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Wall Street faces Washington crackdown after
GameStop rollercoaster
The frenzy surrounding the trading of GameStop stock
is triggering Washington’s most intense scrutiny of Wall Street in more than a
decade.
Reddit's users have said they wanted to punish hedge
funds that were betting on further declines in GameStop and other struggling
companies. As the stock rose, the short sellers suffered. |
By ZACHARY
WARMBRODT, KELLIE MEJDRICH and VICTORIA GUIDA
01/29/2021
07:26 PM EST
https://www.politico.com/news/2021/01/29/wall-street-washington-crackdown-gamestop-463935
The frenzy
surrounding the trading of GameStop stock is triggering Washington’s most
intense scrutiny of Wall Street in more than a decade, teeing up hearings and
investigations that threaten brokers and hedge funds at the center of the
turmoil.
Online stock
brokerage Robinhood Financial is facing the sharpest questions and has been
bulking up its Washington presence as its profile has risen. In the last year,
the firm has recruited a gallery of insiders with experience at the Securities
and Exchange Commission, congressional committees and Treasury to help guide it
through the gauntlet.
Robinhood
drew millions of small, often young investors into the market last year with
its popular trading app but has faced fines, lawsuits and accusations that it
has failed to protect its customers. It enraged lawmakers on the left and right
this week when it shut down purchases of the skyrocketing GameStop stock for a
day, sending its shares plunging along with those of other companies, even as
hedge funds and other sophisticated Wall Street players were allowed to
continue trading.
The fervor
will ensnare a wide range of Wall Street players, igniting what many critics
say is a long overdue debate about whether the complex structure of the market
serves average investors or is fraught with conflicts of interest and
susceptible to manipulation.
“I am
deeply concerned that these casino-like swings in the value of GameStop and
other company shares are yet another example of the gamesmanship that
interferes with the ‘fair, orderly, and efficient’ function of the market,
raising obvious questions about public confidence in the market and those
trading in it,” Sen. Elizabeth Warren (D-Mass.) said Friday in a letter to the
SEC.
The trading
chaos rattling Robinhood and other trading platforms is connected to rallies in
more than a dozen stocks that appear to be driven in part by users of the
social media website Reddit. The site’s users have said they wanted to punish
hedge funds that were betting on further declines in GameStop and other
struggling companies. As the stock rose, the short sellers suffered. GameStop's
stock rose 68 percent on Friday, rebounding from Thursday's steep decline.
The extreme
volatility forced at least one hedge fund to seek a bailout from investors and
prompted an outcry from Wall Street traders. It’s unclear who exactly is on all
sides of the trades, but the dynamic ignited a populist outcry from lawmakers
who took the opportunity to bash financial firms.
In rapid
succession Thursday, two of Washington's most relentless critics of Wall Street
— incoming Senate Banking Committee Chair Sherrod Brown (D-Ohio) and House
Financial Services Chair Maxine Waters (D-Calif.) — announced they would
conduct hearings on the stock market.
Brown and
Waters are promising to hold Wall Street firms to account in the hearings,
which have not been formally scheduled. They showed no sympathy for hedge funds
taking massive losses and instead vowed to probe their role in the affair.
“We must
deal with the hedge funds whose unethical conduct directly led to the recent
market volatility,” Waters said in a statement. “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.”
The
incident may trigger the most political attention to the mechanics of stock
trading since the 2010 “flash crash,” when an epic, unexpected swing in stock
prices baffled officials and investors, prompting hearings and years-long
investigations.
“Unfortunately,
it should be another ‘flash crash’ moment that wakes people up to their false
sense of security that our markets are functioning properly when they’re full
of fraud, manipulation and conflicts of interest that benefit the big players
and screw the buy-side and the retail players,” said Better Markets President
and CEO Dennis Kelleher, who advocates for greater Wall Street oversight.
Although
numerous other platforms offering app-based trading for retail investors —
including Interactive Brokers, E-Trade, and Schwab — also limited trading
access to GameStop and other stocks, most of the criticism was targeted at
Robinhood, a startup brokerage that says it’s on a mission to “democratize
finance for all.”
The trading
platform has been under fire the past year as a surge of individual investors
stuck at home during the pandemic used its app to dabble in stocks and ride a
rising market. Robinhood has attracted customers with its simple, user-friendly
interface and claims that it offers “commission-free” transactions like those
afforded to “big Wall Street firms.”
But
Robinhood has faced growing questions about whether it’s living up to its name
as a savior for mom-and-pop investors.
Last year,
Robinhood agreed to pay $65 million to settle SEC charges that it failed to
disclose revenue it received from selling its customers’ orders to other
trading firms to execute at high fees, depriving its customers of $34 million.
Massachusetts
regulators separately accused the company of violating investment advice laws
and treating stock trading like a “game” to lure young and experienced
customers to make more trades.
