SEC says brokers enticed by payment for order flow are making trading into a game to lure investors

The Securities and Exchange Commission said online brokerages, enticed to increase revenue through the controversial industry practice of payment for order flow, are turning stock-trading into a game in order to encourage activity from retail investors.

Wall Street’s main regulator on Monday released its highly anticipated report on the GameStop mania earlier this year. The 44-page report detailed how the trading frenzy went down and raised red flags on a number of issues, including the back-end payments that brokerages receive, gamification of trading, as well as disclosures on short sales. But it stopped short of laying blame on a single cause or entity.

“Payment for order flow and the incentives it creates may cause broker-dealers to find novel ways to increase customer trading, including through the use of digital engagement practices,” SEC officials said in the report.

Payment for order flow is one of the largest revenue sources at Robinhood, the millennial-favored stock trading app that raked in a record number of new customers over the past year and went public in August. The practice, though, is under increased scrutiny as many say it has a conflict of interest with brokerages incentivized to send orders to the market-maker that pays them the biggest rebate. SEC chair Gary Gensler had warned that banning this practice is not off the table.

To motivate trading, some brokers including Robinhood made their platforms visually enticing and offer game-like features such as points, rewards, leaderboards and bonuses to increase engagement. Amid criticism, Robinhood got rid of its confetti animation in March.

“Consideration should be given to whether game-like features and celebratory animations that are likely intended to create positive feedback from trading lead investors to trade more than they would otherwise,” the report said.

Still, the SEC review may fall short to some in terms of making concrete recommendations and laying the groundwork for potential changes to U.S. trading practices. The agency also didn’t reach a conclusion as to whether any of the trading — and the restrictions on trading — was manipulative and whether brokerages played by the rules during the mania.

The agency acknowledge that the extreme volatility in meme stocks tested the capacity and resiliency of the markets.

At the height of the mania in January, a band of amateur traders in Reddit’s WallStreetBets forum bid up heavily shorted stocks “to the moon,” creating massive short squeezes in names like GameStop and AMC. The unprecedented volatility backfired on Robinhood, which had to tap credit lines and restrict trading in a list of the short-squeeze names as the central Wall Street clearinghouse at one point mandated a ten-fold increase in the firm’s deposit requirements.

“This episode highlights the integral role clearing plays in risk management for equity trading, but raises questions about the possible effects of acute margin calls on more thinly-capitalized broker-dealers and other means of reducing their risks,” SEC’s report said. “One method to mitigate the systemic risk posed by such entities to the clearinghouse and other participants is to shorten the settlement cycle.”

The SEC also brought up whether more transparency of short selling should be required. Right now, securities lending and borrowing is a relatively opaque system as investors aren’t required to report their bearish bets and the SEC only collects data on how much of a company’s stock is sold short.

“The interplay between shorting and price dynamics is more complex than these narratives would suggest,” SEC officials said in the report. “Improved reporting of short sales would allow regulators to better track these dynamics.”