8\
---------------------------------------------------------------------------
\7\ Statement of Acting Chair Lee and Commissioners Peirce,
Roisman, and Crenshaw Regarding Recent Market Volatility (Jan. 29,
2021), available at https://www.sec.gov/news/public-statement/joint-
statement-market-volatility-2021-01-29.
\8\ Id.
---------------------------------------------------------------------------
I have complete confidence that the Commission and its staff will
identify and pursue any evidence of noncompliance or wrongdoing.
Accordingly, I focus my testimony on the market structure and market
infrastructure \9\ issues that have been raised in the aftermath of the
January trading. Before addressing specific issues, I summarize some
guiding principles that I find useful in thinking through them.
---------------------------------------------------------------------------
\9\ The term ``market structure'' (or ``market microstructure'')
generally refers to the operation and regulation of financial markets.
The term ``market infrastructure'' (or ``market plumbing'') generally
refers to the network of systems that facilitate financial market
transactions, such as payment systems, clearance, and settlement.
---------------------------------------------------------------------------
Guiding Principles for Market Structure and Market Infrastructure
Policy
There Are No Solutions; There Are Only Trade-offs \10\
---------------------------------------------------------------------------
\10\ This phrase is often attributed to Thomas Sowell.
---------------------------------------------------------------------------
The regulatory framework of the U.S. equity markets is complicated;
it reflects a complex system of legal and regulatory decisions that
have been made over decades. The markets have evolved within this
framework into a highly interconnected system.
As a result, any change to market structure policy in one area will
likely affect other areas. For example, if payment for order flow were
restricted or banned, zero-commission trades would likely disappear.
This is one tradeoff that the Commission will have to weigh when
deciding whether and, if so, how to make any changes in existing
regulation of payment for order flow arrangements. Changes to existing
market structure and market infrastructure policy always involve
tradeoffs.
Economic Analysis Is a Particularly Useful Tool
The lens of economic analysis is well-suited for evaluating
tradeoffs. While serving as an SEC commissioner, I found my economics
training was a valuable tool on virtually every regulatory and
enforcement decision I had to make.
In 2012, the Commission recognized the importance of going beyond
statutory obligations mere quantitative exercises to incorporate
comprehensive economic analysis in the rulemaking process by adopting
``Current Guidance on Economic Analysis in SEC Rulemaking'' (Current
Guidance). \11\ The Guidance was adopted under SEC Chairman Mary
Schapiro. It has been followed on a bipartisan basis by Chair Mary Jo
White, myself as Acting Chairman, and Chairman Jay Clayton. \12\ I was
glad to see that SEC-nominee Gary Gensler committed to following the
Current Guidance in response to a question during last week's
nomination hearing.
---------------------------------------------------------------------------
\11\ ``Current Guidance on Economic Analysis in SEC Rulemaking'',
(Mar. 16, 2012), available at http://www.sec.gov/divisions/riskfin/
rsfi-guidance-econ-analy-secrulemaking.pdf.
\12\ The Commission has not proposed or adopted any new rules
under current Acting Chair Allison Herren Lee.
---------------------------------------------------------------------------
The SEC's Current Guidance requires the Commission to evaluate a
rule's likely economic consequences, including potential negative
unintended consequences. It requires the Commission to compare a
proposed regulatory action with reasonable alternatives, including the
alternative of not adopting a rule.
Because U.S. equity markets and their regulatory framework are so
complex, the SEC's Current Guidance is a particularly useful tool when
evaluating any potential changes to market structure and market
infrastructure policy.
Frequent Retrospective Reviews of Existing Rules Are Necessary
The only constant in financial markets is change. Markets and
technologies are continually evolving. If we want our capital markets
to remain the envy of the world, our regulatory framework needs to
evolve with them.
Throughout my tenure as an SEC commissioner, I was an outspoken
advocate of retrospective reviews of Commission rules. \13\ I believe
it is a fundamental best practice of good government to observe how the
Commission's regulations work in the real world. Armed with this
information, the Commission can propose thoughtful improvements to its
rules to advance the Commission's essential work to protect investors,
maintain fair, orderly, and efficient markets, and promote capital
formation.
---------------------------------------------------------------------------
\13\ See, e.g., ``Advancing and Defending the SEC's Core
Mission'', Speech by Commissioner Michael S. Piwowar at the U.S.
Chamber of Commerce (Jan. 27, 2014), available at https://www.sec.gov/
news/speech/2014-spch012714msp; Remarks to the Securities Enforcement
Forum 2014, Speech by Commissioner Michael S. Piwowar (Oct. 14, 2014),
available at https://www.sec.gov/News/Speech/Detail/Speech/
1370543156675; Statement Regarding Publication of List of Rules to be
Reviewed Pursuant to the Regulatory Flexibility Act, Public Statement
by Commissioner Michael S. Piwowar (Sept. 15, 2016), available at
https://www.sec.gov/news/statement/piwowar-statement-list-of-rules-
regulatory-flexibility-act.html; Remarks at FINRA and Columbia
University Market Structure Conference, Speech by Commissioner Michael
S. Piwowar (Oct. 26, 2017), available at https://www.sec.gov/news/
speech/speech-piwowar-2017-10-26; and Statement of Commissioner Piwowar
at Open Meeting Regarding Amendments to the Commission's Whistleblower
Program Rules, Commissioner Michael S. Piwowar (June 28, 2018),
available at https://www.sec.gov/news/public-statement/statement-
piwowar-whistleblower-062818.
---------------------------------------------------------------------------
I am not alone in this view. For example, the Regulatory
Flexibility Act of 1980 requires agencies such as the Commission to
perform a periodic review of rules that have or will have a significant
economic impact upon a substantial number of small entities within ten
years of the publication of such rules as final rules ``to determine
whether such rules should be continued without change, or should be
amended or rescinded.'' \14\ The Regulatory Flexibility Act identifies
the following factors for analysis: (1) the continued need for the
rule; (2) the nature of complaints or comments received concerning the
rule from the public; (3) the complexity of the rule; (4) the extent to
which the rule overlaps, duplicates, or conflicts with other Federal
rules, and, to the extent feasible, with State and local governmental
rules; and (5) the length of time since therule has been evaluated or
the degree to which technology, economic conditions, or other factors
have changed in the area affected by the rule. \15\
---------------------------------------------------------------------------
\14\ 5 U.S.C. 610.
\15\ 5 U.S.C. 610(b).
---------------------------------------------------------------------------
In 2011, President Obama signed an Executive Order to enhance the
Regulatory Flexibility Act's goals by directing independent agencies
such as the SEC to develop and implement a plan to conduct ongoing
retrospective analyses of existing rules. \16\ The stated goal is ``to
determine whether any such regulations should be modified, streamlined,
expanded, or repealed so as to make the agency's regulatory program
more effective or less burdensome in achieving the regulatory
objectives.'' \17\
---------------------------------------------------------------------------
\16\ See Executive Order 13579--Regulation and Independent
Regulatory Agencies (July 11, 2011), available at https://
obamawhitehouse.archives.gov/the-press-office/2011/07/11/executive-
order-13579-regulation-and-independent-regulatory-agencies. See also M-
11-28--Memorandum for the Heads of Independent Regulatory Agencies
(July 22, 2011), available at https://obamawhitehouse.archives.gov/
sites/default/files/omb/memoranda/2011/m11-28.pdf.
\17\ Id.
---------------------------------------------------------------------------
Because markets and technologies are continually evolving, frequent
retrospective reviews of market structure and market infrastructure
rules by the Commission are necessary to ensure that they are not
outdated, obsolete, or overly burdensome.
Specific Issues
The Trade Settlement Cycle
When a retail (or institutional) customer buys or sells a security
through a broker, the broker routes the order to a trading venue for
execution and then submits the resulting trade to the Depository Trust
and Clearing Corporation (DTCC) for clearance and settlement. In the
United States, most securities transactions take two days (T+2) to
settle. To mitigate the market, liquidity, counterparty, and systemic
risks associated with the delay in settlement, DTCC requires brokers to
post margin using their own funds.
On January 28, 2021, Robinhood received a notice from DTCC that
Robinhood owed a net deposit of approximately $3 billion. \18\ After
discussions with Robinhood staff in which Robinhood notified DTCC that
it would impose trading restrictions in GameStop and other securities,
DTCC reduced the net deposit to approximately $1.4 billion. \19\ To put
that number in context, it represented nearly ten times the amount
required just three days earlier. \20\
---------------------------------------------------------------------------
\18\ See Testimony of Vladimir Tenev Robinhood Markets, Inc.,
``Game Stopped? Who Wins and Loses When Short Sellers, Social Media,
and Retail Investors Collide'', Hearing before the U.S. House Financial
Services Committee (Feb. 18, 2021), available at https://
financialservices.house.gov/calendar/eventsingle.aspx?EventID=407107.
