Yesterday on February 18th, 2021, the US House Committee on Financial Services held the first in a series of online hearings that seek to clarify the events surrounding the activities of the subreddit r/WallStreetBets, which initiated a short squeeze to the detriment of several hedge funds and caused the popular trading application Robinhood to restrict buying certain stocks. The hearing was led by the committee’s chairwoman Maxine Waters (D), who stated:
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.
She expressed concerns that many Americans feel that the financial system on the capital market is stacked against them. Patrick McHenry (R), a ranking member of the committee agreed to this in his opening statement, advocating for less regulation that restricts trading opportunities to institutional investors:
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.
Robinhood Blames Clearinghouse for Trading Halt
In written statements handed in before the hearing, Kenneth Griffin, Founder and Principal Shareholder of Citadel Securities, Gabriel Plotkin, CIO of Melvin Capital Management, and Vlad Tenev, CEO of Robinhood, all denied any allegations of collusion that would have aided short sellers of GME and other stocks pumped by the subreddit.
Tenev also tried to explain the restrictions that made it possible to sell but not to buy the respective stocks.
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.
According to Tenev, the SEC-mandated collateral deposit requirements with their clearinghouse NSCC, jumped from 124 million USD on January 25th to 3.7 billion USD on January 28th, due to the increased buying demand and the increased volatility. Robinhood then decided to impose the restrictions to decrease the deposit deficit owed to NSCC.
While this statement is indeed credible, it does not match up with the initial explanation of Robinhood given by Robinhood. On January 28th, Robinhood announced on their social media accounts that they restricted the buying of certain stocks to protect their users from excessive volatility.
The committee Puts Robinhood’s Transparency Into Question
Maxine Waters was the first to raise objections against Tenev’s explanation, as their liquidity issue with NSCC was kept secret from the platform’s traders, also commenting about past issues concerning Robinhood’s security and transparency:
This liquidity problem had real consequences for your customers, but I wonder if they were all that surprised. Between December 2019 and December 2020, Robinhood customers experienced monetary losses due to system outages. Customer accounts were repeatedly compromised. The firm repeatedly failed to testify its best execution obligations and it mislead its customers regarding its revenue sources. It seems retail investors often get a bad deal on Robinhood.
Furthermore, Waters questioned Robinhood’s business model, which receives money from market makers for routing retail trades through them, rather than charging trading fees:
While you testified today that Robinhood’s customers benefit greatly from payment for order flow, in December 2020, the SEC charged Robinhood for not disclosing that it was getting paid to send customer trades to Citadel Securities and other market makers. Rather than seeking the best terms for its customers, Robinhood provided such inferior trade prices, which cost your customers over 34 million. Is it your testimony, after Robinhood paid the SEC 65 million to settle those charges, that this conflict of interest is in your customers’ best interest?
Furthermore, Citadel Securities, who advertise on their webpage that they handle 47% of the entire US-listed retail trading volume, has been questioned about their relationship with Robinhood and possible conflicts of interest:
Citadel Securities pays Robinhood tens of millions of Dollars to process trades by Robinhood’s customers. […] Your firm makes use of private exchanges called dark pools and other off-exchange trading to trade large sizes without moving the market against you. In fact, at some point last month, 50% of all trades occurred in dark pools or via OTC off-exchange trades. Your business strategy is designed intentionally to undermine market transparency and skim profits from companies and other investors.
In the hearing, Tenev has admitted that the lack of clear communication of their capital requirements and business practices was a mistake and apologized to Robinhood’s users, but many aspects of the relationship between retail trading apps, capital funds, and market makers are still unclear.