Market Trading Trends: Expect Regulatory Guidance to Accelerate Finance & Banking

Gamification tactics and investment advice from social media and chatroom influencers are just some of the disruptive technologies and behaviors that are catching regulators’ attention in 2021 and forcing them to take a closer look – and react. For the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC), the question is to what extent this new generation of traders should be allowed to take advantage of these new tools, applications and free transactions, and what are the necessary safeguards to be in place to protect investors and ensure market integrity? The consensus is that we can expect an acceleration of regulatory guidance in 2022.

During the market “hot topics” panel at Katten’s annual Financial Markets Litigation and Enforcement Symposium Series, Katten attorneys discussed developments in best execution and payment for the order flow, disruptive technology, a new generation of traders and the most controversial activity of the year, the GameStop trading frenzy.

Five dishes to remember

1. A new breed of merchants and the GameStop frenzy

In 2020, one clearing company said it opened six million new accounts, a 137% increase from 2019. One million of these new accounts were Gen Z with an average age of 19. With so many people interested in trading in the market, and a significant number of whom are following social media advice, it should come as no surprise that 2021 has brought unexpected developments. Among them was GameStop’s commercial frenzy fueled by social media platforms and socio-economic nuances.

On the Reddit internet discussion forum “WallStreetBets,” retail investors revel in knowing that GameStop, a dying breed of brick-and-mortar video game stores, was heavily shorted in 2020 and vulnerable to a short squeeze. Wanting to “stick to” hedge funds, Wall Street and the “1%, these new investors encouraged each other to buy the stock and drive it higher. The activity caused a massive price spike – up 928% – in the first weeks of 2021 and effectively forced short sellers, including big hedge funds, to remove their short positions and buy stocks . In turn, the surge has led to unprecedented market volatility and led to major losses for large investors.

In the wake of GameStop’s rise to prominence, clearinghouses and brokerage firms began pointing fingers at each other. But an October 2021 report released by the SEC after congressional hearings on the matter concluded that the price spike was actually caused by a large group of individual retail investors taking inspiration from social media. Although the report did not make specific policy recommendations, regulators should eventually respond.

2. The dubious role of “End-fluencers”

In a similar vein, 2021 has seen a significant increase in the number of social media influencers entering the financial space. Typically, social media influencers have established credibility in a specific industry, have access to a large audience, and can persuade others to act on their recommendations. Although influencers have been around for a while, financial influencers are relatively new.

Fin-fluencer social media activity runs the gamut, from initiating bullish stocks and how to get rich quick to sharing educational materials or personal stories. On the positive side, some believe that end-influencers fill a gap in financial literacy, although most lack formal qualifications. On the downside, there is a lack of transparency regarding the risks associated with the products and investment strategies they recommend and the potential for pump-and-dump schemes.

Additionally, with the growth of flipper influence, more and more companies are adding them to their marketing mix. There’s no better way to reach the next generation of marketers than through social media. Companies and brokers use (and pay) end-fluencers to talk about stocks and services on their behalf. Regulators are now reviewing brokers’ practices and have issued information requests, asking for a detailed history of relationships with influencers, how they first identified them, how they are compensated and any referral agreements in which they might be engaged. also give several pages to privacy issues regarding sharing customer information with influencers. This is certainly an area ripe for more regulation and guidance in the near future.

3. Gamification

Gamification, also known as digital engagement practices, is closely related to investment advice on internet users and chat rooms. Similar to a fitness tracker, investing apps using gamification tactics can track an individual’s trading activity and encourage trades, send alerts, use a leaderboard, and reward the user with badges when they reached certain milestones. There are many regulatory issues involved. For example, is an app that encourages an investor to trade considered a broker recommendation within a regulated activity? We expect FINRA and the SEC to issue more guidance on gamification in the near future.

4. Best Execution Requirements

FINRA Regulatory Notice 2021 21-23 provided specific guidance on payment requirements for order flow (PFOF) and best execution. One observation is that FINRA places price as the primary consideration, above many other criteria, in assessing quality of execution. Meanwhile, SEC Chairman Gary Gensler recently issued a directive to staff to consider whether additional best execution requirements or guidance are needed to promote investor protection, which suggests possible additional best execution requirements to come.

5. Checkout Flow Payment

The PFOF, which has over time survived calls to ban the practice, has faced a further push that would include rule changes or a total ban on the practice in 2021. Calls for review followed the market turmoil and volatility created by the GameStop episode. While the connection between the GameStop saga and PFOF is unclear, in October SEC Chairman Gensler said the agency was indeed reviewing whether PFOF should be amended or banned, with the goal of create a more competitive market.

The growth in the size of payments related to retail order flow attracts additional scrutiny in 2021. In the first three quarters of 2021, the PFOF increased by 41% compared to the same period in 2020. A significant percentage of this increase is linked to options trading which increased by more than 25%, largely due to the increase in the number of retail investors. trading options. Regulators are concerned that brokers are encouraging retail investors to jump into these complex and risky derivatives markets without understanding the risk. Commissioner Gensler suggested that there could be two potential regulations in the near future, one for investment advisers and one for broker-dealers.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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