Gary Gensler: Vast Majority Of Retail Market Orders Go To Dark Pool

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Gary Gensler: Vast Majority Of Retail Market Orders Go To Dark Pool
Image source: CNBC Video Screenshot

Following is the unofficial transcript of a CNBC interview with SEC Chair Gary Gensler on CNBC’s “Squawk on the Street” (M-F, 9AM-11AM ET) today, Tuesday, October 19th.  Following is a link to video on CNBC.com:

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Vast Majority Of Retail Market Orders Go To Dark Pool: SEC Chair

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BOB PISANI: Hey guys. Lot to talk about today. We’ve got a Bitcoin futures ETF trading, we’ve got the GameStop report out. What do they all have in common? Well they’re all regulated by the SEC. Let's talk to the man in charge, SEC Chair Gary Gensler joins us right now. Mr. Chairman, thanks very much for joining us.

GARY GENSLER: Good to be seeing, good to be with you, Bob.

PISANI: So, I want to talk about your GameStop report but I have to start with Bitcoin. We've got a raft of cheering people down here from ProShares, ProShares Bitcoin ETF. The futures ETF is starting trading just started a few moments ago. I have to ask you can you, can you explain to our viewers why you chose to allow a Bitcoin futures ETF to begin trading but have not yet approved a regular Bitcoin ETF?

GENSLER: Bob, thank you for that question. Just to give you a little context. I think that we in the official sector should be technology neutral but not policy neutral and so what we’re trying to do is ensure to the best we can within our authorities to bring projects into the investor protection perimeter. And so, what you just mentioned, Bitcoin futures have been overseen by our sibling agency the Commodity Futures Trading Commission which I was once honored and proud to serve there and that's been four years and some of these applications came in and when effective, as you said one of them went effective with regard to those products over at the Chicago Mercantile Exchange that our sibling agency oversees.

PISANI: I think the important thing here is you've made it clear in the past that this does not have the some of the concerns that approving a full Bitcoin ETF would have. You don't have people breaking into exchanges for example, you don't have problems with fraud or manipulation. Was that a factor, it seems that that was a factor in the fact that you went ahead and allowed the Bitcoin futures ETF. You don't have those particular problems here.

GENSLER: Oh, well I'm not going to get into any one application or project. I think what you have here is a product that’s been overseen for four years by a US federal regulator and CFTC, and that's being wrapped inside of something that within our jurisdiction called the Investment Company Act of 1940. So, we have some ability to bring it inside of investor protection. It's still a highly speculative asset class and listeners should understand that underneath this, it still has that same aspect of volatility and speculation but there's our sister agency is overseeing this for four years and then it brings it inside, as I said, an 80 year old law here at the SEC.

PISANI: I move on to the GameStop report usual thorough report from your staff. I think this will be the historical record of what happened but I'm curious about the recommendations. You have been talking for many months about payment for order flow and gamification and the potential deleterious effects of both of these on the US trading system and yet there was no discussion about how this might have impacted the trading for GameStop. I'm wondering if there is some kind of connection? Was payment for order flow and gamification factoring what happened with GameStop or not? The report doesn't say.

GENSLER: So, I think that the events of January revealed a number of things and as the staff suggested for additional consideration these two topics plus two others that we look out for the investing public when brokerage jobs, when robo advisors are using new data analytics and, and marketing to us using behavioral prompts to possibly get us to trade in a way that benefits them, benefits the application and the, and the program in conflict potentially with what benefits asked the investing public. Also imbedded in some of those issues are the structure of the stock markets itself. It's so much of the market now is, is evidenced in the report in January and these ones are about half of the market is not going to a transparent sort of market that fully lit market that you earlier showed, but it's going to dark holes and wholesalers so those issues the staff suggested up. What, we're going to take a closer look at in terms of what policies can help the public.

JIM CRAMER: Chairman Gensler, it's great to have you on the show again. I know that your position on trying to invest. Well, I read a great book that you wrote about no free lunch, that’s why we have diversification. And then I read this report and I absolutely understand, it's very thorough it's got great stuff and talks about how options didn't really affect things, what did impact. And then on page, the last, number two, there's this sentence, “payment for order flow in the incentives it creates may cause broker dealers to find novel ways to increase customer trading including through the use of digital engagement practices.” I read this and it felt like a bit of a lamentation. I felt that right before that you talked about, don't forget, companies underneath the memes are actual employees, customers plans to invest, and then you get to this and I wanted you to be able to say, it may be this is unfortunate because I know that people want, they want to open as much engineering, but this is not Chairman Gensler. Chairman Gensler’s against any idea that we should be doing these digital engagement practices that might hurt investors.

