Summary
With that, we close the six-hour hearing on the legal and financial ramifications of the massive buy-up of stocks that threatened to upend the US financial system.
Main issues brought up today include the gamification and ease of access for trading brought by Robinhood’s app, and the mental health and financial implications of that. Repeatedly the suicide was mentioned of one Robinhood user who believed he had racked up hundreds of thousands of dollars in debt. Lawmakers say Robinhood needs better protections and customer service for users who need support.
Many lawmakers also mentioned payment for order flow, a controversial practice pioneered by Bernie Madoff. Through the practice, stockbrokers get a kickback for essentially selling the ability to execute trades.
Tenev said in the hearing that around 50% of Robinhood profit comes from payment for order flow. Some legislators questioned whether it should be allowed, while others, in particular Alexandria Ocasio-Cortez, suggested such gains should be passed on to customers rather than pocketed by Robinhood and its rich cohorts like hedge fund managers.
Still others suggested taxing these transactions in general. Rashida Tlaib said a 0.1% tax on financial transactions would discourage high risk trading while raising more than $800bn for taxpayers in the next ten years alone.
Maxine Waters, chairwoman of the committee which assembled the hearing, said there will be at least two hearings investigating the GameStop incident.
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AOC: Robinhood should pass more profits to its users
Alexandria Ocasio-Cortez also zeroed in on the payment for order flow financial model Robinhood uses in her questioning.
Earlier during questioning, Tenev revealed that more than half of Robinhood’s revenue comes from payment for order flow, a controversial practice in which stockbrokers get a kickback for essentially selling the ability to execute trades. Ocasio-Cortez noted that the practice obscures the true costs of trade from users.
“Would you be willing to commit today to voluntarily pass on the proceeds of the payment for order flow to Robinhood customers?” she asked.
Tenev avoided answering the question, saying that Robinhood is a “for-profit business and needs to generate some revenue to pay for the costs of running this business”.
.@AOC asks if Mr. Tenev will voluntarily hand the proceeds of Payment for Order Flow to their customers?
— AFR (@RealBankReform) February 18, 2021
Mr. Tenev basically says no, that it would lead to the end of free commissions
AOC: doesn’t that mean it’s not actually free? #GameStop #GameStopHearing pic.twitter.com/YQEsFJ6Ucr
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Tlaib: 'Our folks are tired of bailing you out every time you screw up'
Rashida Tlaib had some strong words for hedge fund owner Ken Griffin and for financial institutions at large.
Tlaib called for a financial transaction tax, saying that taxing Wall Street at just 0.1% would raise $800bn over 10 years.
She cited the power outages in Texas and the poverty in her own district in Michigan that could be helped with such a tax.
Likely referencing the bailout of banks in 2008, Tlaib said it is unfair finance executives always seem to make it out of these financial implosions unscathed.
“Our folks are tired of bailing you out every time you screw up and gamble with their retirement money,” she said.
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Representative flays Robinhood for its poor customer service related to suicide of young trader
Sean Casten of Illinois again highlighted the suicide of Alex Kearns, a 20-year-old amateur trader who committed suicide after his Robinhood app told him he owed more than $730,000 on losses.
The family of Kearns is suing Robinhood after “misleading communications” led the young man to believe he had sustained huge market losses. He called the company’s customer service hotline three times but was unable to communicate with anyone at the company. Believing he had bankrupted his family, he later committed suicide.
“This was a man who was 20 years old,” Casten said. “He was not allowed to buy a beer, but he was allowed to take on $730,000 in options. Your mission is to democratize finance, but regulation exists to protect people like Alex Kearns.”
He asked Tenev about when Robinhood began offering options trading (2018) and noted that the company’s revenue model grew exponentially after adding options trading - a more complex and volatile form of investment.
“There is an innate tension in your business model between democratizing finance, which is a noble calling, and being a conduit to feed fish to sharks,” Casten said.
Casten repeatedly admonished Tenev for Robinhood’s lack of a customer service hotline. He took out his cell phone and called Robinhood’s customer service number, playing back what users hear when they call.
The message - presumably what Kearns heard in his desperation - was an automated voice telling the caller to download the Robinhood app before hanging up.