\19\ Id.
\20\ Id.
---------------------------------------------------------------------------
This incident has caused many investors to ask important questions.
Why does the transfer of ownership for most securities transactions in
the U.S. occur two business days after the trade date? Why haven't we
already moved to T+1 or T+0? I believe I am in a unique position to
answer those questions. That is why I published an op-ed in The Wall
Street Journal last month. \21\
---------------------------------------------------------------------------
\21\ See ``It's T-0 to Go Faster Than T+2'', The Wall Street
Journal, Opinion/Commentary, Michael S. Piwowar (Online Version--Feb.
24, 2021, Print Version--Feb. 25, 2021), available at https://
www.wsj.com/articles/its-t-0-to-go-faster-than-t-2-11614207705.
---------------------------------------------------------------------------
As Acting Chairman of the SEC, I led the effort in 2017 to move
officially from T+3 to T+2. \22\ At that time, T+2 was the best option
based on economic analysis. The financial system was not yet prepared
in 2017 to move to T+1, but it was ready to take a good first step
toward greater efficiency and timeliness.
---------------------------------------------------------------------------
\22\ See ``SEC Adopts T+2 Settlement Cycle for Securities
Transactions'', Press Release (Mar. 22, 2017), available at https://
www.sec.gov/news/press-release/2017-68-0. See also ``Statement at Open
Meeting Regarding Amendment to Shorten the Trade Settlement Cycle'',
Public Statement, Acting Chairman Michael S. Piwowar (Mar. 22, 2017),
available at https://www.sec.gov/news/public-statement/piwowar-open-
meeting-032217.
---------------------------------------------------------------------------
The change to T+2 was a success. Retail investors benefitted from
quicker access to cash and securities when their trades were executed.
The change reduced the dangers from market, liquidity, counterparty,
and systemic risks across the financial system.
Recognizing that eventually moving to T+1 could have similar
benefits, the Commission directed the staff in the final rule to
undertake to submit a report to the Commission by September 2020. \23\
The specific language in the final rule stated:
---------------------------------------------------------------------------
\23\ See ``Securities Transaction Settlement Cycle'', Final Rule,
SEC Release No. 34-80295 (Mar. 22, 2017), 82 FR 15564 Mar. 29, 2017),
available at https://www.sec.gov/rules/final/2017/34-80295.pdf.
---------------------------------------------------------------------------
``This report will include, but not be limited to an examination
of:
(i) the impact of today's amendment to Rule 15c6-1(a) to
establish a T+2 standard settlement cycle on market participants,
including investors;
(ii) the potential impacts associated with movement to a
shorter settlement cycle beyond T+2;
(iii) the identification of technological and operational
improvements that can be used to facilitate a movement to a shorter
settlement cycle; and
(iv) cross-market impacts (including international
developments) related to the shortening of the settlement cycle to
T+2.'' \24\
---------------------------------------------------------------------------
\24\ Id.
---------------------------------------------------------------------------
Recommendations for the Trade Settlement Cycle
As I recommend in my op-ed, the SEC should release the staff report
and open a comment file on its website for public feedback. The SEC
should hold a public forum to discuss lessons learned from the recent
events so that we all have the benefit of the most up-to-date
information.
But, the SEC cannot move beyond T+2 on its own. Bank regulators
will need to be involved because shortening the length of time between
when a trade is executed and when securities and cash are delivered to
the buyer and seller, respectively, will require improvements in the
speed of bank payment systems. \25\ \26\
---------------------------------------------------------------------------
\25\ See, e.g., ``We Shouldn't Have To Wait for FedNow To Have
Faster Payments'', American Banker--BankThink, George Selgin and Aaron
Klein (Feb. 28, 2020), available at https://www.americanbanker.com/
opinion/we-shouldnt-have-to-wait-for-fednow-to-have-faster-payments.
\26\ In addition, regulators will need to carefully coordinate the
foreign exchange (FX) settlement cycle for market participants who rely
on FX settlements to fund cross-border securities transactions.
---------------------------------------------------------------------------
Accordingly, the Treasury Secretary should convene a principals
meeting of the Financial Stability Oversight Council, the Federal
financial regulators' coordinating body, and initiate a securities
settlement workstream. The purpose of the workstream is to coordinate
regulatory efforts related to whether and how to shorten the settlement
cycle.
Payment for Order Flow
The SEC allows brokers to have a choice of which trading venue to
direct their customers' orders. The broker may direct the order to the
exchange where the stock is listed, a different exchange or alternative
trading system, or a market maker.
The SEC also allows brokers to enter into payment for order flow
arrangements. Market makers may pay brokers for routing orders to them
so long as they fulfill their best execution obligations. A broker must
consider multiple factors when seeking best execution of customers'
orders, including the opportunity to get a better price than what is
currently quoted (price improvement), the speed of execution, and the
likelihood that the trade will be executed. \27\
---------------------------------------------------------------------------
\27\ See ``Fast Answers--Best Execution'', (May 9, 2011),
available at https://www.sec.gov/fast-answers/answersbestexhtm.html.
---------------------------------------------------------------------------
Payment for order flow arrangements could represent a conflict of
interest between their broker and their customer. Brokers may choose to
route customer orders to the market maker that offers the highest
payment to the broker rather than to the trading venue that offers the
best execution for the customer. However, the SEC's best execution
requirements mitigate this conflict of interest. The SEC and FINRA
regularly conduct examinations of broker-dealers for compliance with
best execution obligations and bring enforcement actions when they find
violations. \28\
---------------------------------------------------------------------------
\28\ See, e.g., ``FINRA Fines Robinhood Financial, LLC $1.25
Million for Best Execution Violations'', News Release (December 19,
2019), available at https://www.finra.org/media-center/newsreleases/
2019/finra-fines-robinhood-financial-llc-125-million-best-execution,
and ``SEC Charges Robinhood Financial With Misleading Customers About
Revenue Sources and Failing to Satisfy Duty of Best Execution'', Press
Release (Dec. 17, 2020), available at https://www.sec.gov/news/press-
release/2020-321.
---------------------------------------------------------------------------
Were Robinhood customers who traded GameStop stock in January 2021
advantaged or disadvantaged by Robinhood's payment for order flow
arrangements?
Currently available public information does not allow for a direct
analysis of the execution quality that specific Robinhood customers
received on their GameStop orders in January 2021. However, analysis of
two SEC-required disclosures can shed some light on the issue of
whether retail investors, on average, across all brokers, received
price improvement on their GameStop orders in January 2021.
SEC Rule 606 under Regulation NMS requires broker-dealers to
provide quarterly disclosures of information regarding the handling of
their customers' orders. \29\ Using Robinhood's Rule 606 report for the
fourth quarter of 2020, I determined that the three venues where
Robinhood routed most of its orders were Citadel Execution Services, G1
Execution Services, and Two Sigma Securities. Robinhood discloses on
its Rule 606 report that it receives payment from these venues to
direct equity order flow.
---------------------------------------------------------------------------
\29\ Securities Exchange Act Release No. 51808 (June 9, 2005), 70
FR 37496 (June 29, 2005).
---------------------------------------------------------------------------
SEC Rule 605 under Regulation NMS requires market centers that
trade NMS stocks to make available to the public monthly electronic
execution reports that include uniform execution quality measures. \30\
Market centers report these measures separately for each stock, but
those measures are aggregated across all broker-dealers who route to
them. Using the Rule 605 reports for January 2021 of each of the three
venues above, I calculated their execution quality statistics for their
order executions of GameStop stock. See Table 1 below.
---------------------------------------------------------------------------
\30\ Id.
I calculated the total dollar amount of orders in GameStop stock
executed inside the quote and outside the quote for each venue. For all
three venues, the dollar amount of orders executed inside the quote
(receiving price improvement) exceeded the dollar amount of orders
executed outside the quote (receiving price disimprovement), resulting
in net price improvement, in aggregate, for GameStop stock orders
routed to them in January 2021. The average price improvement ranged
from $0.03 to $0.06 per share.
Recommendations for Payment for Order Flow
The SEC Division of Examinations should expand its ongoing
initiative in the area of payment for order flow. \31\ The Division
should focus its efforts on order routing and best execution
obligations in a zero-commission environment.
---------------------------------------------------------------------------
\31\ U.S. Securities and Exchange Commission 2021 National
Examination Priorities, Division of Examinations, available at https://
www.sec.gov/files/2021-exam-priorities.pdf.