GENSLER: So, let me sort of address that. I think that we’ve found on platform after platform whether it's in, in, in streaming apps or retail apps, a very social media, that we're in a transformative time. The 2020s is rapidly changing on top of the invention of the internet, internet many decades ago, we have data analytics, artificial intelligence that markets to each of us a little differently. I mean you might type something in a text and then all of a sudden find you're being advertised something you typed to a personal friend in the text. So those features are all around. What we're raising the question is, is in finance, what does that mean for finance? These digital engagement practices, the underlying separating you from me and from all of us and then if the applications marketing for their revenues and payment for order flow does have an inherent conflict that the brokerage application is increasing their revenues if we trade more. And so are they using these behavioral prompts to get us to trade more or to move to different products, options trading or trading on margin which inherently have more risk in them, and where do we, the SEC, help the investing public out to help them do well when there's these inherent conflicts inside the, kind of inside the box.

CRAMER: Right, but I guess what I struggle with is, you've got this great moment here. There are one million of these accounts belonging to investors with an average age of 19. I think these investors if they're focusing on, let's say, trying to put together a fantasy team, I think they’re spending a lot more time on fantasy trying to figure out who the, who's on tonight. How to be able to make it so what's the line, what's the over, they’re spending more time Chairman Gensler on their fantasy lineup than they are trading. They are trading like banshees. Don’t we want to encourage them to spend as much time as they do on their fantasy lineup.

GENSLER: Well I think that that investing for the long term tends to have higher returns than day trading or even hourly trading and sometimes, not always, but sometimes these applications encourage individuals to have high trading volumes or trade on margin or options that have inherently higher risks. And so that's where, there’s, there's a worthwhile public debate and I think, I thank the staff of the SEC to serve up this report. I think yes, as you said earlier, now it's the job of the commission to sort through what we do with these additional considerations.

PISANI: Mr. Chairman, the staff determined that a short selling squeeze was a factor, but it wasn't the primary reason for the big sell, price run up in GameStop. It was positive sentiment I'm reading from the report here that sustained the week's low-price appreciation, positive sentiment, not the short squeeze, short covering was a small fraction of the overall buying volume. I guess I'm wondering though despite that you've been talking about potential changes in short selling rules. Do we need to make any changes? Do we need more, for example, disclosure about short selling?

GENSLER: I think that the markets could benefit from greater transparency, not only on short selling, but a related activity in the markets which is called stock loan when you borrow a stock to sell it short. Congress actually, our US Congress actually about 11 years ago passed two provisions that mandated, directed the SEC to do greater transparency in short selling, and this related activity stock loan. So I have asked staff for recommendations on this to promote, meaning that on a regular basis the market would benefit from seeing the volumes and activity in the lending market, meaning lending securities, and also this short selling activity.

PISANI: Just to follow up on payment for order flow. Most, most viewers of the trading activity in the last 30, 40 years agree that the American investor has never gotten a better deal not only have commissions essentially go to zero but even trading costs are much lower, execution quality has improved dramatically in the last 30 years. I know there's a little bit of debate about it exactly how much but the average investor seems to be getting a very good deal, can you, do you feel you're going to be actually able to demonstrate a real harm from payment for order flow? Number one and number two, can you tell us what comes next here you've got the commission with your staff with a very excellent report on the facts, but not a lot of direction about where it should be going. Is the commission then going to meet and make recommendations or make rule changes from here? What's the path here forward after this commission staff report?

GENSLER: Well, let me say this, you're, you're right that our markets have gotten more, have moved to zero commission but it doesn't mean it's free. There's still payment underneath these applications. It also doesn't mean that it's always best execution and we've had, we've had cases where we've announced in the last 18 months where there has been this conflict between the broker on the one hand and this payment for order flow on the other. And let me just remind your viewer that if you place a retail market order, as shown in this report, the vast majority of those don't go to the transparent lit markets, they go to the dark market with these, these pools that are not competing and so I’ve asked staffing, can we achieve this simple concept that your order when you place it competes with other orders and buyers if you're selling will compete to get, and to pay you hopefully, the best execution for that price order by order by order. That's what I've asked staff and I think that that's an important concept of competition that helps the investors on one side, helps the companies on the other side that are raising money in our markets.

