Some of the biggest players in last month’s GameStop trading frenzy will face a congressional grilling Thursday from representatives who have largely been critical of Wall Street.
After Robinhood and other brokerages restricted trading in several highly-volatile stocks in late January, lawmakers on both sides of the political aisle had a rare bipartisan moment: this needed to be looked into.
Despite the uproar, there likely won’t be significant legislation following the hearing, experts say.
“Sweeping legislation is pretty unlikely given the divide in Congress,” says Daniel Smith, a partner at ACA Compliance Group, an advisory firm for financial services. “But there could be some rulemaking that comes out of this from the regulatory agencies.”
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What players are involved?
The House Financial Services Committee will hold a virtual hearing at noon EST Thursday, looking into whether market manipulation was involved in the event after a band of small-time investors helped boost GameStop shares 1,000% in just two weeks.
They are also looking into whether Robinhood and other brokerages that temporarily restricted trading in GameStop shares and other stocks were in compliance with federal regulations.
The chief executives of Reddit, Robinhood, electronic-trading firm Citadel Securities and hedge fund Melvin Capital will attend. Also at the hearing will be the investor who spearheaded the GameStop buying frenzy on the r/WallStreetBets Reddit forum, Keith Gill, also known as “DeepF—ingValue.”
Will brokerages face new regulations?
Questions have been raised as to whether the calls for regulation of Robinhood and other online brokerages will gain traction after the company, along with TD Ameritrade and Interactive Brokers, restricted buying shares on high-flying stocks like GameStop and AMC Entertainment.
It appears those restrictions followed the brokerage firms’ customer agreements and were aimed at preserving their net capital positions, which are required by the Securities and Exchange Commission and other regulators, according to Thomas Gorman, a partner at the law firm Dorsey & Whitney who previously worked at the SEC.
“The brokerages were doing what they were supposed to do,” Gorman said. “If they didn’t raise money and limit trading, they would have crashed and it would have been a disaster.
“So the rules saved the investors, the markets and brokerage houses,” Gorman said. “That’s the story we’ll likely hear on Capitol Hill. A lot of people aren’t going to like it.”
Brokerages may take voluntary steps to head off the need for additional regulations placed on them, according to Smith.
“Some brokerages may attempt to make it more difficult for their customers to make large leveraged bets so that they don’t run into similar issues like the GameStop frenzy,” Smith said.
Sen. Elizabeth Warren, D-Mass., who is well known for her disapproval of Wall Street, wrote in a letter following Robinhood’s actions that it is “long beyond time for the SEC to act” regarding the market volatility.
Robinhood responded to Warren’s letter, stating they “acted in compliance with all other applicable laws and regulations.”
Warren replied that Robinhood’s response “reveals that the company did not have enough cash on hand to manage a surge in trading” and though the company “promised to democratize trading” they “hid information about its prerogative to change the rules by cutting off trades without notice.”
She continued the response doesn’t make clear “the full extent of Robinhood’s ties to giant hedge funds and market makers” and the “SEC should ban these harmful and exploitative clauses outright.”
A Senate Banking Committee hearing is in the works, though a date has yet to be announced.
Republicans have also been critical of Robinhood.
Rep. Patrick McHenry, R-N.C., the Republican ranking member on the committee, told Cheddar he supports a hearing to learn more about Reddit users “outsmarting and outwitting hedge funds” and explained he thought this controversy drew such bipartisan criticism because it was a “power to the people moment.”
What about hedge funds?
Another area that regulators will look at closely is the possibility of placing caps on short selling in an effort to make it harder for hedge funds to have large short positions, experts say.
Regulators could do this through additional reporting and disclosure requirements for short sellers, or through caps on the amount of stock they can short, according to Smith.
Democrats wish to see the SEC increase capital and disclosure requirements for brokerages and hedge funds.
However, Maxine Waters, D-Calif., has said a legislative response isn’t at hand yet: “I think we have a long way to go.”
Short sellers have faced temporary bans before but have always come back. For a few weeks in the fall of 2008, the SEC temporarily banned short selling in nearly 1,000 financial stocks. The agency feared the practice was helping drive a drop in share prices during the depths of the global financial crisis.
Critics have argued that it made it more difficult to buy or sell an investment.
Will Reddit users face consequences?
Democrats have stood with the Redditors, who largely organized the purchase of the volatile stocks, after Robinhood blocked its users from continuing to buy shares.
Rep. Alexandria Ocasio-Cortez, D-N.Y., tweeted shortly after the episode that it was “unacceptable” and lawmakers needed to know why Robinhood blocked “retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit.”
Jerome Selvers, an attorney at Sonnenblick, Parker & Selvers, and a former SEC division and enforcement trial attorney, doesn’t believe that most Reddit users will be subject to regulation if they weren’t getting compensated as securities professionals, financial advisers or brokers, who would normally be regulated by the SEC.
“The SEC regulates markets. It doesn’t regulate free speech,” said Selvers. “In my opinion, there is no likelihood that there is any regulation that is going to come out of the hearings directed at the free speech that’s discussed on Reddit or any platform.”
Though it doesn’t preclude the SEC from seeking sanctions against someone if that person committed fraud, Selvers added.
Keith Gill, who helped drive the GameStop mania on the r/WallStreetBets Reddit forum, was hit with a lawsuit over securities fraud. The suit, filed Tuesday in federal court in Massachusetts, accused him of misrepresenting himself as an amateur investor and of profiting by artificially inflating the price of GameStop shares.
Gill, who also goes by “Roaring Kitty” on YouTube, where he dolls out financial advice, is a chartered financial analyst, a registered broker and was previously employed by Massachusetts Mutual Life Insurance. He resigned from his job on Jan. 28, according to securities regulators in Massachusetts.
The lawsuit also named Mass Mutual and a brokerage subsidiary of the company as defendants, arguing that they had an obligation to supervise Gill’s conduct. Those who are registered brokers can’t do transactions without permission from their firm, according to Selvers.
Still, Selvers is skeptical about whether the lawsuit will be successful.
Robinhood CEO to defend company
Robinhood CEO Vladimir Tenev is expected to defend his company against suggestions it wasn’t acting in the best interests of its customers, according to his testimony published Wednesday.
“Any allegation that Robinhood acted to help hedge funds or other special interests to the detriment of our customers is absolutely false and market-distorting rhetoric,” his statement reads.
Tenev, in his testimony, said the company’s action was simply to “to allow us to continue to meet our regulatory deposit requirements” to ensure trading on other stocks could continue.
In addition, Gill will testify he didn’t “solicit anyone to buy or sell the stock for my own profit” and that he did not speak “to any insider.”
“I believed the company was dramatically undervalued by the market. The prevailing analysis about GameStop’s impending doom was simply wrong,” his testimony says.