By Dave Michaels and Paul Kiernan

WASHINGTON -- The trading mania around shares of companies like GameStop Corp. this week poses a dilemma for Gary Gensler, the Biden administration's choice to head the Securities and Exchange Commission: While broadening investor participation, the stampede also poses new risks that could spread to other participants.

The SEC generally encourages greater involvement of retail investors. But as more individuals become short-term speculators trading on momentum signals and not much else, the agency could come in for blame when bubbles burst and investors are saddled with losses. There are also implications for the brokerage business, which feeds off the higher demand and can be hobbled by the volatility it creates.

The SEC said Friday that it would examine whether any traders manipulated prices by exhorting others on social-media websites to buy the trendy stocks. The upheaval occurs at a time when Congress has questioned the regulator's supervision of the retail investing landscape.

"There are problems emerging that are going to have to be dealt with, and my guess is Gary Gensler will want recommendations on his desk when he walks in on the first day," said Mark Berman, a regulatory consultant and former SEC official.

Since stepping down from his role leading the Commodity Futures Trading Commission in early 2014, Mr. Gensler has been teaching finance at the Massachusetts Institute of Technology and writing about financial-technology innovation, including the rise of cryptocurrencies such as bitcoin.

A different trend appears to be at work this week: the combination of social media and financial technology that makes it easier and cheaper to trade. SEC officials who briefed House lawmakers this week said that social media isn't a new factor in trading but has become a more important driver in retail investing, according to a person familiar with the meeting.

A younger generation of traders has shunned traditional gatekeepers -- brokers who give advice over the phone or in person -- in favor of making their own decisions about which securities to buy.

Inexperienced investors looking for trading ideas can ride the momentum created by communities such as Reddit's WallStreetBets, where gung-ho traders goad one another to buy shares and hold them until the price goes "to the moon," as the traders often say. Their tolerance for losses is high, and many participants revel in buying stocks that are disfavored by bigger investors such as hedge funds.

Trading platforms such as Robinhood Markets Inc. have benefited. Robinhood doesn't charge commissions, and its "gamification" features celebrate trading with digital confetti and enable push notifications that keep the market on users' minds.

This week's surge in trading temporarily prompted Robinhood to prevent customers from buying some of the most popular stocks. The firm said it made the move for risk-management reasons. Robinhood and other online brokers were asked to provide more cash to clearinghouses to cover transactions.

The four-member SEC said Friday it would closely review the firms' explanations for their moves to limit trading.

SEC rules were updated in 2019 to require stockbrokers to act in the best interests of investors when providing investment advice. But Robinhood, Charles Schwab Corp. and other online trading platforms avoid such rules when they enable investors to buy and sell shares on their own, without the intermediation of a broker.

Democratic lawmakers have said the rules are too weak, mainly because they didn't ban many conflicts of interest that brokers face. Democrats are likely to have more influence over the SEC's agenda because they will control relevant committees in both the House and the Senate.

"These wild fluctuations are just the latest indication that many private-equity firms, hedge funds, and other investors, big and small, are treating the stock market like a casino, giving little consideration to the companies, communities, workers, and consumers that may be affected by these risky bets," Sen. Elizabeth Warren (D., Mass.) wrote Friday in a letter to the SEC.

Sen. Sherrod Brown (D., Ohio), who will take over as chairman of the Senate Banking Committee, which oversees the SEC, said this week he would convene a hearing to examine the tumult and the commission's supervision.

His counterpart in the House, Rep. Maxine Waters (D., Calif.), chairwoman of the Financial Services Committee, said Thursday she will hold a hearing.

"We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility," she said in a statement.

But Sen. Pat Toomey (R., Pa.) said low-cost trading platforms have largely been a positive development for smaller investors and urged restraint.

"When examining this episode, regulators and Congress should tread with extreme caution and avoid needlessly inserting themselves into equity markets," Mr. Toomey said in a statement.

Barbara Roper, director of investor protection at the Consumer Federation of America, said the GameStop episode suggests rules ought to be updated to account for brokers' ability to drive investor behavior using psychological cues rather than outright recommendations.

"They have these nudges that are designed to encourage conduct that is profitable for the firm and not necessarily good for their customers," Ms. Roper said. "The companies need to be accountable for their nudges."

One of Mr. Gensler's recent MIT lectures looked at Robinhood, Charles Schwab and other firms that offer free trading, a trend he traced to the abolition of fixed commission rates in the 1970s, according to a video of the class available online.

Mr. Gensler didn't criticize Robinhood in his lecture but explained how its growth influenced other brokers to copy its pricing model.

"What we've found whether it is in Facebook or many other online applications outside of the financial world, it is zero fee," Mr. Gensler said in the lecture. "And then the business model is earning money is some other way."

Mr. Gensler didn't respond to a voice-mail message seeking comment Friday.

With commissions at zero, online brokers have to make money other ways. One is to sell customers' orders to high-speed traders, which execute them like a stock exchange would. The speedy traders have profitable ways to trade with mom-and-pop orders and get deeper insight into market demand.

The SEC is short handed following the departure of former Chairman Jay Clayton and many of his senior staff. The acting chair, Democratic commissioner Allison Herren Lee, made a brief statement about the market turmoil for the first time on Wednesday.

Ms. Lee's office didn't immediately respond to a request for comment. It is unclear how soon Mr. Gensler will get a confirmation hearing, where senators are likely to question him about this week's events.

"She's got an awkward position being acting chair, and that is got to have a limiting effect," said James Cox, a law professor at Duke University. "It means all the more reason to try and accelerate the confirmation for Gensler and get his staff in."

--Siobhan Hughes and Orla McCaffrey contributed to this article.

Write to Dave Michaels at dave.michaels@wsj.com and Paul Kiernan at paul.kiernan@wsj.com

(END) Dow Jones Newswires

01-29-21 1815ET