---------------------------------------------------------------------------
The Commission should hold a roundtable to discuss payment for
order flow. The event would provide a public forum for in-depth
discussions of how payment for order flow is working in a zero-
commission environment.
The Commission should consider amending Rule 605 and Rule 606 of
Regulation NMS to provide better public transparency of execution
quality measures. For example, the Commission should consider requiring
each broker to report execution quality measures for every stock they
route to every market center quarterly (or monthly).
Short-Selling and Securities Lending
Some have attributed at least part of the large influx of buy
orders that pushed up the stock price to a short squeeze, causing
short-sellers to buy additional shares to cover their short positions.
The episode has created a lot of interest in the effects that short-
sellers have on the market.
It is important to remember that abusive short-selling--sales to
manipulate a stock price--is already illegal. The SEC has promulgated
rules to prohibit abusive short-selling practices and regularly
enforces those rules. \32\ As a result, the vast majority of short
sales that occur in the United States are legal. \33\
---------------------------------------------------------------------------
\32\ See ``Short Sales (Regulation SHO)'', Final Rule, SEC Release
No. 34-50103 (Jul 28, 2004), 69 FR 48008 (Aug. 6, 2004), available at
https://www.sec.gov/rules/final/34-50103.htm.
\33\ See, e.g., ``Key Points About Regulation SHO'', SEC Office of
Investor Education and Advocacy publication (Apr. 8, 2015), available
at https://www.sec.gov/investor/pubs/regsho.htm.
---------------------------------------------------------------------------
Academic research shows that short-selling generally has a positive
effect on market quality. According to a recent study, ``most empirical
papers report that during periods of regular trading activity, short-
selling has a positive influence on liquidity, price discovery and
price efficiency, thus supporting the idea that short-selling is
crucial to maintain the orderly functioning of markets.'' \34\ \35\
Also, ``the existing evidence short-selling cannot be blamed for having
triggered downward price reversal during the 2008 financial crisis.''
\36\ Short-sellers also protect other investors by detecting and
publicizing fraud. \37\
---------------------------------------------------------------------------
\34\ Stefano Alderighi and Pedro Gurrola Perez, ``What Does
Academic Research Say about Short-Selling Bans?'' WFE Research Working
Paper (Apr. 29, 2020), available at https://ssrn.com/abstract=3775704.
\35\ The same study shows that academic research finds that short-
selling bans disrupt the orderly functioning of markets. Their negative
effects include reducing liquidity, increasing price inefficiency, and
hampering price discovery.
\36\ Id.
\37\ See, e.g., Testimony of Owen A. Lamont, ``Hedge Funds and
Independent Analysts: How Independent Are Their Relationships?''
Hearing before the U.S. Senate Committee on the Judiciary (Jun. 28,
2006), available at https://www.govinfo.gov/content/pkg/CHRG-
109shrg31059/html/CHRG-109shrg31059.htm. Regulation SHO provides
limited exceptions for market makers when fulfilling their market maker
obligations.
---------------------------------------------------------------------------
Regulation SHO requires a broker-dealer to have reasonable grounds
to believe that the security can be borrowed so that it can be
delivered on the date delivery is due before effecting a short sale
order in any equity security. \38\ However, it has been widely reported
that approximately 140 percent of GameStop's stock had been sold short.
At least part of this disparity can be attributed to a lack of
transparency in securities lending.
---------------------------------------------------------------------------
\38\ See, e.g., ``Key Points About Regulation SHO'', SEC Office of
Investor Education and Advocacy publication (Apr. 8, 2015), available
at https://www.sec.gov/investor/pubs/regsho.htm.
---------------------------------------------------------------------------
Recall the massive U.S. Government bailout of the creditors of the
insurance giant American International Group, Inc. (AIG). AIG's failure
was mainly due to its credit default swaps portfolio and its securities
lending program, not its insurance business. AIG's credit default swap
and securities lending counterparties received much of the Government
bailout. \39\ Title VII of the Dodd-Frank Act \40\ established a
regulatory framework for swaps (and securities-based swaps), and the
SEC and CFTC have promulgated regulations under the statute. Section
984 of Dodd-Frank required the SEC to ``promulgate rules that are
designed to increase the transparency of information available to
brokers, dealers, and investors, with respect to the loan or borrowing
of securities.'' \41\
---------------------------------------------------------------------------
\39\ See, e.g., Congressional Oversight Panel, June Oversight
Report, ``The AIG Rescue and Its Impact on Markets, and the Government
Exit Strategy'' (June 10, 2010); Louise Story and Gretchen Morgenson,
In ``U.S. Bailout of AIG, Forgiveness for Big Banks'', New York Times
(June 29, 2010); William Greider, ``The AIG Bailout Scandal'', The
Nation (Aug. 6, 2010); Scott E. Harrington, ``The Financial Crisis,
Systemic Risk, and the Future of Insurance Regulation'' (Sept. 2009).
\40\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Pub. L. No. 111-203 (2010).
\41\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
984(b), Pub. L. No. 111-203 (2010).
---------------------------------------------------------------------------
To date, the SEC has finalized only one rule that could be
characterized as being responsive to Dodd-Frank Section 984. To
increase the comparability of securities lending fees between open-end
funds, the Commission adopted amendments to fund registration
statements. The amendments required disclosures relating to fund
securities lending activities, including income and fees from
securities lending and the fees paid to securities lending agents in
the prior fiscal year. \42\ These amendments were a good start, but the
SEC should further improve the transparency of securities lending.
---------------------------------------------------------------------------
\42\ See, ``SEC Adopts Rules To Modernize Information Reported by
Funds, Require Liquidity Risk Management Programs, and Permit Swing
Pricing'', Press Release (Oct. 13, 2016), available at https://
www.sec.gov/news/pressrelease/2016-215.html.
---------------------------------------------------------------------------
Recommendations for Short-Selling and Securities Lending
The SEC should hold a public forum and open a request for comment
on the transparency of securities lending. In evaluating various
transparency alternatives, the SEC should distinguish between
``regulatory reporting'' and ``public transparency.'' Regulatory
reporting refers to the information available to the SEC to perform its
regulatory functions. Public transparency refers to the information
that the SEC makes available to market participants, investors, and
academic researchers.
Then, the SEC should use economic analysis to determine whether
and, if so, how to increase regulatory reporting in securities lending.
The SEC should conduct a separate economic analysis to determine how
much, if any, new information should be provided to the public.
Accredited Investor Definition
As mentioned above, low-income households have lower rates of
ownership of public companies than high-income households. In 2019, 15
percent of households in the lowest income quintile held stocks in
public companies--directly or indirectly through funds and retirement
savings accounts--compared to 88 percent of households in the highest
income quintile. \43\ While I am not aware of any statistics on
ownership rates by household income level for private companies, the
gap is undoubtedly worse. SEC rules effectively prohibit low-income
investors from investing in this high-growth sector of the economy.
---------------------------------------------------------------------------
\43\ See ``Main Street Owns Wall Street'', ICI Viewpoints, Sarah
Holden and Michael Bogdan (Feb. 10, 2021), available at https://
www.ici.org/viewpoints/21-view-equityownership.
---------------------------------------------------------------------------
The SEC's accredited investor definition essentially divides the
world of private company investors into two arbitrary categories of
individuals--those persons who are accorded the privileged status of
being an accredited investor and those who are not. \44\ In short, if
you make $200,000 or more in annual income or have $1 million or more
in net worth, then you are in the privileged class and could choose to
invest in the full panoply of investments, whether public or private.
\45\ If not, the SEC has decided that, for your protection, you are
restricted access to invest in private companies.
---------------------------------------------------------------------------
\44\ See, e.g., Remarks at the Meeting of the SEC Advisory
Committee on Small and Emerging Companies, Public Statement by
Commissioner Michael S. Piwowar (May 18, 2016), available at https://
www.sec.gov/news/statement/piwowar-opening-remarks-acsec-
051816html.html; Remarks at the ``SEC Speaks'' Conference 2017:
``Remembering the Forgotten Investor'', Speech by Acting Chairman
Michael S. Piwowar (Feb. 24, 2017), available at https://www.sec.gov/
news/speech/piwowar-remembering-the-forgotten-investor.html.
\45\ The SEC recently expanded the definition of accredited
investor to include, among other things, individuals ``holding in good
standing one or more professional certifications or designations or
other credentials from an accredited educational institution that the
Commission has designated as qualifying an individual for accredited
investor status[.]'' See ``Accredited Investor Definition'', Final
Rule, SEC Release Nos. 33-10824; 34-89669 (Aug. 26, 2021), 85 FR 64234
(Oct. 9, 2020), available at https://www.sec.gov/rules/final/2020/33-
10824.pdf. However, the expanded definition is not likely to
substantially increase the number of low-income individuals who qualify
under the new definition.
