Written by Norman Isaac Mwambazi

Robinhood, Reddit CEOs Testify Before Congress on GameStop

Towards the end of last month, small traders through their discussions in Reddit groups fuelled the surging of stocks of …

Towards the end of last month, small traders through their discussions in Reddit groups fuelled the surging of stocks of companies that were struggling on the stock market, making their stock prices shoot to all-time highs. Some of the companies that hugely benefitted from this period include video game retailer GameStop, movie theatre operator AMC, and tech company Blackberry among others.

This surge shook WallStreet, with professional investors asking themselves questions of what to do about these traders and the stocks they picked up. This unexpected rise forced several trading platforms like Robinhood, E*Trade and Interactive Brokers to limit their customers from making certain trades with GameStop.

Traders complained about this decision by these trading platforms of limiting them from trading, and the Financial Services Committee from the US House of Representatives heard their complaints and called upon the Chief Executive Officers (CEOs) of the involved companies to testify.

The Committee scheduled a virtual hearing on Thursday, February 18, 2021, on recent market volatility involving GameStop stock and other stocks. Among those who testified are Vladimir Tenev, CEO of online trading firm Robinhood Markets, Inc., and Steve Huffman, CEO and co-founder of social media community and online forum site Reddit. The committee is chaired by Representative Maxine Waters (D, Calif.).

It should be remembered that Waters released the following statement on January 28, 2021, in the wake of the GameStop stock trading controversy. In it, she casts hedge funds as an enemy of ordinary American savers and investors:

“Hedge funds have a long history of predatory conduct and that conduct is entirely indefensible. Private funds preying on the pension funds of hard-working Americans must be stopped. Private funds engaging in predatory short selling to the detriment of other investors must be stopped. Private funds engaging in vulture strategies that hurt workers must be stopped.

“Addressing that predatory and manipulative conduct is the responsibility of lawmakers and securities regulators who are charged with protecting investors and ensuring that our capital markets are fair, orderly, and efficient. As a first step in reining in these abusive practices, I will convene a hearing to examine the recent activity around GameStop (GME) stock and other impacted stocks with a focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors.

“We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price.”

During the hearing yesterday, Rep. Alexandria Ocasio-Cortez clashed with Tenev over whether Robinhood investors are truly trading for free on the platform, alleging that the company is simply “hiding the cost” from retail investors by subsidizing it with payment for order flow.

“Would you be willing to commit to voluntarily pass on proceeds of payment for order flow to Robinhood customers?” Ocasio-Cortez asked.

Tenev baulked at the question several times before ultimately pointing out that payment for order flow “allows for commission-free trading.”

The implication, Ocasio-Cortez said, was that trading on Robinhood isn’t truly free after all. Tenev conceded that Robinhood is a “for-profit business and needs to generate some revenue to pay for the costs of running this business.” However, he claimed, Robinhood’s model has become the standard industrywide.

Robinhood CEO Tenev admits to making mistakes

During his testimony, Tenev admitted that the company made some mistakes during the meme stock trading frenzy but he was somewhat evasive when Congresswoman Madeleine Dean asked him to elaborate.

“You admitted to making mistakes, specifically, what mistakes did you make?” Dean asked.

“I admit to always improving. We are not going to be perfect. And we want to improve and make sure we don’t make the same mistakes twice,” Tenev responded.

On why Robinhood restricted trading

Tenev admitted that the app did not have the liquidity needed to meet an early-morning demand from its clearinghouse for $3 billion on January 28, 2021.

“At that exact moment we would not have been able to post the $3 billion in collateral,” Tenev said.

Within a few hours, Robinhood managed to persuade the clearinghouse to lower its request to $1.4 billion, and the app imposed controversial restrictions on GameStop and 12 other stocks.

Congressman Anthony Gonzalez pointed out that if Robinhood did not impose those restrictions, the clearinghouse would have stepped in and liquidated unsettled trades.

“It would not have been a good situation for the firm or the customers,” Tenev said, adding that it would have caused a “total lack of access to markets” for users.

Gonzalez said this would have been an “enormous catastrophe for Robinhood.”

“I believe a vulnerability was clearly exposed in your business model and perhaps in the regime that governs your capital requirements. We just can’t live in a world where my constituents could have had their shares liquidated without their consent,” he said.

Robinhood and payment for order flow

Tenev also faced hostile questioning about his company’s underlying business model that is payment for order flow.

Vlad Tenev disclosed two important stats:

  • More than half of Robinhood’s revenue is derived from payment for order flow, the trade execution practice that received heavy scrutiny during the hearing. Pressed on how much of Robinhood’s business comes from payment for order flow, Tenev said, “I don’t recall the exact percentage. It’s over 50%.”
  • He also acknowledged that Citadel Securities is Robinhood’s “largest counter-party,” in that it receives the bulk of Robinhood trading orders. 

How significant was this hearing to investors

It is possible that the hearings may lead to additional legislation and regulation concerning the securities markets, but this is by no means certain.

One thing that is certain though is that extended questioning about payment for order flow, the incentives that it creates, and the degree to which Robinhood engages in gamification are all matters that are bound to tarnish that company’s image, but not necessarily to dissuade a significant number of Robinhood’s clients or potential clients from using its platform.