Mission SEC

Gamestop wasn’t our fault. 

That’s the conclusion of the Securities Exchange Commission in a 45-page report.  I’m reminded of Gulliver.

Not tiny people with tiny ropes tying down the giant SEC while it slept.  Satire. That the SEC exonerated itself comes as no surprise. Ask the Department of Flooding if it had anything to do with the failure of anti-flooding systems and the answer will be: Nope.

I’ve got just one beef with the SEC in this report, and read on, and you’ll see.  I commend the SEC for saying things like: To understand what transpired in January 2021, it is necessary to understand the market structure within which the events occurred.

We use the phrase “market structure” all the time.  Here, the SEC did.  Coincidence?

Illustration 94594512 / Markets © Idey | Dreamstime.com

Who is the SEC’s audience?  The public, yes. But I’m a market-structure expert. That memo is for market participants, not neophytes. Those who depend on the public equity markets. Such as public companies – who should possess the capacity to understand it (like alert reader Jay D. in New York City did!).

You do it right, public companies.  File your regulatory filings. Tell your superlative story. Meet financial targets, issue your ESG reports, hold your DEI teach-ins, put “sustainable” in everything.

Then your stock soars 500% and you don’t know why. Sure, up 500% is awesome but not knowing why is a condition that should never exist in a free, fair and open market.

Or worse, your stock plunges from $40 to $10 in a day, at the open, even though not a single stockholder sold.  That happened to AVIR yesterday. Sure, bad news on the Covid-19 front. And I can’t say no holder sold.

But isn’t the market supposed to prevent dramatic, reactionary moves in prices? We have a systemwide network of volatility girders instituted by the SEC to prevent midday panic.

Did you know your stock can trade when no holder buys or sells?  We’ll come to that at the end.  It’s how the $50 trillion construct of the US stock market clings together. And why Gamestop happened.

Let’s get to what the SEC said is necessary to understand. I’ll trim it because the memo is 45 pages long – terse for a government missive but I need 800 words for this column.

The SEC says retail trades proceed from a retail broker to somebody else for execution, report to the consolidated tape, and pass on for clearing, which can take up to three days.  Meanwhile in the options market there are a million securities, vastly more than total stocks, where the prices come from brokers and trades settle in two days or less.

How can derivatives change owners before the underlying asset?  Good question.  Unanswered.

And on page 11 of the memo is a painfully discursive paragraph on what traders may do with retail orders.  I’m condensing in Cliff’s Notes fashion: Market-makers may choose to trade with money that’s less sophisticated and avoid what’s more sophisticated, to reduce the risk of loss. And apparently it’s possible to easily segment these orders.

Got that?  I’ll dumb it down one step more, and this is my beef: The SEC is fully aware that some have a huge advantage over others.  Yet the SEC says to begin Section 2.2 that its mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

Well, how can that be true if some know what others don’t? People have gone to jail for years because they bought and traded on what others don’t know. Here it appears to be happening willy-nilly.

Because the SEC needs an unfair market. The one we have won’t work if it’s fair. There is no other conclusion.

What about Payment for Order Flow, where retail brokers like Robinhood and Schwab sell trades to “wholesale” buyers like Citadel Securities and Two Sigma?

Wholesalers buy things only because they can sell what they buy at a profit.  Period.

The SEC knows it. The SEC knows some have better information than others.  And the SEC knows it exempts firms like Citadel from the short-locate rules under Reg SHO Rule 203(b)(2).

Because the mission of the SEC is to preserve the market. Which can’t hum continuously. Unless it’s gamed. So the SEC pays whomever it must with favors to see that it hums.

Sounds like politics.

As to how Gamestop happened and why no buyers or sellers are needed, see my Meme Stocks presentation.

Traders, you can’t beat the market if you don’t know how it works.  Public companies, we’re wasting time and money doing things that don’t matter.

The starting point is making sure our CEOs and boards know how the market works. We can help you begin this new mission.