---------------------------------------------------------------------------
As an SEC commissioner, I took my investor protection mandate
extremely seriously. However, I challenge the SEC's investor protection
rationale for prohibiting nonaccredited investors from investing in
high-risk companies. Here, I appeal to two well-known concepts from the
field of financial economics. The first is the risk-return tradeoff.
Because most investors are risk averse, riskier securities must offer
investors higher expected returns. As a result, prohibiting non-
accredited investors from investing in high-risk securities is the same
thing as prohibiting them from investing in high-expected-return
securities.
The second economic concept is modern portfolio theory. By holding
a diversified portfolio of securities, investors reap the benefits of
diversification; that is, the risk of the portfolio as a whole is lower
than the risk of any individual securities. The statistical correlation
of returns is key. When adding higher-risk, higher-return securities to
an existing portfolio, as long as the new securities' returns are not
perfectly positively correlated with (move in exactly the same
direction as) the existing portfolio, investors can reap higher
portfolio returns with little or no change in overall portfolio risk.
In fact, if the correlations are low enough, the overall portfolio risk
could actually decrease.
These two concepts show how even a well-intentioned investor
protection policy can ultimately harm the very investors the policy is
intended to protect. Moreover, restricting the number of accredited
investors in the privileged class can have additional adverse impacts.
The accredited investors may enjoy even higher returns because the
nonaccredited investors are prohibited from buying and bidding up the
price of high-risk, high-expected-return securities. Remarkably, by
allowing only high-income and high-net-worth individuals to reap the
risk and return benefits from investing in certain securities, the SEC
is actually exacerbating wealth inequality. \46\ \47\
---------------------------------------------------------------------------
\46\ See Thomas Piketty, ``Capital in the Twenty-First Century'',
translated by Arthur Goldhammer (Cambridge MA: The Belknap Press of
Harvard University Press, 2014).
\47\ Another unfortunate consequence of the accredited investor
definition is that small businesses face higher costs of capital.
---------------------------------------------------------------------------
Recommendation for the Accredited Investor Definition
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.
The Role of the Senate Banking Committee
Throughout my testimony, I have made several recommendations for
the SEC. This Committee, through its oversight role, has the
opportunity to influence the SEC's agenda toward improving the current
state of retail investing. If this Committee believes that the SEC's
market structure and market infrastructure rules should keep pace with
changes in markets and technologies, ``deep-dive'' hearings on specific
issues--both SEC oversight hearings and hearings with subject matter
expertise--would be helpful.
If this Committee believes legislation would be necessary to
improve a particular market structure or market infrastructure policy,
I urge caution in legislating prescriptive standards. For the reasons
stated above, the SEC is in the best position to promulgate rules based
on the current environment and update those rules as needed in response
to changes in the markets and technologies.
Thank you for bringing attention to these critical issues and for
the opportunity to testify here today. I am happy to answer any
questions you may have.
______
PREPARED STATEMENT OF ANDREW N. VOLLMER
Senior Affiliated Scholar, Mercatus Center at George Mason University
March 9, 2021
Chairman Brown, Ranking Member Toomey, and Members of the
Committee: I am pleased to have an opportunity to comment on several
timely and important issues related to the Federal securities laws. I
have extensive experience with those laws. I was Deputy General Counsel
of the Securities and Exchange Commission from mid-2006 to March 2009
and taught courses on securities regulation at the University of
Virginia School of Law from 2014 to 2019. For many years, I was a
partner in the securities enforcement practice of Wilmer Cutler
Pickering Hale and Dorr LLP and am currently a senior affiliated
scholar with the Mercatus Center at George Mason University.
My testimony will address (1) the recent trading activity in the
common stock of GameStop Corp. and a few other companies, (2)
securities trading platforms such as Robinhood Financial, and (3)
considerations for further action. My conclusion is that the
information currently available has not revealed a problem of
sufficient severity to justify Congress imposing new regulations in
these areas.
New information could change that, but, in any deliberations about
possible additional legal restrictions, Congress should give weight to
and respect the personal liberty interests involved.
Gamestop
The rapid increase and decrease in the price of the common stock of
GameStop and a few other companies has received a great deal of
attention. My information about the events during the past several
weeks is from publicly available sources, and my understanding is that
various investigations into the details are being conducted. My views
are based on the public information, but new information and details
from the investigations could affect my opinions. I am open to
persuasion from new facts.
Based on the information I have seen, misconduct probably did not
occur in the recent trading of GameStop. Some concerns about a pump-
and-dump scheme or a manipulation have been raised, but the public
information does not bear those fears out. In the standard type of
pump-and-dump scheme, one or more persons make material false or
misleading statements to the market to drive a stock price up or down.
The SEC is investigating, but my understanding is that the main group
of individuals trading GameStop, those using the Reddit WallStreetBets
social media forum, did not make material false or misleading
statements and were not deceived by others.
For securities manipulation, a person needs to create a false
impression of buying or selling activity. The Supreme Court has said
that manipulation is ``virtually a term of art when used in connection
with the securities markets.'' \1\ Manipulation ``refers generally to
practices, such as wash sales, matched orders, or rigged prices, that
are intended to mislead investors by artificially affecting market
activity.'' \2\ Some important legal authorities have taken broader
approaches, \3\ but the essence of a manipulation is buying or selling
activity that is not legitimate or genuine.
---------------------------------------------------------------------------
\1\ Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 (1976).
\2\ Sante Fe Indus., Inc. v. Green, 430 U.S. 462, 476-77 (1977);
see also Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 6 (1985).
\3\ See, e.g., Markowski v. SEC, 274 F.3d 525 (D.C. Cir. 2001).
---------------------------------------------------------------------------
The traders using the WallStreetBets site actually bought GameStop
and the other stocks. If a person bears market risk, that is, a non-
trivial risk that the buyer or seller will make or lose money on the
transaction, then the person did not engage in artificial trading even
if he or she had evil intent. In addition, when a person actually buys
stock, it is very hard to tell the difference between evil intent to
manipulate the stock price up and a person's desire for the stock price
to go up naturally.
The effects of the GameStop trading on the larger secondary market
for securities do not, at the moment, appear to be widespread or
severe. The trading activity in GameStop, AMC, and Blackberry was
limited to a few companies and was short term. Some investors made
money in GameStop and some lost money. Short sellers of GameStop might
have a legitimate complaint about the WallStreetBets buyers, and the
short sale rules in the securities laws could be reviewed, but those
rules were not the major cause of the price increases. The sharp rise
and fall in the price of GameStop did not have apparent effects on
broader market gauges. \4\ Even if an index fund or an exchange traded
fund owned GameStop, that holding was only one name in a diversified
portfolio, and the price of GameStop stock began to correct itself
within a short time with no significant damage to the pricing or
liquidity in the more general market for listed equities.
---------------------------------------------------------------------------
\4\ Anneken Tappe, U.S. stocks post their worst month since
October as the GameStop frenzy rages, CNN Business (Jan. 29, 2021)
(reporting that, in January 2021, the month of the GameStop increase,
the Dow and the broader S&P 500 had their worst month since October),
https://www.cnn.com/2021/01/29/investing/dow-gamestop-stock-market-
today/index.html. Data from Google Finance show that GameStop went up
1784 percent in January 2021 while the S&P 500 index went up 0.4
percent and the Russell 2000 index, which included GameStop at the
time, went up 6.6 percent.
---------------------------------------------------------------------------
I do not want to sound like I encourage the behavior of the
WallStreetBets traders. I do not. The actions of the GameStop buyers
were not consistent with the purpose of the Federal securities markets.
The purpose of the securities markets is to allow companies with good
ideas to raise capital and to let millions of investors buy and sell
existing shares based on their assessment whether companies have good
commercial ideas or not.
My understanding is that the WallStreetBets crowd was engaged in
group behavior that was in part to stymie some short sellers, in part
to identify with the other members of the group, and in part to have
some entertainment. Most were not buying and selling GameStop based on
an assessment of the likelihood of profit at the company (although some
were), but those buying without analysis of the fundamental value of
the retailer knew what they were doing, were not misled, and knew they
could lose money. As discussed below, the events surrounding GameStop
do not appear to require new securities restrictions or regulation.
Robinhood
The broker-dealer Robinhood has come under scrutiny because many of
the WallStreetBets traders use it and because it has certain features
that encourage buying and selling securities. Those features include
commission free trades, accounts with no minimum dollar amounts, the
availability of option trading and fractional shares of stock, and an
ability to buy and sell securities on an attractive, easy-touse
internet site. Some have called the Robinhood mobile app the
``gamification'' of securities trading.