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Representative questions whether it is reckless to gamify investment
Cindy Axne of Iowa targeted Tenev with questions about the Robinhood app’s design and the consequences of gamifying trade. She asked who truly stands to benefit from the rise of Robinhood, which Tenev has repeatedly asserted aims to “democratize” investment.
“Your clients are not your customer - the users are the product, your customer is sitting next to you - it’s companies like Citadel securities that stand to make a fortune on retail order flow,” Axne said.
Axne noted that Robinhood incentivizes inviting friends to the app and gamification of trading, “adding gaming elements that look like gambling.”
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Robinhood took from its customers to boost its own business model, lawmaker alleges
Michael San Nicolas of Guam, a Democrat, congratulated the small investors who orchestrated the short squeeze: “Robinhood made that possible,” he said.
But he also questioned Tenev about the $3bn shortage, and where the money borrowed to cover it came from. Tenev said he got $3bn from venture capitalists, which San Nicolas argued means Robinhood materially benefited from the shareholders.
San Nicolas said Robinhood’s Silicon Valley ethos of “move fast and break things” led it to value scale over anything else.
“That’s where I have a serious concern,” he said. “Your business model causes you to take extraordinary risks, and you took from customers to protect your position. That is very, very troubling.”
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Tenev admits Robinhood did not have the collateral to back the huge increase in trade
Vlad Tenev admitted during questioning on Thursday that Robinhood halted buying on the platform because it did not have the funds to back the huge influx of trading in the Reddit frenzy.
Robinhood is required to place a deposit using its own funds at a clearinghouse to cover risks until trades are settled between a buyer and seller. On 28 January, the company was informed by its clearing house, NSCC, that it had a deposit deficit of approximately $3bn – up from $124m just days before.
Anthony Gonzalez, a Republican from Ohio, asked if Robinhood indeed had that $3bn of collateral at the time.
“At that moment, we would not have been able to post the $3bn of collateral,” Tenev said.
Gonzalez said that proves Robinhood was “unprepared to protect his constituents and customers from non-consensual liquidation” and “barely avoided disaster”.
“In a sense, I love your company,” Gonzalez said. “At the same time, I believe a vulnerability was clearly exposed.”
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Reddit CEO is asked if financial advice on the forum can be trusted
Steve Huffman, CEO of Reddit, conceded in questioning on Thursday that users on the forum responsible for the GameStop buy-up are an “eccentric” bunch but that they did not breach any of the platform’s terms of service.
He said financial advice on Reddit, in fact, is better than what is seen on TV because each post has been vetted by its voting process, which requires endorsement by hundreds and even thousands of users before it is widely visible. Huffman:
On Reddit you’re seeing retail investors who are giving authentic advice based on their knowledge, and you would not call into question positions they may hold before they talk about it on television.
Are Robinhood users better off than the average investor?
One issue that has come up repeatedly in today’s hearing is what Robinhood has to offer consumers, besides ease of entry into the investment space.
Lawmakers’ questioning has offered a rare look into the profit model of Robinhood and just how much customers have made and lost on the app.
Jim Himes, a Democratic representative of Connecticut, asked Robinhood CEO Vlad Tenev whether customers would make more if they had bought a low-cost S&P 500 index fund rather than individual stocks on Robinhood’s app.
Tenev said that Robinhood customers have made $35bn in profits, but is unwilling to say what rate of return that represents. Himes said that number means little without more context.
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Did Reddit’s coordinated buying represent market manipulation? Expert says no
The meteoric rise of GameStop stocks was fueled largely by a frenzy on Reddit community r/WallStreetBets. Arkansas Republican Representative French Hill asked Thursday whether that constituted “market manipulation” - artificially impacting the price of a security or otherwise influencing the market for personal gain.
Keith Gill, who is also speaking on Thursday’s panel, has been sued in a class action lawsuit accusing him of exaggerated claims and misrepresented posts as part of his role on Reddit in kicking off the GameStop market frenzy, which personally netted him more than $30m.
“I think there’s little evidence at this time that there’s any false or deceptive conduct taking place,” said Jennifer Schulp, director of financial regulations studies at the Cato Institute speaking on the forum.
