How An SEC Trading Rules Proposal Could Be A Game Changer For GME And AMC
For years now, retail investors have pleaded for more transparency in market structures. Finally responding to those pleas, the SEC now says it plans to increase competition between firms that execute retail trades, increase the efficiency of the equity markets, and deter conflicts of interest.
Activities heavily criticized by GameStop ( GME) - Get GameStop Corporation Report and AMC Entertainment ( AMC) - Get AMC Entertainment Holdings Inc. Class A Report retail investors, such as payment per order flow, would be affected by the SEC's plan. Here is a deeper look at how meme stock investors may benefit from this development.
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PFOF Under SEC ScrutinyPayment for order flow (PFOF) refers to the compensation received by brokerage firms from other parties (usually market makers) for brokerages’ execution of trades. In effect, market makers will pay brokerages - usually in the ballpark of a few cents per trade - to direct their orders through them.
PFOF is quite controversial, however. That’s because it inherently involves potential conflicts of interest. Indeed, some traders claim that PFOF causes some executable orders to be turned into non-executable orders when brokerages decide to reroute an order to a market maker that is willing to pay a higher order flow fee. The upshot is that traders may not be getting a fair market price when they buy or sell securities.
PFOF is forbidden in several other countries, including Canada and the UK. And the practice doesn’t have a particularly strong endorsement track record either. One of PFOF’s biggest early proponents was market maker Bernie Madoff, who later pleaded guilty to several federal felonies, including securities fraud.
According to recent revelations by SEC Chair Gary Gensler, the SEC is putting in place a plan that will require trading firms to compete with each other to execute trades originating from retail investors. The SEC Chair also noted that "Ninety percent of retail orders are routed to a small percentage of wholesalers." Thus, practices such as payment-per-order flow would come under scrutiny by the SEC, while new order-by-order competition proposals, if enacted, would provide the markets with a more transparent view of trades.
In addition, new measures would heighten SEC requirements for brokers regarding the data those brokers keep on order execution. Much of that data (e.g., monthly summaries of price movements) would be made available for the benefit of individual investors.
Many commission-free brokers, such as Robinhood, derive the majority of their revenues from payment per order flow. According to Robinhood's Chief Legal Officer Dan Gallagher, the SEC's efforts to tinker with stock market rules are "misguided." Gallagher claims that today’s status quo trading still works very well for ordinary investors.
How does PFOF Affect Meme Stocks Trading?GameStop's trading boom during January 2021 and AMC's successive boom in the months that followed caught markets' attention. During that period, more and more people became aware of retail investors’ concerns regarding a lack of transparency in the markets.
Many believe that, through payment for order flow, market makers are manipulating retail traders’ and investors’ orders for their own benefit.
There are also concerns that a large chunk of orders going through market makers are destined for dark pools. Dark pools are like private exchanges that are off-limits to the public. Dark pools are legal and were created to facilitate block trading by individual investors who do not wish to impact the markets with large orders and lower transaction costs between brokers and clearinghouses.
However, the main disadvantage of dark pools is their opaque nature. High-frequency trading firms can take advantage of this opacity to engage in predatory practices - e.g., hiding orders that should be going straight to buyers.
According to Urvin Finance CEO Dave Lauer, almost half of the trades that take place in the U.S. take place over-the-counter (OTC), and many other countries have rules to prevent internalization and off-exchange execution of small orders. But in the U.S., no such rules exist.
How This Could Affect GME, AMC, And Retail Investors In GeneralThere is no hard evidence of irregularities or illegal behavior when it comes to market makers feeding orders through dark pools. Nevertheless, offering competitive alternatives to PFOF trading would provide more transparency as to what happens off-exchange and would help discourage any nefarious behavior.
Order-by-order competition would mark a major improvement to the market’s overall transparency. The SEC’s new rules would require that all wholesalers and market makers compete for orders, which would tighten spreads, minimize conflicts of interest, and maintain price and size improvement of retail orders.
All those improvements should be a boon to those trading or investing in high-volume, meme-y stocks such as GME and AMC.
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)
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