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GME and AMC: Legislators Concerned About Market Makers' Role

The House investigation of the meme stock trading activity has brought into question the role of market makers in retail trading.

The U.S. House Committee on Financial Services released an extensive and detailed report of a year-long investigation into what it has dubbed the January 2021 Meme Stock Market Event (MSME). Lawmakers expressed concern about the role of market makers in trading stocks such as GameStop  (GME) - Get GameStop Corporation Report, AMC Entertainment  (AMC) - Get AMC Entertainment Holdings Inc. Class A Report, and other meme plays.

Figure 1: GME and AMC: Legislators Concerned About Market Makers' Role

Figure 1: GME and AMC: Legislators Concerned About Market Makers' Role

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Market Makers Are a Key Issue

Since the January 2021 event, the committee has held a series of virtual hearings titled "Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide."

During the hearings, concerns were raised about the unbalanced concentration of trade execution by market makers.

The main concern is the fact that more than 40% of the trades in the U.S. were executed by a single market maker. According to Chairwoman Maxine Waters, the business strategy of certain market makers "is designed intentionally to undermine market transparency and skim profits from companies and other investors."

Another concern is that market makers can trade ahead of their clients due to having access to unfulfilled orders. In this way, market makers can take advantage of anticipating the movement of a stock with this first-hand data.

Finally, there is the concern that large market makers may be benefiting from the structural advantages of the market, mainly due to their significance in maintaining the functioning of the market and trading activities.

Where Do Retail Investors Stand?

According to Dennis Kelleher, president and CEO of Better Markets, retail investors end up getting the "worst deal" from such advantages that giant market makers have based on current market structures. Kelleher went on to say that only by balancing and creating a more transparent and fair system can retail investor confidence rise again.

SEC Chairman Gary Gensler emphasized the prohibition of trading in front of a customer order and also said that the payment per order flow (PFOF) model allows one or two market makers to dominate the retail trading market. And that can give these entities competitive advantages over the rest of the market — namely, retail investors.

Recently, the SEC proposed trading rules to scrutinize practices like PFOF and ensure greater competitiveness among wholesaler market makers. Proposals for order-by-order trading, if enacted, may promote greater transparency in trading. Also, new measures such as stricter requirements for brokers on data like monthly summaries of price movements would be made available for the benefit of retail investors.

The "Apes" Turn to Direct Registration

GameStop and AMC shareholders (a.k.a the "Apes") have been engaging through their social media communities and board rooms in a way to "shield" the influence of any questionable practices on their favorite stocks.

Even with the whole Meme Stock Market Event being debated at high legislative levels, GameStop and AMC investors are skeptical about market structures and have opted to directly register their shares through the Direct Registration System (DRS). This allows them to avoid having their shares under the custody of a brokerage firm.

This way, in theory, shareholders would be shielded from trading halts, having their shares lent to short sellers, or placed in the hands of market makers. GameStop reported in late April that 12.7 million of its common stock had already been registered with a major transfer agent, ComputerShare.

(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)