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On Wednesday, March 17, 2021, from 10:00 a.m. (ET) full Committee Chairwoman Waters and Ranking Member McHenry will host a virtual hearing entitled, “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part II.”
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Witnesses for this one-panel hearing will be:
• Michael Blaugrund, Chief Operating Officer, New York Stock Exchange
• Vicki Bogan, Associate Professor, Cornell University
• Alexis Goldstein, Senior Policy Analyst, Americans for Financial Reform
• Dennis Kelleher, Co-Founder, President and Chief Executive Officer of Better Markets
Overview
In January 2021, retail investors on social media site Reddit’s “WallStreetBets” subchannel (“subreddit”) collectively executed an investment strategy to induce a short squeeze in stocks such as GameStop, AMC and KOSS, as well as other securities they identified as being heavily shorted by hedge funds. These social media users collectively drove the stock prices up, forcing short sellers, who bet the stock price would go down, to purchase shares at an increased price. On February 18, 2021, the House Financial Services Committee held a hearing to discuss the facts and circumstances around the short squeeze with those who were directly involved, including Keith Gill, WallStreetBets user; Kenneth C. Griffin, Chief Executive Officer, Citadel LLC; Steve Huffman, Chief Executive Officer, Co-Founder, Reddit; Gabriel Plotkin, Chief Executive Officer, Melvin Capital Management LP; and Vladimir Tenev, Chief Executive Officer, Robinhood Markets, Inc. These events raised several critical questions about the conflicts of interest between payment for order flow and best execution, the sufficiency of short sale disclosures, whether settlement times should be accelerated, the market dominance of certain participants, and the impact of gamification on America’s capital markets. These issues are discussed in more detail below.
Payment for Order Flow and Best Execution
Instead of sending customer orders to national exchanges, Robinhood Financial LLC, as well as other retail broker-dealers, route customer orders to principal trading firms or electronic market makers that, in turn, either execute the orders or submit them to market centers. Principal trading firms profit from accepting these orders “either by taking the other side of the customer orders and exiting the positions at a profit … or by routing the orders to other market centers.” Broker-dealers also receive incentives from submitting their customers’ orders to a particular principal trading firm. One such incentive is called “payment for order flow” (PFOF).
Reporting from Alphacution, a research firm, indicates that aggregate PFOF revenue nearly “tripled at four major brokerages—TD Ameritrade, Robinhood, E*Trade, and Charles Schwab— to $2.5 billion in 2020 from $892 million in 2019.”4 Other broker-dealers, including Webull, Ally Invest, and Interactive Brokers reportedly received nearly $300 million in such payments. Some argue that PFOF helps to lower retail broker-dealer commissions and allows some retail brokerdealers, such as Robinhood, to offer “commission-free trading.” Others, including the U.S. Securities and Exchange Commission (SEC or Commission), have noted that, in some cases, commission-free trading comes “with a catch,” including customers receiving inferior execution prices.
The SEC’s regulatory approach to PFOF has largely involved disclosure requirements aimed at addressing the potential conflicts of interest that PFOF may pose for broker-dealers. Critically, in addition to those disclosure requirements, retail broker-dealers are also required to get the “best execution” for their customers. This means that if a retail broker-dealer routes customer orders to a market maker, retail broker-dealers such as Robinhood have to make sure the market maker will execute the customer’s order on the most favorable terms and prices reasonably available in the market. The retail broker-dealer may not, for instance, route an order based solely on which market maker will offer the most incentives for order flow. Nonetheless, there is an inherent conflict between a retail broker-dealer’s receipt of PFOF, and its best execution obligations, because retail broker-dealers may be inclined to send a customer order to the principal trading firm that will pay the most, instead of to the one that will execute the customer’s order on the most favorable terms.
Form 13-F Reporting
Section 13(f) of the Securities and Exchange Act of 1934 and Rule 13(f) requires institutional investment managers….
Hearing page: https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=406268