The criticisms of Robinhood fail to give appropriate weight to the
benefits of its business model. The Robinhood brokerage service is
innovative and makes significant positive contributions to society and
the economy. It reduces costs for consumers, makes securities trading
simpler and easier, increases consumer choice, and lowers barriers to
participation in the market for the common stock of companies listed on
stock exchanges. It therefore opens the securities markets and equity
securities ownership to a much larger part of the population and to
people with less income and wealth than those who are typically
associated with participation in the equity markets.
Expanding access to the equity securities markets for many new
retail investors is especially notable. It is directly responsive to
the concern that direct ownership of corporate stocks by individuals
has declined since World War II. \5\ It is also directly responsive to
the desire to make exchange-listed securities more accessible to lower
income people and to give them more opportunities to increase wealth.
\6\
---------------------------------------------------------------------------
\5\ Kristian Rydqvist et al., Government policy and ownership of
equity securities, 111 J. Fin. Eco. 70, 71 (2014) (``Since World War
II, household direct equity ownership has declined precipitously. In
the United States, just after the war, households directly own 90
percent of the stock market; by 2010, this figure has come down to
below 30 percent.'').
\6\ The United States has made progress increasing household
ownership of securities when both direct ownership and indirect
ownership are considered. Indirect ownership means ownership of
corporate equities through mutual funds or retirement plans. The
percent of U.S. households owning stock directly and indirectly grew
from approximately 32 percent in 1989 to 53 percent in 2019. When
indirect ownership is taken into account, all income groups from the
lowest to the highest quintile of family income increased stock
ownership. This information is from a report of the Investment Company
Institute that summarized the Federal Reserve Board's 2019 Survey of
Consumer Finances. See Sarah Holden & Michael Bogdan, ``Main Street
Owns Wall Street, ICI Viewpoints'' (Feb. 10, 2021), https://
www.ici.org/pdf/21-view-equityownership-print.pdf.
---------------------------------------------------------------------------
Robinhood therefore increases consumer welfare and achieves
important objectives of the U.S. economic and financial system. All of
this is commendable and should not be faulted.
Another question about Robinhood was the decision to restrict the
ability of its customers to buy GameStop and other securities for a
short period of time. In his testimony before the House Financial
Services Committee on February 18, 2021, the head of Robinhood
explained the circumstances leading to the restrictions. Robinhood
received an unexpected call for a large amount of collateral from a
financial institution that is the clearinghouse for the trades of
Robinhood customers. The restriction on the purchases of GameStop was
part of the response because Robinhood was not able immediately to
provide the requested collateral. Robinhood explained that it did not
restrict customers because of a desire to help short sellers or its
main wholesale broker.
Considerations for Further Action
The events surrounding the changes in prices for GameStop and the
questions about the Robinhood trading platform have so far not revealed
the kind of problem that would justify new legal restrictions or
regulations. New regulation would be appropriate if data and evidence
emerge to show a severe, sustained, recurring harm to investors that a
law could prevent or reduce. We have not seen such a harm yet, but the
more detailed investigations being undertaken could produce evidence of
misconduct or reasons to reconsider the need for new regulation.
Congress and the SEC should not impose new regulations lightly. An
important consideration should be that government rules typically
restrict personal freedom. The GameStop traders might not have been
analyzing the fundamental financial position of GameStop within the
traditions of the capital markets, but they were exercising their
individual civil liberty. A founding principle and continuing
aspiration of the country has been to preserve personal freedom, extend
it when it has been denied, and use government regulation only when a
serious and widespread harm is recurring. If regulation is justified,
it should be narrow and go no further than necessary to correct the
harm.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SINEMA
FROM MICHAEL S. PIWOWAR
Q.1. Federal regulations tend to privilege institutional
investors because of the presumption that they are more
sophisticated. Given recent events, does it still make sense to
treat institutional investors and retail investors differently
when it comes to accessing certain types of offerings?
Should we be assuming that institutional investors always
make better investments than retail investors?
A.1. As I mentioned in my written testimony, U.S. Securities
and Exchange Commission (SEC) rules effectively prohibit low-
income, low-net-worth investors from investing in high-growth
companies.
The SEC's accredited investor definition essentially
divides the world of private company investors into two
arbitrary categories of individuals--those persons who are
accorded the privileged status of being an accredited investor
and those who are not. In short, if you make $200,000 or more
in annual income or have $1 million or more in net worth, then
you are in the privileged class and could choose to invest in
the full panoply of investments, whether public or private. If
not, the SEC has decided that, for your protection, you are
restricted access to invest in private companies.
As an SEC commissioner, I took my investor protection
mandate extremely seriously. However, I challenge the SEC's
investor protection rationale for prohibiting nonaccredited
investors from investing in high-risk companies. Here, I appeal
to two well-known concepts from the field of financial
economics. The first is the risk-return tradeoff. Because most
investors are risk averse, riskier securities must offer
investors higher expected returns. As a result, prohibiting
non-accredited investors from investing in high-risk securities
is the same thing as prohibiting them from investing in high-
expected-return securities.
The second economic concept is modern portfolio theory. By
holding a diversified portfolio of securities, investors reap
the benefits of diversification; that is, the risk of the
portfolio as a whole is lower than the risk of any individual
securities. The statistical correlation of returns is key. When
adding higher-risk, higher-return securities to an existing
portfolio, as long as the new securities' returns are not
perfectly positively correlated with (move in exactly the same
direction as) the existing portfolio, investors can reap higher
portfolio returns with little or no change in overall portfolio
risk. In fact, if the correlations are low enough, the overall
portfolio risk could actually decrease.
These two concepts show how even a well-intentioned
investor protection policy can ultimately harm the very
investors the policy is intended to protect. Moreover,
restricting the number of accredited investors in the
privileged class can have additional adverse impacts. The
accredited investors may enjoy even higher returns because the
non-accredited investors are prohibited from buying and bidding
up the price of high-risk, high-expected-return securities.
Remarkably, by allowing only high-income and high-net-worth
individuals to reap the risk and return benefits from investing
in certain securities, the SEC is actually exacerbating wealth
inequality.
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.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM MICHAEL S. PIWOWAR
Q.1. A Financial Transaction Tax (FIT) would impact all
Americans regardless of income through their retirement funds,
529 college savings plans and ABLE plans for disabled
dependents. With the investments of such a large portion of
Americans across the income spectrum impacted, the effect of an
FTT would ultimately make markets less efficient by reducing
market volumes and decreasing the level of liquidity in the
system. What kinds of regulatory measures and systemic
safeguards must be in place to counteract the negative impacts
of an FTT?
A.1. Imposing a financial transaction tax (FTT) in the United
Sates would result in many negative effects, including
unnecessarily hurting the global competitiveness of U.S.
capital markets.
In 2009, when I was a senior economist at the President's
Council of Economic Advisers, I was asked to conduct research
and prepare a memo for President Obama's top economic policy
advisors on the potential effects of a financial transaction
tax. My research showed that, without exception, every time an
FTT was introduced in another jurisdiction, it resulted in
disastrous consequences. My research yielded three key points:
1. FTTs hurt market quality. Several empirical studies
showed that the imposition of FTTs results in higher
volatility, lower liquidity, and lower trading volume. \1\ As a
result, FTTs have negative effects on price discovery and lead
to a reduction in the information efficiency of markets. \2\
---------------------------------------------------------------------------
\1\ See, e.g., ``Securities Transaction Taxes and Financial
Markets'', Karl Habermeier and Andrei Kirilenko, IMF Working Paper 01-
51 (2001) available at http://www.imf.org/external/pubs/ft/wp/2001/
wp0151.pdf; and ``Transaction Taxes and the Behavior of the Swedish
Stock Market', Steven R. Umlauf, Journal of Financial Economics, Vol
33, No. 2 (1993).
\2\ Id.
---------------------------------------------------------------------------
2. Jurisdictions that do not impose an FTT win at the
expense of jurisdictions that do. For example, when the Sweden
imposed an FTT in the 1980s, a significant amount of trading
volume simply move to the London stock market. \3\ Keep in mind
that this occurred 40 years ago when it was much more difficult
and costly to divert trading activity across borders. A similar
tax today would result in immediate and devastating results.
---------------------------------------------------------------------------
\3\ See, e.g., Umlauf (1993).
---------------------------------------------------------------------------
3. FTTs never raise the expected revenue. Because trading
volume declines (and moves to other jurisdictions) when FTTs
are imposed, actual FTT revenues never come close to the
projections made by proponents. As a result, the main
``benefit'' of an FTT is never worth the costs.
