The Robinhood Hearing -Part 1: Opening Statements and Testimonies
On February 18th 2021, the US House Committee on Financial Services assembled for a virtual hearing titled Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide. Subject of the hearing were of course the events around January 28th when several stocks pumped fuelled by the r/WallStreetBets subreddit.
The committee wanted to identify which players contributed in which way to the events, why the trading app Robinhood restricted trading on these stocks, and which implications the relationships between trading apps, market makers, and hedge funds have on the fair distribution of power on the US stock market.
Bipartisan Support for Retail Investors
The hearing was opened by Chairwoman Maxine Waters (D), who said:
I want to know how each of the witnesses here today and the companies they represent contributed to the historic trading events in January. This recent volatility has put a national spotlight on institutional practices by Wall Street firms and prompted discussion about the evolving role of technology, social media and our markets. These events have denominated potential conflicts of interest and the predatory ways that certain funds operate and they have demonstrated the enormous potential power of social media in our markets. They have also raised issues involving gamification of trading, potential harm to retail investors and the business model of apps with retail investors as their users.
She also commented on the perceived inequity between institutional capital and retail investors:
Many Americans feel that the system is stacked against them and no matter what, Wall Street always wins. In this instance, many retail investors appeared motivated by a desire to beat Wall Street at its own game. Policies like the accredited investor definition blatantly pick winners and losers. If you’re wealthy, you’re good to go and if you’re not, you’re deemed too dumb to be trusted with your own money.
Her opening statement was followed by one of the committees ranking members, Patrick McHenry (R), who agrees on this point:
The sad truth is, the K-shaped economy is nothing new in our capital markets, because the structural core of our regulations literally enshrined inequity. [...] In the eyes of our government, you need to be protected. Protected from your own decisions, protected from your own money. Protected from more opportunities. So you’re left with a savings account, which pays no interest and if you need more money than that, well we create a world where it’s easier to buy a lottery ticket than it is to invest in the next Google.
He stated that retail investors are by far more sophisticated than regulators commonly assume and advocated for less regulations that restrict their trading opportunities:
It’s time we get serious about equity and ownership in the American economy. We should live in a world where a construction worker or Uber driver trading on Robinhood has the same access to equity shares as the white-collar employees who work there. The same goes for Reddit and Reddit users.
DeepFuckingValue: “WallStreetBets on Reddit are leveling the playing field”
Prior to the hearing, all six witnesses, who testified under oath, had the opportunity to hand in a written statement. As a representative for r/WallStreetBets, Keith Gill aka DeepFuckingValue testified, explaining his reasoning behind buying GameStop shares:
As an individual investor, I use publicly available information to study the market and the value of specific companies. I consider a complex array of factors and track hundreds of stocks - all in search of market inefficiencies. […] I did that with GameStop. I believed the company was dramatically undervalued by the market. The prevailing analysis about GameStop’s impending doom was simply wrong.
He also explained his activities on the subreddit:
My investment skills had reached a level where I felt sharing them publicly could help others. I also thought that by sharing my own ideas and accepting critiques, I would be able to identify holes in my analysis. Hedge funds and other Wall Street firms have teams of analysts working together to compile research and critique investment ideas, while individual investors have not had that advantage. Social media platforms like YouTube, Twitter, and WallStreetBets on Reddit are leveling the playing field.
Steve Huffman, Co-Founder & CEO of Reddit, also commented on the events in January:
A few weeks ago, we saw the power of community in general and of this community in particular when the traders of WallStreetBets banded together at first to seize an investment opportunity not usually accessible to retail investors, but later more broadly to defend all retail investors against the criticism of the financial establishment.
Jennifer J. Schulp, Director of Financial Regulation Studies at the Cato Institute’s Center for Monetary and Financial Alternatives, welcomed the new trading opportunities for retail investors:
The increased participation by retail investors in equities markets is positive news for both investors themselves and the markets. Opportunities for individuals to grow their own wealth should be welcomed and expanded, not restricted.
According to her, there is little evidence against Reddit and WallStreetBets:
The SEC will probe whether any trading was the result of “abusive or manipulative trading activity” that is prohibited by the federal securities laws, which generally require, with good reason, some sort of fraud or deception. There’s been little evidence of such misconduct to this point, but the SEC will have access to more information to evaluate the legality of the trading. The SEC also will probe whether any actions by regulated entities, like brokerages or hedge funds, took action “that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.”
Why did Robinhood restrict trading?
Both Kenneth Griffin, Founder and Principal Shareholder of Citadel Securities, and Gabriel Plotkin, Founder and Chief Investment Officer at Melvin Capital Management, denied the allegations of collusion in the wake of the trading activities of January 28th. Plotkin also testified that he closed out of all short positions prior to the trading restrictions and explained the capital injection by Citadel into Melvin Capital:
I also want to make clear at the outset that contrary to many reports, Melvin Capital was not “bailed out” in the midst of these events. Citadel proactively reached out to become a new investor, similar to the investments others make in our fund. It was an opportunity for Citadel to “buy low” and earn returns for its investors if and when our fund’s value went up.
Vlad Tenev, co-founder and CEO of Robinhood also denies having colluded with Citadel, Melvin, and other hedge funds, calling the allegations a “market-distorting rhetoric”:
The trading limits we put in place on GameStop and other stocks were necessary to allow us to continue to meet the clearinghouse deposit requirements that we pay to support customer trading on our platform. We have since taken steps to raise $3.4 billion in additional capital to allow our customers to resume normal trading across Robinhood’s platform, including trading in the stocks we restricted on January 28.
He blames the clearinghouse NSCC for the restrictions after Robinhood fell short by over 3 billion USD in collateral requirements due to the increased number of buy orders and the increased volatility. By his account, the problems came about due to the two-day trade settlement period which require broker-dealers to deposit collateral at their clearinghouse in order to counterbalance the settlement risk:
There is no reason why the greatest financial system the world has ever seen cannot settle trades in real time. Doing so would greatly mitigate the risk that such processing poses. Indeed, realtime settlement would have allowed Robinhood Securities to better react to periods of increased volatility in the markets without restricting the purchasing of securities.
After the witnesses gave their opening statement, Waters and other members were given time to ask questions. In part II of this series, I will go into detail on the accusations the House Committee has made against Robinhood.
