On Friday, the House Financial Services Committee released a report on the 2021 stock market drama surrounding Reddit’s WallStreetBets, the trading app Robinhood Markets Inc (NASDAQ: NASDAQ:HOOD), trading firm Citadel Securities and high-flying stocks like GameStop Corp . (NYSE: NYSE:GME).
What Happened? Congresswoman Maxine Waters (D-CA), chairwoman of the HFSC, released a new report entitled “Game Stopped: How the Meme Stock Market Event Exposed Troubling Business Practices, Inadequate Risk Management, and the Need for Regulatory and Legislative Reform.”
Related Link: SEC Chair Gensler Proposes 'Open And Transparent Auctions' As Alternative To Controversial Payment For Order Flow
In the report, Waters specifically highlights four main findings from its investigation into the meme stock trading frenzy:
- Robinhood exhibited "troubling business practices, inadequate risk management, and a culture that prioritized rapid growth above stability."
- Broker-dealers experiencing the most severe liquidity issues enacted the most expansive meme stock trading restrictions.
- Most firms the HFSC spoke with have no plans to change their policies in the wake of the meme stock fiasco.
- The Depository Trust & Clearing Corporation waived $9.7 billion of collateral deposit requirements on Jan. 28, 2021. The DTCC has no detailed, written policies outlining procedures for these types of waivers.
"The report corroborates that the decisions and requests Robinhood made and waivers granted were generally the same decisions, requests and waivers made and granted by others in the industry. We remain confident that we took the appropriate and responsible steps necessary to protect and support our customers."
Waters On Payment For Order Flow: Waters specifically addressed the controversial practice of payment for order flow, or PFOF.
"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. The report makes clear that significant legislative and regulatory reforms are needed to modernize the regulatory framework for protecting the market and ensuring that the events on January 28, 2021, do not happen again," she said.
GameStop Saga: WallStreetBets users coordinated a massive pump-and-dump strategy targeting GameStop and other highly shorted stocks in January 2021 by leveraging the power of an option market gamma squeeze and a short squeeze.
By aggressively buying out-of-the-money call options and shares of the underlying stocks, these retail traders forced a positive feedback loop of buying volume from momentum traders, institutional hedging and hedge fund short covering. As a result, GameStop shares skyrocketed from under $20 to as high as $483 in a matter of days in January 2021.
Losses at Melvin Capital got so bad that the hedge fund required a $2-billion investment from Citadel, a separate hedge fund business from market maker Citadel Securities, which also pays Robinhood for its order flow.
Robinhood subsequently banned and restricted buying of GameStop, a decision that prompted more than 30 user lawsuits. Robinhood said the decision to restrict trading was not influenced by Citadel or any other customer and was simply made to protect its users from potential losses.
In February 2021, the HFSC held a hearing to investigate the extreme volatility in GameStop and Robinhood’s subsequent decision to temporarily limit buying of so-called “meme” stocks.
The latest report comes after U.S. Congressman Sean Casten’s (D-IL) "Trading Isn’t a Game Act passed out of the HFSC in July 2021. In the report, Casten condemned the so-called "gamification" of trading by Robinhood and other brokers.
"Robinhood continues to function like a virtual casino gamified to harness human psychology – where market makers are the House – designed to drive frequent, short duration, Roulette-like trades, ready to extract fast money from investors against their best interest," Casten said at the time.
Benzinga's Take: The new report comes after U.S. Securities and Exchange Commission Chair Gary Gensler said earlier this month the SEC is exploring a new requirement for brokers to submit retail investor orders to a new auction process through which firms will bid against each other to fill them.
Shares of Robinhood rallied off their lows following Gensler's speech because the SEC chair made clear the regulator is seemingly a long way from an official policy change that would ban PFOF.
Photo: Created with an image from Gage Skidmore on Flickr.
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