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Monday, August 2, 2021

How SEC boss should deal with ‘meme’ stock schemes

Gary Gensler thought he had all the answers when he took the helm at the Securities and Exchange Commission this spring.

Wall Street lawyers and bankers who deal with him tell me he was highly confident — almost arrogant — in explaining his agenda of regulating everything he could while making corporations more woke with various disclosures about the environment, diversity, etc. 

Then the meme-stock frenzy came roaring back, and Gensler was reminded that being the sheriff of Wall Street means you get held account­able when bad stuff happens on your watch. 

These money-losing stocks went bonkers in January, fell back to earth and then soared recently thanks to hordes of retail investors once again plowing whatever savings they had into some of the most speculative companies in the market.

It doesn’t take a market sage to figure out these stock prices will revert to normal once the irrational exuberance runs its course, as they’ve done time and again over the years. The Fed’s easy-money interest-rate policy is the spark that starts such manias.

But the madness of crowds only lasts until something changes the sentiment, making investors suddenly suspicious of hype. People start selling stuff. The smart money gets out first, while the average investor is usually left holding the bag.

That’s when the pitchforks come out and public starts looking for scapegoats.

During the dot-com era, the scapegoats were Wall Street analysts who recommended so many money-losing Internet stocks. After the financial crisis, Congress rounded up for humiliation Wall Street CEOs whose banks received bailouts during what then seemed like an endless series of show trials.

When the meme-stock madness has abated and people are counting their losses, I have no doubt there will be a scapegoat or two or three.

And Gensler is worried he’s going to be at the top of the list. 

Don’t take my word for it. Just look as his flailing attempts to bring some order to the meme-stock buying that shows no signs of normalizing as this column goes to print. 

I am told that Gensler has discussed forcing trading outfits like Robinhood to erect some speed bumps in their trading apps, essentially toying with the idea that passive trading outfits have a duty — just like a regular financial adviser — to warn its users about the pitfalls of gambling with stocks.

SEC boss Gary Gensler is pointing at trading app Robinhood as the main culprit behind ‘meme’ stock trading, when he should be blasting the Federal Reserve’s interest rates.
SEC boss Gary Gensler is pointing at trading app Robinhood as the main culprit behind ‘meme’ stock trading, when he should be blasting the Federal Reserve’s interest rates.
AP Photo/Patrick Sison, File

Yes, much of the meme-stock buying of names like AMC Entertainment and GameStop occurs on Robinhood’s easy-to-use, no-fee app. But smart securities lawyers I speak to say extending fiduciary status to a trading app would essentially take a rewriting of securities laws.

I’m no lawyer (neither is Gensler) but if he went there, discount brokers, not to mention Robinhood, would sue and probably win because as one seasoned corporate-law attorney told me: “He just doesn’t have the legal authority to do that sort of thing.”

Next, Gensler mentioned doing something with the system known as payment for order flow. Brokerages like Citadel buy Robinhood’s buy and sell orders (order flow), and then match them, for discount brokers’ small-investor customers.

Gensler seems to think there might be something nefarious going on with these arrangements even though they allow Robinhood’s customers to trade free, and Citadel has a legal obligation to match orders at the best price.

What’s the evidence they are not? And how will any regulation of the practice stop the trading frenzy, which he describes as “gamification”? Gensler won’t say, but recently he has opined that maybe the orders need to be routed somewhere else, like the major stock exchanges, for better transparency, whatever that means.

Even more recently, Gensler launched an investigation into meme-stock trading. It was disclosed in a filing by one of the memes, GameStop, stating “we received a request from the staff of the SEC for the voluntary production of documents and information concerning an SEC investigation into the trading activity in our securities and the securities of other companies.”

Legal sources say the SEC is looking to pursue a stock-manipulation case, potentially nailing traders for spreading BS about the prospects of the meme companies and then ­unloading shares when convenient at a profit.

Legal sources also say such cases are nearly impossible to win: How do you prove a trade has bad intent as opposed to irrational exuberance in an environment where the Fed’s super-easy interest-rate policy is ­encouraging wild speculation? You really can’t.

Since I mentioned the Fed, here is an easy way for Gensler to avoid ­being the next market scapegoat: He should pick up the phone and call Fed Chair Jerome Powell.

Then Gensler can alert Powell that printing money always leads to speculative bubbles and investor losses. If Powell normalizes now, the meme bubble might burst on its own — before people mortgage their houses to buy more AMC.

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