Former SEC
Chair Jay Clayton told lawmakers last year that “we need to do something” after
the suicide of a 20-year-old man who believed he had suffered huge losses on
Robinhood.
Amid the
sudden Washington scrutiny, Robinhood went on a hiring spree of lobbyists and
former government officials.
Its payroll
includes former SEC Commissioner Dan Gallagher, now Robinhood’s chief legal
officer; former senior congressional aide and Trump administration official
Beth Zorc, the company’s associate general counsel; former SEC chief of staff
and Senate Banking Committee chief investigative counsel Lucas Moskowitz, the
company’s deputy general counsel; and former Treasury and Financial Industry
Regulatory Authority spokesperson Josh Drobnyk, its vice president of corporate
relations and communications.
As the
trading tumult unfolded, Robinhood had an open job listing on LinkedIn for a
federal affairs manager.
On
Thursday, Robinhood CEO Vlad Tenev was forced to deny rumors that it was acting
on behalf of hedge funds and instead said that the company limited trading
because of financial requirements and to “protect the firm and protect our
customers.”
Robinhood
raised $1 billion from investors as it tried to manage investor demand.
Tenev said
the company acted “preemptively” amid extreme market volatility to restrict its
customers from purchasing 13 companies’ stocks as it tried to manage financial
obligations, including SEC capital rules and clearinghouse deposits needed to
back up trades. In an interview with CNBC, Tenev denied that the company faced a
liquidity shortage and rejected rumors that it was acting on behalf of any
outside hedge fund or big market player.
SEC
officials indicated to House aides in a briefing Friday that part of the reason
some brokerages restricted purchases this week was that they were trying to
balance financial obligations linked to the trades during intense volatility,
sources familiar with the briefing said.
“It was a
difficult decision, and that’s what we had to do as part of normal operations,”
Tenev said.
The trading
controversy has also renewed attention on the financial empire of billionaire
Ken Griffin, the founder of two businesses that are exposed to the issue on
different fronts.
Griffin’s
hedge fund Citadel on Monday helped bail out another hedge fund, Melvin Capital
Management, that suffered significant losses because of the GameStop
volatility.
That amped
up scrutiny of another Griffin business, Citadel Securities, one of the
electronic trading firms that buys stock orders from Robinhood and executes the
trades. The widespread industry practice — known as payment for order flow — is
controversial because of concerns about whether it benefits individual
investors. Supporters say it reduces transaction costs.
The Citadel
firms have not been accused of wrongdoing, but they are obvious targets for
lawmakers digging into the issue. Company representatives say the businesses
operate separately. Citadel Securities said it did not order any stock
brokerage to suspend trading. Citadel the hedge fund said it was not responsible
for any broker’s decision to stop trading.
Given the
level of public interest, the GameStop probe will become one of the first and
most scrutinized problems waiting for attention from Gary Gensler, an
aggressive regulator who has been tapped by President Joe Biden to lead the
SEC, if he’s confirmed by the Senate.
"Gensler
would have been all over this if he was in the chair, but he isn’t and he won’t
be until mid-March at the earliest," said Isaac Boltansky, policy research
director for Compass Point Research & Trading.
The SEC
will face pressure to show that it's addressing long-standing market concerns
that lawmakers and investor advocates say have gone unattended, including the
strength of market manipulation rules and transparency measures to help
individual investors.
Hedge
funds, which invest money on behalf of wealthy individuals and institutions,
had already attracted some regulatory attention at the onset of the pandemic.
Extreme stress in key debt markets forced the Federal Reserve to intervene to
ensure all manner of companies would be able to borrow money to survive
nationwide lockdowns. Some hedge funds’ risky trading strategies blew up, which
has been identified as a potential contributor to the market's plight.
Those
events and the GameStop episode have little overlap in terms of the
particulars, but renewed lawmaker attention could feed calls for more
transparency into hedge fund activities. The firms have resisted the push
because proprietary algorithms and strategies are central to their
profit-making.
"The
degree of response that we’re seeing among both lawmakers and the public more
generally is a reminder that there remain a lot of questions about whose
interest the financial system really serves,” said Kathryn Judge, a professor
at Columbia Law School.
Still,
hedge funds’ willingness to bet against stocks, a sometimes-predatory tactic
central to their financial pain in this case, can also help keep prices closer
to a company’s perceived value. That could make it more difficult for lawmakers
to point to specific regulatory shortcomings related to GameStop, particularly
since hedge funds regularly lose money on so-called short selling.
“The hedge
fund industry supports greater access to financial markets,” said Bryan
Corbett, president and CEO of the Managed Funds Association, which represents
that industry. “Essential fairness for all investors requires that there be an
orderly market with an effective price discovery function. It fosters
stability, reduces risk and encourages market confidence.”
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