I was gratified to receive very positive feedback on my
research and memo. More importantly--and quite correctly--the
Obama administration never pursued a policy of trying to impose
an FTT in the United States.
More recently, I have become aware of additional research
that shows FTTs have harmful effects beyond direct capital
markets effects. An FTT imposed in the United States would harm
everyday Americans in a number of ways:
1. An FTT would harm everyday Americans saving and
investing for retirement. Main Street investors would pay the
tax directly when they trade, and pay it again as financial
intermediaries pass on the taxes they face as a cost of doing
business. \4\ According to one study, under the version of the
tax proposed by Senator Bernie Sanders (D-VT), a typical
retirement investor will end up with 8.5 percent less in his or
her 401(k) or IRA after a lifetime of savings. \5\ In dollar
terms, the average IRA investor would have $20,000 less at
retirement as a result of this tax. \6\ FTTs paid by pension
funds would reduce their returns and worsen existing problems
with underfunded pensions. \7\
---------------------------------------------------------------------------
\4\ See, e.g., ``Financial Transaction Taxes: A Tax on Investors,
Taxpayers, and Consumers'', James J. Angel, Center for Capital Markets
Competitiveness (2019), available at https://
www.centerforcapitalmarkets.com/resource/financial-transaction-taxes-a-
tax-on-investors-taxpayers-and-consumers/.
\5\ Id.
\6\ Id.
\7\ See, e.g., Angel (2019); and ``The Hidden Costs of a Financial
Transaction Tax: Estimated Impact on Pension Funds'', Kirsten Wegner,
Modern Markets Initiative (2018), available at https://
www.modernmarketsinitiative.org/ftt.
---------------------------------------------------------------------------
2. An FTT would harm the owners, workers, and customers of
businesses. FTTs increase the cost of capital for any company
whose securities are subject to the FTT. As a result, owners of
those companies--including Main Street investors who hold those
securities directly or indirectly in mutual funds and exchange-
traded funds (ETFs)--would be harmed through lower returns to
capital. \8\ Workers would be harmed through lower returns to
labor. \9\ Customers would be harmed through an increase in the
cost of consumer goods. \10\
---------------------------------------------------------------------------
\8\ See, e.g., ``The Impact of a Financial Transactions Tax'',
Colin Miller and Anna Tyger, Tax Foundation Fiscal Fact No. 690 (2020),
available at https://files.taxfoundation.org/20200122152248/The-Impact-
of-a-Financial-Transactions-Tax.pdf; and Angel (2019).
\9\ Id.
\10\ Id.
---------------------------------------------------------------------------
3. An FTT would harm all American taxpayers. In addition to
the increased costs of consumer goods, everyday Americans would
be harmed by other indirect effects of FTTs. The level and
growth of GDP would be reduced under an FTT, resulting in a
lower standard of living. \11\ Moreover, indirect tax effects
would pernicious and counterproductive. Lower income and
payroll taxes would result from the increased cost of capital
to businesses, and the incentive to hold off on the sale of
financial assets to avoid capital gains taxation would
exacerbate the lock-in effect of these taxes. \12\
---------------------------------------------------------------------------
\11\ Id.
\12\ Id.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HAGERTY
FROM MICHAEL S. PIWOWAR
Q.1. The recent volatility in certain stocks has increased talk
about imposing a financial transaction tax as a downpayment on
the Democrats' pmtisan $1.9 trillion dollar, decade-long
spending spree. This would likely raise trading costs, weaken
market liquidity, harm pensions, and limit everyday Americans'
access to investing.
What are some of the adverse effects of imposing a
financial transaction tax, including on the global
competitiveness of U.S. capital markets?
A.1. Imposing a financial transaction tax (FTT) in the United
Sates would result in many negative effects, including
unnecessarily hurting the global competitiveness of U.S.
capital markets.
In 2009, when I was a senior economist at the President's
Council of Economic Advisers, I was asked to conduct research
and prepare a memo for President Obama's top economic policy
advisors on the potential effects of a financial transaction
tax. My research showed that, without exception, every time an
FTT was introduced in another jurisdiction, it resulted in
disastrous consequences. My research yielded three key points:
1. FTTs hurt market quality. Several empirical studies
showed that the imposition of FTTs results in higher
volatility, lower liquidity, and lower trading volume. \1\ As a
result, FTTs have negative effects on price discovery and lead
to a reduction in the information efficiency of markets. \2\
---------------------------------------------------------------------------
\1\ See, e.g., ``Securities Transaction Taxes and Financial
Markets'', Karl Habermeier and Andrei Kirilenko, IMF Working Paper 01-
51 (2001) available at http://www.imf.org/external/pubs/ft/wp/2001/
wp0151.pdf; and ``Transaction Taxes and the Behavior of the Swedish
Stock Market'', Steven R. Umlauf, Journal of Financial Economics, Vol
33, No. 2 (1993).
\2\ Id.
---------------------------------------------------------------------------
2. Jurisdictions that do not impose an FTT win at the
expense of jurisdictions that do. For example, when the Sweden
imposed an FTT in the 1980s, a significant amount of trading
volume simply move to the London stock market. \3\ Keep in mind
that this occurred 40 years ago when it was much more difficult
and costly to divert trading activity across borders. A similar
tax today would result in immediate and devastating results.
---------------------------------------------------------------------------
\3\ See, e.g., Umlauf (1993).
---------------------------------------------------------------------------
3. FTTs never raise the expected revenue. Because trading
volume declines (and moves to other jurisdictions) when FTTs
are imposed, actual FTT revenues never come close to the
projections made by proponents. As a result, the main
``benefit'' of an FTT is never worth the costs.
I was gratified to receive very positive feedback on my
research and memo. More importantly--and quite correctly--the
Obama administration never pursued a policy of trying to impose
an FTT in the United States.
More recently, I have become aware of additional research
that shows FTTs have harmful effects beyond direct capital
markets effects. An FTT imposed in the United States would harm
everyday Americans in a number of ways:
1. An FTT would harm everyday Americans saving and
investing for retirement. Main Street investors would pay the
tax directly when they trade, and pay it again as financial
intermediaries pass on the taxes they face as a cost of doing
business. \4\ According to one study, under the version of the
tax proposed by Senator Bernie Sanders (D-VT), a typical
retirement investor will end up with 8.5 percent less in his or
her 401(k) or IRA after a lifetime of savings. \5\ In dollar
terms, the average IRA investor would have $20,000 less at
retirement as a result of this tax. \6\ FTTs paid by pension
funds would reduce their returns and worsen existing problems
with underfunded pensions. \7\
---------------------------------------------------------------------------
\4\ See, e.g., ``Financial Transaction Taxes: A Tax on Investors,
Taxpayers, and Consumers'', James J. Angel, Center for Capital Markets
Competitiveness (2019), available at https://
www.centerforcapitalmarkets.com/resource/financial-transaction-taxes-a-
tax-on-investors-taxpayers-and-consumers/.
\5\ Id.
\6\ Id.
\7\ See, e.g., Angel (2019); and ``The Hidden Costs of a Financial
Transaction Tax: Estimated Impact on Pension Funds'', Kirsten Wegner,
Modern Markets Initiative (2018), available at https://
www.modernmarketsinitiative.org/ftt.
---------------------------------------------------------------------------
2. An FTT would harm the owners, workers, and customers of
businesses. FTTs increase the cost of capital for any company
whose securities are subject to the FTT. As a result, owners of
those companies--including Main Street investors who hold those
securities directly or indirectly in mutual funds and exchange-
traded funds (ETFs)--would be harmed through lower returns to
capital. \8\ Workers would be harmed through lower returns to
labor. \9\ Customers would be harmed through an increase in the
cost of consumer goods. \10\
---------------------------------------------------------------------------
\8\ See, e.g., ``The Impact of a Financial Transactions Tax'',
Colin Miller and Anna Tyger, Tax Foundation Fiscal Fact No. 690 (2020),
available at https://files.taxfoundation.org/20200122152248/The-Impact-
of-a-Financial-Transactions-Tax.pdf; and Angel (2019).
\9\ Id.
\10\ Id.
---------------------------------------------------------------------------
3. An FTT would harm all American taxpayers. In addition to
the increased costs of consumer goods, everyday Americans would
be harmed by other indirect effects of FTTs. The level and
growth of GDP would be reduced under an FTT, resulting in a
lower standard of living. \11\ Moreover, indirect tax effects
would pernicious and counterproductive. Lower income and
payroll taxes would result from the increased cost of capital
to businesses, and the incentive to hold off on the sale of
financial assets to avoid capital gains taxation would
exacerbate the lock-in effect of these taxes. \12\
---------------------------------------------------------------------------
\11\ Id.