CRAMER: Well, Mr. Chairman, again I want to praise the staff because those who read this will know there was not a vast conspiracy against them which was really the topic that I know a lot of us felt we were really razzed by because we're all in on some sort of Citadel conspiracy. I think that's completely busted but there was something on page 12 that disturbed me, you talk about some of the marketplace may possess superior information about underlying assets. That sir I think is illegal. Did we discover that some of that superior information should be in front of the commission to find out what's going on?

GENSLER: Well I think that you chose the words carefully maybe there but when, when order flow when, when trading is being purchased and sent to one wholesaler or another wholesaler then they have information that the rest of the market may not have at least for a short period of time, and, and even milliseconds matter in these markets. And so, that's what we're also looking at. You're absolutely right that we, I think from a policy perspective want to look at that and how we instill greater competition in essence for that data as well as for that order flow.

DAVID FABER: Chair Gensler, Chair Gensler, David Faber here. You know we had you on not that long ago, obviously long ranging interview. I wanted to come back to SPACs if I might just for a moment. Haven't really heard that much from the SEC yet and I wonder where you are because it does appear that the market has been making its voice heard when it comes to SPACs. We are seeing the sponsors changing their compensation arrangements, we've seen the pipe market really frees up, and so is the market doing its job, and the SEC therefore perhaps doesn't have to take significant action in any way in terms of regulation for SPACs?

GENSLER: I think that there is, is a need here for greater transparency, greater disclosure. These are, these are innovations that have happened in our markets, special purpose acquisition companies, but they're costly, and they may also have inherent conflicts between a promoter or sponsors who is taking generally about 20% of the offering that if you raise a billion dollars, that's $200 million. Can I repeat the number? $200 million to basically raise money and a blank check type of shell company and then you have two years to go out and try to buy something. And there's also this conflict that if you don't buy something, you don't get the promoter, or the sponsor doesn't get that 20%. So there's an incentive to buy something even if it's not the best purchase in the world particularly as the clock is ticking and you get to the end of the two years so I know I've said this a lot about staff working on recommendations. These, these rules are highly detailed. We need to work on the economic analysis which is so critical to good decision making. You're five commissioners, and so the process does take a number of months and sometimes the public says, where's that document or where's that rule proposal but I would envision that staff will put something up to our five-member commission and if, if there's the support of the commission, we'll put it out to public comment with regard to SPACs with regard to a number of these other topics we've talked about as well.

PISANI: Just a follow up to my question. The second part you didn't quite answer. What's next here? What happens after this report? Does the commission, meet your five commissioners discuss what you want to do? Are you going to make proposed rule changes? I know you have a request for comment on digital engagement practices that are out there. What will become of that? I guess I'm looking for a roadmap for what you're trying to accomplish here.

GENSLER: So, the five of us generally meet bilaterally and then sometimes we meet as a, as a group and as a group when we do that often that leads to what's called a public meeting and the cameras are on and the like. In terms of what's next is staff recommendations on the plumbing, this is called the clearing and settling side. There seems to be broad support in market participants to shorten the settlement cycle. We are secondly assessing the comments that came in on digital engagement. I’ve asked staff to consider whether there's some recommendations we have on those potential conflicts and also better protecting the public. And then the third area that was highlighted was market structure, the entire equity market structure. We haven't updated it in 16 years since 2005 and I think technology's changed so dramatically that it's worthwhile taking a very close look and seeing if we propose something now. In all of these areas as well as short selling, which I talked about earlier that I would anticipate we, we propose things because Congress has told us, mandated that we need to and these four areas I'd envision his staff is debating it, commissioners will weigh in, and then if we think so, we'll put it out to public comment. I, my, my hope is that we put it out and have a lively public debate and see what's best for the markets, and for the investing public.

CRAMER: Mr. Chairman, on page 12, page 6, “In order for a customer to trade options, broker dealers must conduct due diligence that option trading is appropriate for the individual customer.” Sir, Robinhood has millions of customers and there's no way they're doing that. I mean, isn't it time we examine that process?

GENSLER: Well, so it's, this is the, this is one of the challenges to get greater access, our user interfaces one our mobile phones have made it very efficient but then the question that you've just raised is also appropriate, is somebody on the other side looking as to whether, doing the due diligence as you say about that customer opening a higher risk account, an options trading account for instance or a margin trading account, and I think the staff appropriately flagged this issue.

PISANI: Mr. Chairman, I want to thank you for coming on and giving us your thoughts and we very much appreciate the work of your staff and laying out the facts and obviously this is a very important historical document in terms of what happened and we look forward to having you on again soon to let us know what the next steps are. Gary Gensler, Chairman of the SEC Thank you very much for joining us.

GENSLER: Thank you.

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Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver
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