The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) seem to be racing each other to greenlight retail-facing financial products that are holographic images of stocks.  Most of the focus has been around tokenized stocks and prediction markets contracts on securities, but as of November 2, thanks to the one-person CFTC, we can add “perpetual futures” to the list.  None of these products come with the rights, protections, or market plumbing guardrails of stocks.  At the same time, America’s world-beating real capital markets—actual, not holographic, stocks and bonds—are driving the largest investment boom since the railroads. Are capital markets professionals and scholars seeing what’s at stake with that economic split screen?

Economically, stock tokens, prediction market contracts, and “perps” are more or less fancy names for the unprecedented offering of retail-facing security-based swaps.  During the 2008 financial crisis, swaps were at the center of the meltdown and bailout, and Congress, the SEC, and CFTC spent over a decade developing and implementing rules to promote fair, orderly, and efficient swaps trading that would promote—and not destroy—the economy. The SEC and CFTC are now essentially creating end-runs around their own rules and Congress’ clear directions to—on the fly—permit trading in highly leveraged bets on stocks without any of those traditional market protections.

Amazingly, the CFTC has emerged as an alternative universe for unregulated stock-like trading.  Already, the CFTC has allowed retail-facing prediction market contracts on events that are clearly security-based swaps—for which the agency has no regulatory authority.  But far more concerning, the CFTC has permitted its exchanges to offer “perpetual futures” on stocks—specifically on some of the most highly valued companies in the U.S. markets.  Chairman Selig is cheerleading this development.  The objections are coming from all quarters:  bipartisan members of the House and Senate (here and here), investor advocates, and market participants from SIFMA to CBOE to the Healthy Markets Association.  A new association has sued.

Stop to consider what perpetual futures on stocks means for the system.  Without regulatory plug-ins to the SEC’s reporting and surveillance systems, but with up to 20 times leverage and automated, 24-7 settlement, “perps” are a recipe for trouble.  As such, they are readily susceptible to manipulation, triggering potentially catastrophic market swings.  Their lack of reporting rules and disclosures make them ripe vehicles for insiders to dump positions.  And with the market capitalization and profits already highly concentrated in a small number of stocks, is it worth the risk of unleashing these new products on a handful of key stocks?  Is it too far-fetched to imagine the Dot-Com Crash, ‘08 Financial Crisis, the Flash Crash of 2010, and the Archegos Capital Management collapse all rolled into one, with a non-trivial sprinkling of insider trading?  And why, so an alternative holographic stock market can drain liquidity from the market where companies seek to raise the capital they need?

But highly levered stock holograms are not the only dramatic change to market plumbing underway.  The SEC has proposed repealing the heart of the National Market System—the Order Protection Rule—a rule put in place following the extraordinary antitrust scandal of market-maker collusion.  For more than 20 years, this critical investor protection role has structured competition among market intermediaries, like brokers and exchanges, to  limit economic waste.  That doesn’t just benefit investors, but also helps keep the market plumbing efficient so that funds can be deployed to the companies in which they invest.

But there’s more.  The SEC and CFTC are also unwinding the long-established rules preventing vertical integration, which will undermine pro-competition investor protections as well.  Preventing the same firms from being asset manager, broker, exchange, clearing firm, and custodian has been a source of competitive strength for the securities markets.  The collapse of FTX should remind us all that consolidated, vertically integrated intermediaries are a recipe for trouble.

The SEC is making the stock plumbing even more vulnerable to abuse by unwinding disclosures and audit protections that investors need to efficiently deploy capital.  Whether it be by reducing corporate reporting from quarterly to biannually, eliminating transparency around shareholder viewpoints (proposals), creating one-sided shareholder voting mechanisms, or squeezing and dismembering the Public Company Accounting Oversight Board (PCAOB)’s inspections and enforcement arms, the accumulated shortsightedness of this reduction in transparency and integrity, against the backdrop of the enormous economic transformation going on, is worth reflecting on.

For example, the PCAOB’s highly successful standard-setting, inspection, and enforcement programs were put in place following the Enron and Worldcom debacles.  If the PCAOB loses its balanced approach, and instead focuses too much on, say, quality control (QC) systems rather than audit and accounting compliance for individual audits, or fails to sufficiently dig into the audits of, say, circular financing mechanisms and related party transaction disclosures at AI-related and chip firms, major frauds will go undetected.  Think of the Wirecard scandal of 2019, which occurred outside of the PCAOB’s jurisdiction.  And if its enforcement program is entirely transferred to the SEC, the PCAOB’s ability to effectuate its mission of keeping audit systems honest will be lost.

Doing any of this, let alone all of this, at a time when the capital markets are driving the largest investment boom in American history, with already serious real-life risks arising from it, is the height of folly. Twenty years ago, the SEC and CFTC failed to rein in swaps that turned the housing boom and bust into a global meltdown.  Are we rushing down a path of repeating history?

The point of the capital markets is for capital to flow from investors to companies, and returns to flow from companies back to investors, as efficiently as possible, to maximize the bang for the buck and deliver economically useful outcomes from those investments over the long run.  Underneath it all, you want the stock market pipes not to leak.  Helping the regulators and market participants see the big picture may help us all to recognize that the midst of a once-in-a-century capital build-out is not the time to deregulate the very stock market that companies need to drive those investments and effectively mitigate risks.

Andy Green was a commissioner’s counsel at the SEC and board counsel at the PCAOB, senior advisor for fair and competitive markets at the Biden USDA, and staff director of the Senate Banking Committee’s Economic Policy Subcommittee.  As a principal at Center Market Strategies, Green works with the Healthy Markets Association on market structure matters, along with Bonnie Johnston. The views represented herein reflect the views of the authors. 

Saba Qamar was the PCAOB’s first investor advocate.  Her public career includes serving as a senior advisor at the Federal Deposit Insurance Corporation, as policy staff at the White House National Economic Council, and as a counsel at the House Financial Services Committee.

Bonnie Johnston helps guide clients through complex legislative and regulatory landscapes, specializing in investor protection and consumer advocacy.