\12\ Id.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR DAINES
FROM MICHAEL S. PIWOWAR
Q.1. Many of my colleagues across the aisle have recently
spoken in favor of implementing a Financial Transaction Tax
(FTT). They argue that doing so is necessary in order to reduce
market volatility and make sure that Wall Street is paying its
fair share. However, given that data from the Federal Reserve
shows that 53 percent of U.S. families owned some form of
publicly traded stock in 2019 and that 80-100 million Americans
have a 401k, what impact would the imposition of a FTT have on
pensioners and retail investors?
A.1. An FTT imposed in the United States would harm everyday
Americans in a number of ways:
1. An FTT would harm everyday Americans saving and
investing for retirement. Main Street investors would pay the
tax directly when they trade, and pay it again as financial
intermediaries pass on the taxes they face as a cost of doing
business. \1\ According to one study, under the version of the
tax proposed by Senator Bernie Sanders (D-VT), a typical
retirement investor will end up with 8.5 percent less in his or
her 401(k) or IRA after a lifetime of savings. \2\ In dollar
terms, the average IRA investor would have $20,000 less at
retirement as a result of this tax. \3\ FTTs paid by pension
funds would reduce their returns and worsen existing problems
with underfunded pensions. \4\
---------------------------------------------------------------------------
\1\ See, e.g., ``Financial Transaction Taxes: A Tax on Investors,
Taxpayers, and Consumers'', James J. Angel, Center for Capital Markets
Competitiveness (2019), available at https://
www.centerforcapitalmarkets.com/resource/financial-transaction-taxes-a-
tax-on-investors-taxpayers-and-consumers/.
\2\ Id.
\3\ Id.
\4\ See, e.g., Angel (2019); and ``The Hidden Costs of a Financial
Transaction Tax: Estimated Impact on Pension Funds'', Kirsten Wegner,
Modern Markets Initiative (2018), available at https://
www.modernmarketsinitiative.org/ftt.
---------------------------------------------------------------------------
2. An FTT would harm the owners, workers, and customers of
businesses. FTTs increase the cost of capital for any company
whose securities are subject to the FTT. As a result, owners of
those companies--including Main Street investors who hold those
securities directly or indirectly in mutual funds and exchange-
traded funds (ETFs)--would be harmed through lower returns to
capital. \5\ Workers would be harmed through lower returns to
labor. \6\ Customers would be harmed through an increase in the
cost of consumer goods. \7\
---------------------------------------------------------------------------
\5\ See, e.g., ``The Impact of a Financial Transactions Tax'',
Colin Miller and Anna Tyger, Tax Foundation Fiscal Fact No. 690 (2020),
available at https://files.taxfoundation.org/20200122152248/The-Impact-
of-a-Financial-Transactions-Tax.pdf; and Angel (2019).
\6\ Id.
\7\ Id.
---------------------------------------------------------------------------
3. An FTT would harm all American taxpayers. In addition to
the increased costs of consumer goods, everyday Americans would
be harmed by other indirect effects of FTTs. The level and
growth of GDP would be reduced under an FTT, resulting in a
lower standard of living. \8\ Moreover, indirect tax effects
would pernicious and counterproductive. Lower income and
payroll taxes would result from the increased cost of capital
to businesses, and the incentive to hold off on the sale of
financial assets to avoid capital gains taxation would
exacerbate the lock-in effect of these taxes. \9\
---------------------------------------------------------------------------
\8\ Id.
\9\ Id.
Q.2. If the U.S. were to institute an FTT, would you expect
many films would moving their trading operations to an
---------------------------------------------------------------------------
international exchange with a more hospitable tax environment?
A.2. Jurisdictions that do not impose an FTT win at the expense
of jurisdictions that do. For example, when the Sweden imposed
an FTT in the 1980s, a significant amount of trading volume
simply move to the London stock market. \10\ Keep in mind that
this occurred 40 years ago when it was much more difficult and
costly to divert trading activity across borders. A similar tax
imposed in the United States today would result in immediate,
devastating, quite possibly irreversible results.
---------------------------------------------------------------------------
\10\ See, e.g., Umlauf (1993).
Q.3. Is it your belief that Congress should actively use the
tax code to limit the practice of short selling? And is there
any evidence to suggest that imposing an FTT would reduce the
---------------------------------------------------------------------------
prevalence of short selling?
A.3. Imposing a financial transaction tax (FTT) in the United
Sates would result in many negative effects, including
unnecessarily hurting the global competitiveness of U.S.
capital markets.
In 2009, when I was a senior economist at the President's
Council of Economic Advisers, I was asked to conduct research
and prepare a memo for President Obama's top economic policy
advisors on the potential effects of a financial transaction
tax. My research showed that, without exception, every time an
FTT was introduced in another jurisdiction, it resulted in
disastrous consequences. In addition to finding that
jurisdictions that do not impose an FTT win at the expense of
jurisdictions that do (as I mentioned in my answer to your
previous question, my research also found:
1. FTTs hurt market quality. Several empirical studies
showed that the imposition of FTTs results in higher
volatility, lower liquidity, and lower trading volume. \11\ As
a result, FTTs have negative effects on price discovery and
lead to a reduction in the information efficiency of markets.
\12\
---------------------------------------------------------------------------
\11\ See, e.g., ``Securities Transaction Taxes and Financial
Markets'', Karl Habermeier and Andrei Kirilenko, IMF Working Paper 01-
51 (2001) available at http://www.imf.org/external/pubs/ft/wp/2001/
wp0151.pdf; and ``Transaction Taxes and the Behavior of the Swedish
Stock Market'', Steven R. Umlauf, Journal of Financial Economics, Vol.
33, No. 2 (1993).
\12\ Id.
---------------------------------------------------------------------------
2. FTTs never raise the expected revenue. Because trading
volume declines (and moves to other jurisdictions) when FTTs
are imposed, actual FTT revenues never come close to the
projections made by proponents. As a result, the main
``benefit'' of an FTT is never worth the costs.
I was gratified to receive very positive feedback on my
research and memo. More importantly--and quite correctly--the
Obama administration never pursued a policy of trying to impose
an FTT in the United States.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR DAINES
FROM ANDREW N. VOLLMER
Q.1. Many of my colleagues across the aisle have recently
spoken in favor of implementing a Financial Transaction Tax
(FTT). They argue that doing so is necessary in order to reduce
market volatility and make sure that Wall Street is paying its
fair share. However, given that data from the Federal Reserve
shows that 53 percent of U.S. families owned some form of
publicly traded stock in 2019 and that 80-100 million Americans
have a 401k, what impact would the imposition of a FTT have on
pensioners and retail investors?
A.1. The idea of an FTT is hotly debated. Supporters argue that
an FTT would raise revenue for the government, reduce trading
in securities, especially by high frequency traders, fall more
on the wealthy than on middle- and low-income people, and
therefore reduce the gap between the wealthy and less wealthy.
\1\ Opponents argue that an FTT would be harmful. \2\ Extensive
academic literature on FTTs exists. \3\ Scholars for the
Mercatus Center have contributed to this literature. \4\
---------------------------------------------------------------------------
\1\ Naomi Jagoda, ``Financial Trade Tax Gains Traction with 2020
Democrats'', The Hill, February 25, 2020.
\2\ SIFMA, ``A Financial Transaction Tax Is a Retirement Tax Which
Harms Working Americans'', the U.S. Capital Markets and Individual
Investors, 2019.
\3\ See, for example, Jean-Edouard Colliard and Peter Hoffmann,
``Financial Transaction Taxes, Market Composition, and Liquidity'',
Journal of Finance 72, no. 6 (2017): 2685-2716. Further studies are
cited in Leonard E. Burman et al., ``Financial Transaction Taxes in
Theory and Practice'', National Tax Journal 69, no. 1 (2016): 171-216;
and George H.K. Wang and Jot Yau, ``Would a Financial Transaction Tax
Affect Financial Market Activity?'' (Policy Analysis No. 702, Cato
Institute, Washington, DC, July 9, 2012).
\4\ Phillip Swagel and Cynthia Boruchowicz, ``Policies To Address
Income Inequality and Increase Economic Opportunities for Low-Income
Families'' (Mercatus Research, Mercatus Center at George Mason
University, Arlington, VA, May 2017), 26-27; Holly A. Bell, ``Using the
Market to Manage Proprietary Algorithmic Trading'', in Reframing
Financial Regulation: Enhancing Stability and Protecting Consumers, ed.
