SEC Report Describes GameStop Trading Market Volatility, Recommends Further Study
November 5, 2021
The market volatility last January “tested the capacity and resiliency of our securities markets in a way that few could have anticipated,” concludes a recent SEC staff report on the market disruptions caused by the trading in GameStop and other companies’ stock (so-called “meme” stocks) during that time. Over a period of just a few weeks, 100 stocks experienced large price movements or increased trading volume that significantly exceeded broader market movements. The amount of “short interest” in some of the stocks (the number of shares sold short as a portion of the total shares outstanding) also exceeded the market average during this time. The staff conducted the study to evaluate whether the SEC should consider changes to market structure rules in light of these events.
The report describes the roles in these events played by individual investors’ “positive sentiment” of the companies expressed on social media, short sellers, broker-dealers, and clearing houses. While it notes that “the trading in meme stocks during this time highlighted an important feature of United States securities markets in the 21st century: broad participation,” it also points to the “trading disruptions and deteriorations in some measures of liquidity.” For example, the market volatility led to margin calls and capital charges on some retail broker-dealers, which, in turn restricted buying in some of the stocks. At the time, many speculated that short squeezes by some institutional investors, such as hedge funds, played a major role in the market turmoil. The report finds, however, that short squeezes were not the main driver of the events and that “hedge funds broadly were not significantly affected” by the meme stock trading. Nevertheless, the report notes that these short squeezes “highlight the role and potential impact of short selling and short covering.” The report also notes that staff “did not observe that any advisers to private funds and registered funds experienced liquidity issues or difficulties with counterparties.”
The report warns investors that, “when share prices change rapidly and brokerage firms suddenly suspend trading, investors may lose money.” While the report did not find any evidence that market practices, such as payment for order flow, off-exchange trading, wholesale market-making, or any other market practice were the cause of the market volatility, the report identifies four areas in the equity and options markets that the staff believes the SEC should consider for further study as a result of the events, including:
- Factors that may cause a brokerage to restrict trading. The market events raised questions about thinly-capitalized brokers’ ability to meet margin calls, although the staff notes that such risks could be mitigated by shortening the settlement cycle.
- Digital engagement practices and payment for order flow. Brokers may use the “game-like features and celebratory animations” to cause investors to trade more, and payment for order flow may cause broker-dealers to find ways to increase customer trading.
- Trading in dark pools and the role of wholesalers. Wholesalers that purchased much of the retail order flow of GameStop and then executed off exchange made the trading less visible to the wider market. Wholesalers face fewer requirements about their operational transparency and resiliency as compared to exchanges or ATSs.
- Improved reporting of short selling. Short selling data could allow the SEC to monitor the interplay between shorting and price dynamics.
The report concludes that the events of January 2021 “present an opportunity to reflect on the market structure and regulatory framework and identify additional areas for potential study and further consideration in the interests of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.”
See SEC Staff Report on Equity and Options Market Structure Conditions in Early 2021 (Oct. 14, 2021); SEC Press Release; Chair Gensler Statement; and Commissioners Peirce and Roisman Statement.