She did say due to the anonymous nature of Reddit it is possible there is some “deceptive behavior” that could not readily be determined. Other have argued that Robinhood’s freezing of GameStop stocks in response to the buy-up itself represented market manipulation.
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Tenev addresses the suicide of a former customer
Robinhood chief executive officer Vlad Tenev addressed in the hearing on Thursday the suicide of a 20-year-old man that was tied to the trading platform.
The family of Alex Kearns is currently suing Robinhood in a California court after the newbie trader took his own life believing he owed $730,000 due to a glitch on the app, a year before the Reddit investing frenzy that caused many to gain or lose huge sums of money in a very short time.
His death led to former SEC chair Jay Clayton and current lawmakers calling for better legislation to prevent such losses from happening in the future.
In Thursday’s hearing, Congressman Emanuel Cleaver II of Missouri asked Tenev to explain how someone with no experience could invest such a potentially devastating amount of money in such a short time. Tenev again cited Robinhood’s mission of “democratizing finance for all”. His full response below:
The passing of Mr. Kearns was deeply troubling to me, and to the entire company. We have taken a series of very aggressive steps to make our products safer for our customers, including adding additional education, as well as strengthening and tightening the requirements for getting options and bettering our customer support line. It was a tragedy and we went into immediate action to make sure that we are not just the most accessible option for trading for our customers but the safest as well.
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Everyone is shouting
Representative Brad Sherman, Democrat from California, had some pointed questioning for Citadel owner Ken Griffin regarding how the average trader on Robinhood is treated compared to more wealthy Wall Street traders and larger firms.
He asked about payment for order flow – a controversial practice in which stock brokers get a kickback for essentially selling the ability to execute trades. This allows some larger customers to avoid paying higher transaction fees. Sherman said it is a means for hiding the true costs of trading.
Griffin kept attempting to skirt the question: “Congressman, I believe that’s an excellent question – the execution quality that we can provide as measured by terms of price improvement is heavily related or correlated to the size of the order we receive.”
“Everybody I’ve talked to in this industry says when you’re a broker being paid for order flow, you get a worse execution,” Sherman replied, referencing the dealing in which Robinhood is paid for its customers’ trades by market-makers like Citadel.
Finra fined Robinhood $1.25 million in December 2019 for this practice, saying it sent customer trading orders to broker-dealers without guaranteeing the best price.
Griffin defended the payment for order flow practice, saying “it has allowed the American retail investor to have the lowest execution cost they’ve ever had in the history of US financial markets”.
Sherman also repeatedly asked if the average Robinhood customer gets the same deals and prices as larger firms like Fidelity.
“Is the Robinhood customer getting the same price as the Fidelity customer?” Sherman asked Griffin.
Griffin wouldn’t say, talking around the answer and explaining that it can’t be determined “because the Robinhood community tends to be smaller in quantity” before getting cut off again.
“You’re evading questions by making up other questions,” Sherman shouted. “You are doing a great job of wasting my time. If you want to filibuster you should run for the Senate.”
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Tenev defends decision to freeze buying of GameStop
Tenev, Robinhood’s CEO, said customers would have been very angry if it had prevented them from selling off GameStop shares.
During the Reddit-fueled meltdown, Robinhood banned the purchase of GameStop buying, but not selling. Many have speculated this was done at the behest of hedge funds who stood to lose millions from the buy-up, which Tenev disputed.
“Preventing customers from selling is a very difficult and painful experience where customers are unable to access their money,” Tenev said. “We don’t want to impose that type of experience on our customers unless we have no other choice.”
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Lawmakers roast Robinhood CEO
In addition to comments from Waters, Robinhood CEO Vlad Tenev faced intense criticism from other lawmakers.
Carolyn Maloney, a Democrat from New York, accused Tenev of recklessly handling customers’ money.
“You reserve the right to make up the rules as you go along,” she said.
“I’m sorry for what happened,” Tenev replied. “I’m not going to say that Robinhood did everything perfect.”
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Chairwoman Maxine Waters is reclaiming her time
Maxine Waters, the chairwoman of the House committee on financial services, took a stern tone with executives involved in the hearing on Thursday.
