Gary Gensler Plays Robinhood

The SEC’s stock trading redesign won’t help individual investors

WSJ editorial.

"Gary Gensler has some plans for you. His Securities and Exchange Commission on Wednesday gave Americans until March 31 to digest and comment on 1,656 pages of proposed regulation that would re-engineer the equities market in the name of fixing a nonexistent problem.

The impetus for the SEC’s stock-trading overhaul was the rally in “meme” shares such as GameStop last year. Multiple stocks surged in price as retail investors trading via firms such as Robinhood shared bullish tips on social media, many with the goal of squeezing hedge funds that had short positions. 

Several brokers limited trades amid volatile prices and clearinghouse margin calls. An SEC staff report last fall found no evidence of market manipulation or systemic risks. Yet Mr. Gensler argued that the practice known as “payment for order flow” presents business conflicts that harm retail investors.

Where’s the evidence? We can’t find it in the 1,656 pages of new rules. The payments to Robinhood, Schwab and other brokers from wholesalers such as Citadel Securities aren’t conflicted or shady like Sam Bankman-Fried’s FTX with his Alameda trading house. The arrangements are disclosed to investors.

Here’s how it works: Brokers that offer zero-commission trading route customer orders to wholesalers, which can execute trades at better prices than are available on stock exchanges because they aren’t competing with large institutional investors. This “payment for order flow” lets wholesalers make money from the spread between a stock buying and selling price. Retail investors benefit since they don’t pay commissions and can get better prices on trades even if it’s fractions of a cent.

But stock exchanges are unhappy because less trading on exchanges means less revenue. About 40% of trading volume now occurs off exchanges. Institutional investors such as pension funds that trade mostly on exchanges also complain that they get worse prices when there are fewer counter-parties. Mr. Gensler dislikes trading off exchanges because it’s less visible to regulators. “The markets have become increasingly hidden from view, especially for individual investors,” he said Wednesday.

Yet the SEC’s proposed rules concede that payment for order flow offers better prices for individual investors. The SEC claims, however, that investors would benefit from even better prices if markets were structured differently—i.e., the way Mr. Gensler wants.

The new SEC rules seek to replace payment for order flow with auctions that have “various market participants competing to execute their marketable orders at the best price possible.” These auctions would be separate from the exchanges but could be operated by the exchanges.

Brokers would funnel small retail orders into these auctions where institutional investors and others would compete for best price. Only if wholesalers can beat some price metric would they be allowed to skip the auctions. Institutional investors “potentially could trade at better prices if given an opportunity to interact with the marketable orders of individual investors in fair and open auctions” (our emphasis), the SEC says. It also estimates that its “fair and open auctions” could yield $1.5 billion for investors, or about one cent per $100 traded.

That’s doubtful. Brokers might have to return to charging commissions or other trading fees to replace payments from wholesalers. As GOP Commissioner Mark Uyeda noted in a dissent, the SEC estimate also “does not factor in the potential benefits associated with the proposed changes” from two other SEC rule-makings that could “facilitate competition.”

One change would let exchanges reduce the price increments at which stocks are quoted and traded—known as “ticks”—to less than one cent. This reduction of tick sizes could help “level the playing field,” to borrow Mr. Gensler’s words, between the exchanges and wholesalers that often execute trades at increments smaller than a cent.

But most of Mr. Gensler’s stock-trading overhaul isn’t intended to improve competition or protect retail investors. The beneficiaries are Nasdaq, Calpers and brokers that can support zero-commission trading with other revenue.

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Amid the crypto crashes and alleged FTX fraud, one would think that Mr. Gensler would have higher priorities than redesigning the stock market to fulfill a thought experiment. An SEC Inspector General report recently warned that his move-fast-and-break-things agenda is overwhelming staff and diverting resources from investor protection. His redesign of stock trading is a regulatory vanity project that won’t help investors."