The GameStop saga continues to play out nearly six months later, with the SEC and other regulators looking at possible enforcement actions. Hogan Lovells partner Aaron Cutler and Chase Kroll, director of strategic communications at the firm, break down what this means for market participants and explain how attorneys can best prepare clients for more regulatory oversight.
Outstanding market events that garner public attention often elicit congressional inquiries, and sometimes even lead to regulatory reforms.
But few times in recent memory have a cataclysm of disparate but equally significant events, such as the retail meme stock investing-induced volatility and the fallout from Archegos Capital Management’s default on margin calls, come to a head all at once.
With a new Biden administration and a Democrat-controlled Congress looking to make its mark on financial services regulation, financial institutions should expect sustained scrutiny from the House Financial Services and Senate Banking Committees, and a slate of regulatory reforms.
Based on the roughly 16 hours of congressional hearings, stacks of prepared testimonies, discussion drafts, and congressional statements that have already come to pass from these events, there are a few key takeaways beginning to emerge.
These expected developments likely will affect every corner of the market. Hedge funds should prepare for additional disclosure requirements related to short sales, and increased frequency and expanded scope of 13-F disclosures, while brokers should prepare for significant scrutiny related to gamification and behavioral prompts within the user interface/user experience (UI/UX) of trading apps.
Market makers can expect a shortened settlement cycle, and even retail traders may see limitations on trading options, spreads, and on margin.
Firms should also consider the risk of being called to testify before a hostile congressional panel. Before the letter from Congress comes in, thinking about who should testify and preparing that person to provide written and oral testimony to Congress will be critical.
It is also a good time to begin building, or developing further, relationships with members and staff on both sides of the aisle to potentially address and head off problematic inquiries ahead of a public hearing.
Sen. Sherrod Brown (D-Ohio), chairman of the Senate Banking Committee, sent letters asking for additional information from banks with links to Archegos. Congress may dig deeper. Democrats with majority control of both the House and Senate have the ability to subpoena witnesses and documents as part of congressional investigations.
In late January, there was a social media organized meme stock short squeeze involving GameStop, which led to brokers facing capital requirements, and throttling the buy side of certain equities. There was confusion and outrage from participants, pundits, and politicians. There were calls for investigations and congressional hearings.
Then in March, Archegos’ highly leveraged positions led to a $20 billion wave of forced liquidations at a number of major financial institutions, some of which incurred significant losses. Members of Congress called for investigations, and Sen. Brown told CNBC that he expects the Securities and Exchange Commission and other regulators will take a closer look.
House, Senate Hearings
The House Financial Services Committee held hearings in February, March, and May, and the Senate Banking Committee held a hearing in March. Committee members heard about the events of late January in trading in GameStop stock from market participants, entertained policy proposals from think tanks and academics, and discussed potential legislative and regulatory responses from the regulators.
Ahead of the third House hearing, the committee prepared six discussion drafts of potential legislation. These drafts address 13-F disclosures, family office exemptions, gamification of trading apps, options trading for retail traders, payment for order flow, and ‘trading ahead.’ While the draft bills offer a helpful glimpse into congressional sentiment, it is more likely that the Congress will defer to the regulators, who spoke during the hearings.
SEC, FINRA Considerations
Robert W. Cook, president and CEO of the Financial Industry Regulatory Authority, said he is investigating a number of issues related to the investment activity and industry response to the events in January, and will be recommending enforcement actions when the investigations are complete. This theme also was echoed by SEC Chair Gary Gensler. The SEC and FINRA are fact-finding and asking for staff recommendations. There will be proposed rules and requests for public comment in the coming months.
Gensler said he and his staff are considering 13-F filing requirements and short selling disclosures, as well as whether to include total return swaps and other security-based swaps under new disclosure requirements.
Cook said he was also looking at increasing disclosure requirements, but that “the SEC has primary policymaking responsibility such as market structure, payment for order flow, short-sale regulation and disclosure.”
Gensler also has indicated that he instructed his staff to prepare a request for public comment on gamification of trading apps, and that he will look at retail trading restrictions such as margin and payment requirements, and capital requirements for brokers. Cook, meanwhile is considering requiring “more granular information about payment forward or for flow.”
Gensler said shortening the settlement cycle could reduce costs and risks, and that he has directed staff to put together a proposal on how that might be enforced.
The regulators will soon publish draft rules, regulations, and requests for comment. Congressional committees will likely call for more hearings and investigations.
Firms ought to prepare for all of the above, and part of that preparation should include engaging with the regulators, and having discussions with members of Congress on both sides of the aisle.