Meme stocks exposed bad business practices, poor risk management, House committee says: Wealthtech Weekly

June 24, 2022 2:27 PM

Representative Maxine Waters, a Democrat from California and ranking member of the House Financial Services Committee, questions witnesses during a hearing in Washington, D.C., U.S., on Wednesday, Oct. 25, 2017

A federal investigation into the meme stock frenzy that gripped Reddit investors in early 2021 has led to a host of recommended policy changes from the House Committee on Financial Services and calls for better treatment of all retail investors.

The majority staff report titled “Game Stopped” was released Friday by Committee Chair Maxine Waters, a Democrat from California, and Al Green, a Democrat from Texas who serves as chair of the Subcommittee on Oversight and Investigations.

According to officials, the combination of institutional investors betting against meme stocks and retail traders purchasing them en masse created a trading frenzy that drove historic market volatility that reached its peak in January.

In response, Waters called for a federal probe of the circumstances and practices that led to the volatility.

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“Last year’s meme stock market frenzy raised important questions about the fairness of our financial markets, the gamification of trading, the treatment of retail investors and so much more,” Water said in a statement. “In response to those events, my committee held multiple hearings — including the first of them with CEOs from Robinhood, Citadel Securities and many others — to get to the bottom of the role these companies played in the volatility and disruption in the stock market in January 2021.”

The 138-page report released this week is the result of a 16-month committee staff investigation that included more than 50 interviews with representatives from 19 financial institutions and the analysis of more than 95,000 pages of documents.

Waters said the investigation revealed the need for better market regulation to address the “troubling business practices that were uncovered.”

“Payment for order flow and gamification make it profitable for a new generation of trading apps to push retail investors to make as many trades as possible, making the markets more volatile than ever,” Water said, noting that significant legislative and regulatory reforms are needed to modernize the regulatory framework protecting the market and ensuring that this kind of frenzy won’t happen again.

Four key findings were unearthed via the investigation, including the committee determining that Robinhood exhibited troubling business practices, inadequate risk management and a culture that prioritized rapid growth above stability.

“Robinhood’s disproportionately high order flow and unique formula for calculating PFOF rebates strained several market makers and introduced risk to the stock market. Robinhood’s PFOF formula became a point of contention between Robinhood and Citadel Securities during the meme stock market event,” the report said. “Robinhood asserted to the public and testified to the committee that the company was ‘always comfortable with [its] liquidity’ leading up to its historic trading restrictions, despite the actions undertaken by Robinhood’s executive leadership to respond to liquidity issues it faced in the days leading up to the meme stock market event.”

The committee also found that broker-dealers facing the most severe operational and liquidity concern executed the most expansive trading restrictions amid the frenzy; that most of the firms they spoke to lack explicit plans to change their policies for how they will meet their collateral requirements during extreme market volatility; and that the Depository Trust & Clearing Corporation does not have detailed, written policies and procedures for waiver or modification of a "disincentive” charge it calculates for brokers that are deemed to be undercapitalized.

The DTCC, which waived $9.7 billion of collateral deposit requirements in late January 2021, has regularly waived such charges during periods of acute volatility in the two years before the meme stock event, according to the study.

The committee staff recommends policy changes so that regulators “can better understand the influx of retail traders; enhance supervision of retail facing “superbrokers”; and strengthen capital and liquidity requirements and oversight.”

“The report reached multiple key conclusions, including the finding of existing deficiencies with the current market regulatory structure,” Green said in a statement. “My hope is that the report’s findings will lead to improvements in the functioning and regulation of the U.S. securities markets and result in a more fair and secure system for all investors.”

The full report can be found here.

Scroll down to get caught up on other recent tech news you might have missed in our Wealthtech Weekly recap.

Wealthramp and Smart Kx teaming up to help advisors automate fee calculations for improved accuracy, compliance

Financial advisor matching platform Wealthramp has entered a new partnership with intelligent billing and contract system Smart Kx to help advisors with fee calculations.

Officials said starting this week, fee-only financial advisors on the Wealthramp network that leverage the collaboration will improve fee calculations in their portfolio management systems and eliminate manual processing and compliance risks.

The companies say this will allow advisors to spend more time with clients and manage a more efficient practice. The SEC’s Division of Examination reviews whether RIAs have adopted and are following policies and procedures that result in charging fair and accurate fees. RIAs are also required to sufficiently communicate with clients so they understand costs associated with their services.

