Robinhood in Reverse (2): A Fall From Grace?
In recent years, short selling has been a game well played by the Wall Street whales — the big hedge funds, quant funds, and institutional investors. With the amount of information and resources and the size of positions these whales can hold, investors would usually panic and dump off their investments in the stock that the whales have announced to short. However, this isn’t the case anymore. Thanks to the creation of Reddit and Robinhood, the big whales now have to pay attention to a school of fish called the millennial investors. In the first episode of the series, we walked through Robinhood’s rise. In this episode, we’ll talk about the Robinhood-GameStop saga and its impact on Robinhood and retail investing.
GameStop Inc. is a struggling gaming retail franchise that has quickly been forgotten by the digital era. In fact, the company lives in the memories of many millennials as it was one of the most popular go-to game stores up till the mid 2010s. The Robinhood-GameStop saga could be traced back to when it appointed 3 new directors to join its board in the beginning of 2021. One of those directors is named Ryan Cohen, the co-founder and former CEO of the popular online pet product retailer Chewy. The appointment of Ryan Cohen quickly caught the eyes of many millennial investors as they believe this millennial entrepreneur is the savior to help turn GameStop around with his successful background in the eCommerce business.
Reddit users on the subreddit r/wallstreetbets started to actively discuss that the company might be severely undervalued with promising results from its eCommerce sales in its latest earnings report (GameStop’s eCommerce sales reported a 257% year-over-year increase). The subreddit forum also cited the bullish stance of Michael Burry, a famous hedge fund manager who rose to fame due to the movie “The Big Short”. However, as of January 2021, many institutional investors were still firm on their short positions in GameStop, including Citron Capital and Melvin Capital. It soon became a battle of the Wall Street giants and the every day investors in a David versus Goliath fashion.
Led by now legendary individual investor Keith Gill, retail investors from the community r/wallstreetbets gathered to drive up the company’s stock price, forcing the hedge funds out of their short positions. For the first time in stock market history, the retail investors brought down the Wall Street giants as one cohesive group. This is when major trading platforms like Robinhood and TD Ameritrade decided to step in and halted the trading activity involving the GameStop stock. Robinhood pointed to the intraday volatility as its main reason for the restriction, while TD Ameritrade acted in “the interest of mitigating risk”. By placing restrictions on buy orders and allowing sales of the stock, price volatility is controlled. In other words, the short sellers could prevent their losses to go even further.
According to Robinhood’s official statements, the company placed the restrictions because they wanted to “make sure their customers stay informed while the market was undergoing significant volatility”. In another official statement, Robinhood explained that their decision was based on following the deposit requirements at the clearinghouses that were designed to reduce risk. However, Reddit users quickly made allegations on the conflict of interest faced by Robinhood as they questioned the company’s relationship with Citadel Securities. As one of Robinhood’s biggest client and income source, Citadel Securities is a sister company to Citadel LLC, who is a majority shareholder in Melvin Capital. These allegations were later denied by both parties.
As you may already know from the headlines, many individual investors took their rage from this unequal treatment to both online and offline forms of protest. The biggest question that stems from this saga is whether this market is actually “free”. The hedge funds, quant funds, and institutional investors get to trade freely at their own will, but the individual investors have to play by the rules as these big players say so. Understanding volatility is crucial in investment strategies, but individual investors should also be able to make their own decisions. This is definitely not the kind of Robinhood people asked for.
After this incident, many millennial investors took home a great lesson about our financial system. One interesting phenomenon to note from this saga is the unprecedented trust among retail investors to help drive up the price and push for this movement together against one common enemy, as a typical investor in the past may just bail halfway through after making profits. This was the first time that retail investors showed that they could match up with institutional investors and said something significant about how the market dynamics will change with Millennials and Gen Zs taking over. However, will this phenomenon continue in the post COVID-19 era when businesses open up again? My guess is that we probably won’t see another incident like this for a very long time.
As to the question of whether our financial system is rigged or not, it won’t be an easy one to answer, especially when it could be traced back to the institutional differences in the systems that shape our economies and societies. Under a democratic system, the Department of the Treasury and the SEC will take steps to ensure the public’s interests are protected. But will these hearings and measures make the financial system more balanced and favorable to the general public? Highly unlikely. Going forward, Robinhood will still stand as the role model in all modern day financial innovators. It will just get back up from right where it fell off.
