Dave Lauer Profile picture
Jun 24, 2022 21 tweets 10 min read Read on X
The House Financial Services Committee released a 183 page report on what the events of early 2021 exposed in terms of market weaknesses, conflicted business models, and the various problems exposed by retail interest. I haven't read it yet, but will send out thoughts when I do.
Wow - moving those names to PCO was extremely effective in generating sell pressure and reducing collateral requirements. Image
As #WeTheInvestors have explained to the SEC and Congress, gamification is not the real issue here. The issue is a completely broken business model that puts brokers' interests at odds with their customers'. ImageImage
RH "did not incorporate best practices observations from FINRA for improving its stress tests nor did it utilize publicly available guidance from the DTCC for calculating collateral obligations."

Why is RH still allowed to operate? Constant fines and corrupt biz practices. Image
I honestly find this key finding to be very damning. Why was the DTCC doing this? What if they had been wrong? Why could they made ad hoc decisions like this? What systemic risk did they introduce by doing this? Undercapitalized firms put entire system at risk, why bail one out? Image
Again in the report we read about how the NSCC regularly waives capital charges. This could be due to a flawed margin calculator that overprices volatility, but if that's the case then why isn't it being fixed? Instead these ad hoc interventions introduce systemic risk. Image
I feel like I'm going to keep screaming about this - undercapitalized brokers (ESPECIALLY ones offering free trading) represent a huge systemic risk to markets. Willful ignorance (or just straight up ignorance) should be enough for FINRA to revoke their B/D licenses. Image
This paragraph really downplays the level of dependence and concentration in markets. Citadel bragged that they were the only firm left executing trades during the big run - that's a massive risk to markets, and not something to be proud of. We shouldn't be dependent on one firm. Image
Overall this is a great thread summarizing the entire report. I'm just going to go through and give my reactions, not try to summarize it as well as here:
Standard response from Congress - go study the problem! Also looks like Congress wants more trading halts.

That said, @jschwall1 will be thrilled at this recommendation that internalizers be subjected to Reg SCI. It's about damn time. ImageImage
@jschwall1 I like the first two recommendations getting the SEC more involved in liquidity rules and management. But the rest of these depends on conflicted SROs that have already proven incapable of policing the firms who pay them. This SRO model is completely broken, it's time to overhaul Image
@jschwall1 I mean this in all constructive seriousness - WHAT THE ACTUAL FUCK @FINRA? This is how we are policing brokers? Oral observations with no evidence, follow-up or repercussions? I can't believe this isn't a joke.

(this tweet might get me kicked off the committee I volunteer on) Image
Well that's a completely surprising result of an ORAL OBSERVATION, I could never have seen that happening. Image
OK - coming back to this report, will be posting some more thoughts throughout the day when I have time. FINRA's oral "advice" to RH would have left them in far better shape to manage through the volatility, and highlights a rule deficiency for liquidity planning. Image
This overall explanation is in-line with my conversations with industry experts - the NSCC margin calculator combined with RH's lack of sufficient capitalization (and that of other brokers - including many Apex customers, as we'll read later) resulted in the PCO restriction. Image
These internal conversations about whether RH could handle their scale are something else. Maybe infrastructure investments are a good idea when your entire business model is getting clients to trade as much as possible. ImageImageImage
"We're supposed to support the retail" Image
Something we don't talk about much is how RH's PFOF model is DOUBLY corrupt. By calculating PFOF based on spread, they are not just incentivized to get their clients to trade more - they also want them trading higher spread, less liquid names. It's a disgusting business model. ImageImageImage
The entire section on RH strong-arming Wolverine and threatening other middlemen is eye opening. Pushing these firms to ignore their own risk constraints or lose the most lucrative business is not how you want markets to run. RH has too much power. ImageImage
Neat how the NSCC recognized the potential for systemic risk, and decided to waive many liquidity charges. Just shows you that TBTF is alive and well - get big fast, and be confident that the rules won't apply to you. ImageImage

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More from @dlauer

Sep 12, 2023
Today @GaryGensler will be testifying before the Senate Banking Committee at 10am ET. You can watch the livestream here:

His written testimony is here:

The testimony is written at a very high level, but gives a good overview of the full scope of the SEC's activities and current agenda. I'd encourage everyone to take a look - and importantly the equity market structure reforms that we care so much about are the first agenda items addressed.banking.senate.gov/hearings/09/06…
banking.senate.gov/imo/media/doc/…
@GaryGensler First question from Sen Crapo is about MMTLP - he is asking whether the SEC is reviewing the trading halt, and whether the SEC will release the results of the investigation.

Gensler answers that FINRA rules govern this issue, and that the SEC was not involved.
@GaryGensler Crapo asks whether MMTLP situation has been analyzed for naked shorting, fraud or wrongdoing. Will blue sheets be released or a share count?

Gensler: We cannot comment on ongoing investigations. I will follow-up with staff about these data requests.
Read 16 tweets
Dec 20, 2022
This is my shocked face. We said exactly this to the SEC in our June meeting, because it was admitted by a big wholesaler on CNBC. Image
So... maybe... I dunno... eliminate rebates and PFOF? Image
Turns out, when wholesalers execute orders at a price worse than the midpoint, 75% of the time there's midpoint liquidity on-exchange. Now start routing orders there and reduce adverse selection, and that number will go up significantly. Image
Read 6 tweets
Dec 14, 2022
Open Meeting has just moved on to the new equity market structure reforms, starting with Rule 605.
Big changes to Rule 605 will provide far more transparency on execution quality by broker and market center. This update is first in over 20 years and long overdue.

First - it's extended to brokers with > 100k customer accounts (retail brokers).
Second, 605 reports will be dis-aggregated to produce separate reports for various types of orders, such as retail, institutional, retail auctions, and odd lots.

Third, standardized human readable summary reports will be required - excellent addition.
Read 16 tweets
Dec 14, 2022
SEC open meeting getting ready to begin here:
sec.gov/news/upcoming-…

🧵A high-level thread with our initial view of the proposed rules, which are split into four proposals.
1. Changes to Rule 605 that will modernize execution quality disclosures and extend those disclosures to retail brokers.
This means brokers will finally have to publish standardized execution quality metrics that we can use to compare how good of a job they’re doing at executing orders, and what kind of execution quality they’re getting from their counterparties.
Read 14 tweets
Dec 14, 2022
Today the SEC proposed the most significant changes to US market structure since Regulation NMS was passed, in 2005. These proposals incorporate many of the ideas that we - #WeTheInvestors - presented to the SEC earlier and repeatedly this year.
#WeTheInvestors have had a significant impact on the SEC’s actions - through our dialogue, our proposals, and our presence. These rule proposals are the culmination of those efforts.
But these proposals are only the beginning. Over the coming weeks, We The Investors plans to take seven action steps:
1. Read more than 1,600 pages of rule proposals. Yikes!
Read 13 tweets
Dec 13, 2022
It's going to be quite a day today! SDNY will unseal their indictment and the FTX hearing in the House will be even more interesting now. SEC has also charged SBF with securities law violations, complaint here: sec.gov/litigation/com…
The SEC complaint doesn't tell us much we didn't already know, but really lays it out simply. He diverted customer funds, Alameda had unlimited credit lines against customer funds and when Alameda couldn't satisfy their loans they raided more customer funds.
Nice use of scare quotes there SEC - it's not a loan if you have no intention of paying it back. Now, the ponzi scheme part of all of this is that maybe he thought he could pay it back with more customer funds, but doesn't much matter. Lotta fraud here, everywhere you look.
Read 7 tweets

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