Last November the SEC conducted 130 examinations and identified deficiencies in nearly all of the reviews, according to leaders from Wealthramp and Smart Kx. Industry experts estimate that fees and client agreements are inconsistent between about 50% and 60% of the time.

“Fees have always been an issue in the industry, with the onus largely on the individual investor to understand and audit what their advisor is charging,” Smart Kx CEO Lacey Shrum, a former chief compliance officer, said in a statement. “In our current market with inflation adding pressure, clients will be more diligent in reviewing how much they are paying and the calculation accuracy. Now more than ever, RIAs want to spend time building deeper relationships with clients and prospects, not worrying about or defending their incorrect fee calculations.”

Smart Kx automates fee calculations the moment an advisor begins working with a client. The platform ensures individual client fees are documented and aligned with fee disclosures at all times, preventing overbilling or underbilling.

Because Smart Kx was built to calculate the fee directly off of the client fee agreement, audit requirements are reduced and grants the advisor control and insight over revenue.

Wealthramp will also begin using Smart Kx for its own billing, and the two companies will deliver educational content and resources to help advisors identify any discrepancies in their current processes.

“A lot of advisors say they are client-first, and Wealthramp and the advisors on its network are actually living up to this mission,” Shrum said in a statement. “The fact that the company is women-led makes this collaboration even more meaningful.”

“I created Wealthramp because I was disappointed with how the industry incentivizes selling and promotes ‘advisors’ who don’t act in their clients’ best interest,” Pam Krueger, founder and CEO of Wealthramp, added. “People deserve much better, which is why we vet every advisor on our network to ensure they are true fiduciaries. The problem is even fee-conscious advisors can struggle with manual processes and billing errors that limit their ability to give clients peace of mind.

“We’ve been tracking the SEC’s reports and hearing directly from advisors who are looking for solutions to help eliminate this issue, and the response for Smart Kx has been overwhelmingly positive.”

Bank of America makes strategic investment in alternative investment platform iCapital

iCapital, a global fintech platform driving access and efficiency in alternative investing for the asset and wealth management industries, has announced that Bank of America has made a strategic investment in the company.

While the terms of the investment have not been disclosed, officials say it deepens a partnership that began in 2018. iCapital will use the investment to bolster the technical capabilities of its global alternative investing solution that supports more than $130 billion in platform assets.

Bank of America invested in iCapital at the same $6 billion valuation as iCapital's last funding round in December 2021.

It’s also another milestone in the relationship between iCapital and BofA. In March 2019, iCapital acquired Bank of America’s alternative investment feeder fund operations, allowing Bank of America to streamline and automate ongoing fund operations and administration services for Merrill and Private Bank advisors.

“We are honored to have the support of Bank of America to further iCapital’s mission to provide financial advisors with a complete alternative investing solution,” Lawrence Calcano, chairman and CEO of iCapital said in a statement.

Nancy Fahmy, head of alternative investments, specialty asset management and investment solutions specialists for Bank of America, said the two organizations share the belief that “alternative investments are an important component of a well-diversified portfolio, and it is critical to increase access, education and service to advisors and their clients.”

BNY Mellon's Pershing introduces next generation advisor platform at INSITE 2022

During its flagship annual conference held last week in Texas, BNY Mellon's Pershing unveiled a new advisor platform and enhancements to its NetXServices integration portal.

Called NetX360+, the next-generation platform was crafted to work as a personal digital partner to advisors, according to Tim Foley, managing director of technology at Pershing. Highlights include a more streamlined user interface and more intuitive experience.

“The more you engage with it, the more it will provide a curated experience, including insights tailored just for you,” Foley said in a statement. “We have an incredible wealth of data that we're using to make the experience smarter, more personalized and more intuitive. It's extremely powerful, spotlighting better ways to serve your clients and targeted opportunities to grow your business."

Officials said the platform will offer “hyper-personalization” based on individual user profile and usage patterns; machine learning-driven search results for faster access to relevant data; new data insights based on client behavior and market activity that highlight recommended next best actions; and integrated learning via a digital adoption platform to help users achieve greater proficiency.

Meanwhile, Pershing’s NetXServices Integration Portal has been enhanced with easier access to its integration capabilities. In addition, the portal has been updated with a complete API set, including two new options designed to deliver real-time data access and convenient self-service.