Maxine Waters: yes or no
— manny (@mannyfidel) February 18, 2021
Robinhood CEO: pic.twitter.com/3oDUwsdD7P
She frequently interrupted Robinhood CEO Vlad Tenev, demanding he actually answer the questions she was posing as he meandered around the point. Waters stated “yes or no, answer the question” a minimum of ten times in the first hour of the hearing.
Maxine Waters to the Robinhood CEO: "I don't have time, I just need a yes or no answer."
— Emily Stewart (@EmilyStewartM) February 18, 2021
Tattoo it on my arm.
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Reddit CEO and Reddit user involved in r/WallStreetBets forum testify
Reddit CEO Steve Huffman explained in his opening statement how Reddit moderation works, what the r/WallStreetsBets community is, and how Reddit dealt with the January stock buy-up.
He said WallStreetBets is a “real community” with real users.
He added that Reddit’s content policy prohibits “hate, harassment, bullying and illegal activity” and that threats or harassment of Plotkin and others were removed.
“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,” Huffman said.
Later, a member of that community testified. Reddit user “Roaring Kitty”, real name Keith Gill, started his opening statement by telling lawmakers “I am not a cat”.
He stressed that he is simply an individual talking about this investment choices, not making suggestions for investments in any official or professional capacity. The goal of his posts, and of the Reddit community, was to make trading more understandable and accessible to the average person.
“It’s alarming how little we know about the inner workings of the market,” Gill said.
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Melvin Capital CEO Gabriel Plotkin claims the company was not looking for a bailout
Gabriel Plotkin, CEO of one of the hedge funds hit by the coordinated Reddit trades, claims Melvin did not coordinate or ask for Robinhood’s ban on trading.
The GameStop frenzy targeted hedge funds like Melvin with huge short positions in GameStop, which had bet the share price would fall and stood to cash in when it did so. After the Reddit-fueled surge, the fund lost 53% in January. It reportedly received a $2bn+ capital infusion from Citadel as its losses grew.
“To be sure, Melvin was managing through a difficult time, but we always had margin excess and we were not seeking a cash infusion,” Plotkin said.
He says he was the subject of antisemitic and threatening posts on Reddit surrounding the markets incident.
“I want to make clear at the outset that Melvin Capital played absolutely no role in those trading platforms’ decisions,” said Plotkin. “In fact, Melvin closed out all of its positions in GameStop days before platforms put those limitations in place.”
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Citadel owner Ken Griffin: we had ‘no role’ in Robinhood’s decision to restrict certain stocks
Ken Griffin is the billionaire owner of hedge fund Citadel and high-speed trading firm Citadel Securities, which works with Robinhood.
He said in testimony on Thursday that the firm provided securities to meet investors’ needs during the unprecedented surge of trading of GameStop stocks, but had “no role” in the decision made by Robinhood to restrict trading of those stocks.
The incident “reflects the competence of our firm’s ability to deliver in all market conditions”, he said.
Opening statements: Robinhood, Citadel, and Melvin Capital CEOs
We are off running with some opening statements from the biggest players in the Reddit-fueled stock market meltdown.
First, Robinhood CEO Vlad Tenev spoke about how he came to found Robinhood, talking of his childhood in Bulgaria, where the financial system was “on the verge of collapse”. Tenev said he wanted to give more people access to financial systems.
“We created Robin Hood to economically empower all Americans by opening mutual markets to them,” he said.
He referenced just how much money has been created by Robinhood investments, saying “the total value of our customers’ assets on Robinhood exceeds the net amount of money they have deposited with us, over $35bn”.
Next, Citadel CEO Kenneth Griffin and Melvin Capital CEO Gabriel Plotkin will speak.
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House committee hears testimony from those involved in trading controversy
Executives from the investing site Robinhood, the social media site Reddit, and other tech companies are testifying on Thursday in the first public hearing in an investigation into a recent public trading meltdown orchestrated on social media.
The House financial services committee will hear testimony from parties involved in the recent trading in GameStop, AMC cinemas and other companies whose share values soared to astronomical levels as small investors piled into the stocks.
We’ll follow the hearing live throughout the day – stay tuned.
