The onset of fall signals a sad realization that summer has ended, but also the joy that “market structure” season has arrived for securities industry participants and policy wonks. Right on cue, in early October, SEC staff issued a report on equity and option market structure conditions related to the “meme” stock events in early 2021. Market structure geeks and investors alike had been clamoring for this after Chairman Gary Gensler announced he had instructed the staff to study the issues. But to the dismay of many, including SEC Commissioners Peirce and Roisman, the report amounted to little more than a secondhand retelling of events and a beginner’s guide to equity and option market structure basics.
So what does the report cover? Well, it focuses on five key factors that Gamestop and other meme stocks experienced during the turbulent period: (1) large price movements, (2) large volume changes, (3) large short interest, (4) frequent Reddit mentions, and (5) significant coverage in the mainstream media. The report also identifies four primary areas of market structure and the SEC’s regulatory framework for potential study and additional consideration: (1) forces that may cause a broker to restrict trading, (2) digital engagement practices (DEPs) and payment for order flow (PFOF), (3) wholesalers and trading in dark pools, and (4) market dynamics of short selling. Also woven throughout the report is a discussion of increased retail investor participation in the markets brought about by reduced or eliminated commissions and trading via mobile apps.
While related sound bites have been plentiful, there have been zero market structure/mechanics/plumbing changes in the nearly 10 months since the meme stock events transpired. But if one were to do a bit of crystal-balling, the stage is set for SEC action in 2022, especially in the following areas.
- The focus on DEPs indicates that, at a minimum, SEC staff will issue guidance on their concerns and expectations in this area and perhaps even interpretations of when prompts or other “nudges,” as Chairman Gensler calls them, rise to the level of recommendations. The staff report comes on the heels of the August 2021 SEC request for comment on BD and IA use of DEPs. Sticking with DEPs, the SEC will also take a closer look at “dark patterns”—what it considers to be user interface design choices that are knowingly designed to confuse users, make it difficult for users to express their actual preferences, or manipulate users into taking certain actions.
- Regulation Best Interest also likely comes into focus, including related to brokers’ actions aimed at customers and their consideration and disclosure of conflicts of interest. While the interplay between DEPs and Reg. BI may not be immediately apparent, the intended investor protections afforded via Reg. BI apply only to brokers’ recommendations to their retail customers, not to self-directed or otherwise unsolicited transactions. We expect the staff to take a stance on whether and how particular DEPs amount to a “call to action.”
- PFOF likely will neither be banned nor explicitly curtailed. But we do expect SEC staff to reemphasize brokers’ best execution obligations, the interplay with PFOF, and perhaps provide additional guidance in this area. We could even see something resembling a non-prescriptive interpretation of, or guidance on, the regulatory requirement to achieve best execution, for which Commissioner Roisman previously has called.
We’ll certainly see and hear more on these issues over the coming months, not only from the SEC and its staff (and possibly in the form of enforcement actions), but also from the industry during the remainder of market structure season 2021. On that note, SIFMA’s annual equity market structure conference is in mid-November and is sure to provide bountiful views on these and other, related topics (including a keynote address by Commissioner Roisman).
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