Hester Peirce and Benjamin Klutsey (Arlington, VA: Mercatus Center at
George Mason University, 2016), 262-65; George H.K. Wang, ``Securities
Transaction Taxes and Market Quality of Equity and Futures Markets:
Issues and Evidence'' (Mercatus Research, Mercatus Center at George
Mason University, Arlington, VA, March 2014).
---------------------------------------------------------------------------
The cost of an FTT would fall on both professional
investors and individual investors. An FTT would reduce the net
returns of retail investors and retirees who have mutual funds
or retirement funds because retirement plans and mutual funds
buy and sell securities, which are transactions that would be
subject to the tax. Writers dispute the amount of the cost to
individuals with retirement accounts or mutual funds. \5\
---------------------------------------------------------------------------
\5\ Michael Edesess, ``Vanguard Opposes a Tax on Wall Street Its
Founder John Bogle Favored--and the Reason May Surprise You'',
MarketWatch, September 3, 2020. According to Edesess, ``The real burden
of an FTT will fall on the professional traders.'' SIFMA, ``A Financial
Transaction Tax Is a Retirement Tax''; Burton G. Malkiel and George U.
Sauter, ``A Transaction Tax Would Hurt All Investors'', Wall Street
Journal, December 8, 2009. According to Sauter, `` `Wall Street' would
not foot the bill for the presumed $150 billion tax. In fact, the tax
would simply be added to the cost of doing business, burdening all
investors, including 401(k) plans, IRAs and mutual funds.''
---------------------------------------------------------------------------
Financial economists do not agree on all the effects of an
FTT. They do tend to agree that a tax would reduce the volume
of securities trading and would not produce as much revenue as
expected. \6\ Some analysts claim that an FTT could cause
riskier investments or more price volatility. \7\ It might be
fair to say that the tax would alter securities trading
behavior in unexpected and unintended ways.
---------------------------------------------------------------------------
\6\ Colin Miller and Anna Tyger, ``The Impact of a Financial
Transactions Tax'' (Fiscal Fact No. 690, Tax Foundation, Washington,
DC, January 2020), 1.
\7\ Miller and Tyger, ``The Impact of a Financial Transactions Tax
1''.
---------------------------------------------------------------------------
Supporters of an FTT believe that it will discourage high-
frequency trading (HFT). \8\ Neither Congress nor the staff of
the SEC have concluded that HFT should be discouraged. As late
as 2018, Congress had not determined that HFT causes undue
harms that needed to be regulated and instead was keeping its
policy options open while collecting further evidence. In
legislation, Congress instructed the SEC staff to prepare a
report assessing the benefits and risks of algorithmic trading
to equity and debt markets and recommending necessary changes
to Federal regulation. \9\ (For practical purposes, algorithmic
trading is another term for HFT.)
---------------------------------------------------------------------------
\8\ Aaron Klein, ``What Is a Financial Transaction Tax?'' Voter
Vitals, Brookings Policy, March 27, 2020).
\9\ Economic Growth, Regulatory Relief, and Consumer Protection
Act, Pub. L. No. 115-174 502, 132 Stat. 1296, 1361-62 (2018).
---------------------------------------------------------------------------
The SEC staff delivered the requested report in early
August 2020 but did not recommend any additional regulation to
curtail HFT activities. \10\ In fact, the staff did not
conclude that harms from HFT outweigh the benefits and, if
anything, dwelled more on the benefits. Algorithmic trading in
the equities markets, the staff wrote, ``has improved many
measures of market quality and liquidity provision during
normal market conditions, though studies have also shown that
some types of algorithmic trading may exacerbate periods of
unusual market stress or volatility.'' \11\ In addition, the
SEC staff discerned that algorithms help market participants
reduce risks from the increasing complexity of many
interconnected markets. \12\
---------------------------------------------------------------------------
\10\ Staff of the Securities and Exchange Commission, Staff Report
on Algorithmic Trading in U.S. Capital Markets, August 5, 2020.
\11\ Staff of the Securities and Exchange Commission, Staff Report
on Algorithmic Trading in U.S. Capital Markets, 4.
\12\ Staff of the Securities and Exchange Commission, 4.
---------------------------------------------------------------------------
The staff also surveyed the academic literature and
concluded that, ``Overall, most academic studies find that
algorithmic trading and HFTs have improved market quality and
helped reduce transaction costs. There is ample evidence
suggesting that, under normal market conditions, algorithmic
trading and HFTs improve liquidity and price efficiency and
reduce short term volatility.'' \13\
---------------------------------------------------------------------------
\13\ Staff of the Securities and Exchange Commission, 70 (footnote
omitted). According to the report, most studies ``find that algorithmic
trading and high-frequency trading improve price efficiency and
decrease the time it takes for prices to incorporate new information.''
Staff of the Securities and Exchange Commission, Staff Report on
Algorithmic Trading in U.S. Capital Markets, 77.
---------------------------------------------------------------------------
The staff noted that evidence of the effect of high-speed
trading in periods of stress was mixed. At least ``some
academic studies . . . find that algorithmic trading and high-
frequency trading continue to reduce volatility during periods
of heightened volatility.'' \14\
---------------------------------------------------------------------------
\14\ Staff of the Securities and Exchange Commission, Staff Report
on Algorithmic Trading in U.S. Capital Markets, 79.
Q.2. If the U.S. were to institute an FTT, would you expect
many firms would move their trading operations to an
---------------------------------------------------------------------------
international exchange with a more hospitable tax environment?
A.2. Capital flows freely across international boundaries and
seeks the most efficient markets. Adding costs with a new
securities tax in the United States inevitably will drive some
amount of securities trading to lower-cost jurisdictions.
According to economist Aaron Klein, ``Several countries
attempted large FTTs in the past and experienced significant
capital migration.'' \15\
---------------------------------------------------------------------------
\15\ Klein, ``What Is a Financial Transaction Tax?''; Bell,
``Using the Market''.
Q.3. Is it your belief that Congress should actively use the
tax code to limit the practice of short selling? And is there
any evidence to suggest that imposing an FTT would reduce the
---------------------------------------------------------------------------
prevalence of short selling?
A.3. Short selling is socially valuable. Short sellers help to
discover accurate prices and to identify companies that are
overvalued or engaged in questionable conduct. Academic studies
do not support the claims that short selling causes distress in
the securities markets. \16\ Tax and regulatory policy should
treat short selling and short covering no better and no worse
than long buying and selling. Tax, disclosure, and other
obligations should be comparable and not more onerous for short
transactions.
---------------------------------------------------------------------------
\16\ For example, see Peter Molk and Frank Partnoy, ``The Long-
Term Effects of Short Selling and Negative Activism'', University of
Illinois Law Review (forthcoming). See also Ekkehart Boehmer and Juan
Wu, ``Short Selling and the Price Discovery Process'', Review of
Financial Studies 26, no. 2 (2013): 287-322. The authors state that
stock prices are more accurate when short sellers are more active. See
also Alessandro Beber and Marco Pagano, ``Short-Selling Bans Around the
World: Evidence From the 2007-09 Crisis'', Journal of Finance 68, no. 1
(2013): 343-81. According to Beber and Pagano, bans (a) were
detrimental for liquidity, especially for stocks with small market
capitalization, high volatility, and no listed options; (b) slowed down
price discovery, especially in bear market phases, and (c) failed to
support stock prices, except possibly for U.S. financial stocks). See
also Pedro A.C. Saffi and Kari Sigurdsson, ``Price Efficiency and Short
Selling'', Review of Financial Studies 24, no. 3 (2011): 821-52. Saffi
and Sigurdsson report that relaxing short-sales constraints are not
associated with an increase in either price instability or the
occurrence of extreme negative returns). Finally, see Securities and
Exchange Commission, Office of Economic Analysis, ``Economic Analysis
of the Short Sale Price Restrictions under the Regulation SHO Pilot'',
February 6, 2007. This report provides analysis of price restrictions
on short sales.
---------------------------------------------------------------------------
If an FTT is applied neutrally and equally to all
securities sales and purchases, it would reduce short selling
and covering to the same extent as long buying and selling. I
am not aware of evidence that an FTT would reduce short sales
more than it would reduce other securities transactions. As
mentioned earlier, most commentators agree that an FTT would
reduce the number of securities transactions.
The main objective of the Federal tax system should be to
raise revenue to fund Congress's expenditures at the least cost
to economic activity. Using tax provisions to encourage or
discourage particular types of conduct or to benefit or
penalize particular groups or activities leads to complexity in
the law, difficulties in complying with the law, concealed
differential treatment, and unforeseen and unpredictable
consequences.
Additional Material Supplied for the Record
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
[all]