Robinhood CEO rebuts GameStop hedge fund conspiracy theory, reveals what really happened

When GameStop’s 500% exponential rise in stock this week reversed Thursday to collapse after trading platforms like Robinhood blocked clients from buying stocks, outrage and theories were not lacking on what was behind the decision of the trading platform.

One theory in particular, alleging that the move could come from outside pressure from hedge funds bypassing GameStop’s stock, quickly caught the attention of a surprising group, including Sen. Ted Cruz, representing Alexandria Ocasio- Cortez, Reddit, Fox News, CNN, and the Winklevoss twins.

It’s easy to see why the theory has spread so quickly, given that Robinhood, like most major brokerage firms, is effectively selling its users’ order stream to Citadel, a hedge fund that this week helped inject more than $ 2 billion into another hedge fund, Melvin Capital, which saw losses from its short position against GameStop add up rapidly. But Robinhood is not unique in its Citadel connection to the sell order flow (as Yahoo Finance has explained in detail before) and Robinhood was not unique this week in suspending purchases of certain inventory by customers.

Where Robinhood’s decision to halt trading could become unique, however, stems from a closer examination of the real reason CEO Vlad Tenev provided in a Yahoo Finance Live interview on Friday.

First, Tenev did not beat around the bush to refute the “conspiracy theory” that outside hedge funds like Citadel played a role in Robinhood’s thinking.

“On this conspiracy theory, I think I have said over and over again that it is not true,” he told Yahoo Finance. “Our decision to temporarily prevent clients from buying certain securities had nothing to do with whether a market maker or market player or someone like that was pressuring us or asking us to do so. . It was all about market dynamics and clearing house deposit requirements in accordance with regulations. “

A compensation system built “ on modern technology ”

So what are these regulations? Without going into detail, brokerage houses like Robinhood typically route trades through a clearinghouse, which helps streamline the trading process until client trades, such as buying GameStop shares, are streamlined. are regulated. Usually this process takes a few business days to settle and the clearing house that supports this transaction is required to provide collateral on behalf of the broker to facilitate a forward transaction as an intermediary. But when volatility hits and stocks move up and down during those two days of settlement, this process can become prohibitive.

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This would correspond to the same reason given to Yahoo Finance by Webull, another free stock trading platform and direct competitor of Robinhood, which also briefly suspended buy orders placed by clients on Thursday for GameStop stocks, AMC or Koss. Both CEOs pointed to those same clearinghouse regulations as the reason for the suspension of share purchases.

“It was not our choice,” Webull CEO Anthony Denier said in an interview Thursday. “Our clearing company phoned us and told us we were going to have to stop authorizing new open positions in all three names: [AMC, GameStop and Koss.]”

In fact, the increased volatility around these stocks, including GameStop’s 300% surge this week, has made it more expensive for Apex Clearing, Webull’s clearinghouse of choice, to hold responsibility for these stocks while transactions placed by customers on Webull were settled. “The cost of clearing these things went up 3 times overnight,” he said.

“Our clearing company just cannot afford the cost of settling these transactions,” Denier said at the time. “We can’t use client funds to cover this cost because of the regulations, so clearing houses have to go into their own pockets to do it and they just can’t afford the cost.”

Early Thursday afternoon, when the purchase of certain titles on Robinhood remained on hold, Webull quickly resumed purchases on GameStop and AMC only after Denier said Apex told him the outside clearinghouse had been in. able to secure additional funding and negotiated collateral levels with the final intermediary in the settlement process, the Depository Trust & Clearing Corporation.

However, Robinhood differs from Webull in that it does not use an outside clearing house. On the contrary, as explained in a Robinhood 2018 blog post, the trading platform decided to cut ties with the same clearinghouse that Webull used, Apex Clearing, to develop the technology internally. The blog post celebrates the feat, noting that its Clearing by Robinhood platform was “the only clearing system built from the ground up, and on modern technology, in the past decade.”

It was an interesting move, Denier notes, given that clearing operations tend to be extremely capital intensive and highly regulated due to collateral requirements. The advantage, however, is that a business is likely to earn substantial income by adding the ability to use client assets throughout the process and can be a great source of money in the brokerage industry.

Indeed, Robinhood might have been the last to build this ability, but it certainly wasn’t the first. The respective clearing houses established by business competitors Charles Schwab and TD Ameritrade (Charles Schwab Clearing Services and TD Ameritrade Clearing) were built years ago. Coincidentally, TD Ameritrade reported more than $ 200 million in revenue from the sale of its shares and its option order flow in the first quarter of 2020 alone, according to company filings, including 83 million dollars from Citadel Securities. In the same quarter, Robinhood reported $ 91 million in payment for order flow revenue, $ 39 million from hedge fund. The same Robinhood total in the third quarter more than doubled to $ 190 million.

But during all of the volatility this week, neither Schwab nor TD Ameritrade have had to restrict client buy orders on GameStop, AMC or Koss – a point that brokerages have recently made clear when only margin requirements were proactively adjusted.

Considering that neither TD Ameritrade nor Charles Schwab had to suspend even basic buy orders on any security, let go of the incredibly volatile movements of GameStop or AMC, this begged the following question. : What is wrong with the Robinhood system? And perhaps more to the point, if Robinhood made this decision to take on the additional responsibility of its own clearinghouse, why was the possible volatility not addressed before it had to raise some emergency funding from it. ‘a billion dollars?

“I don’t really want to go into the details of what exactly happened,” Tenev told Yahoo Finance when pressed on the matter. “I think if you look at this whole situation, it’s a new situation. A relatively small number of stocks have gone viral on the internet and as things that go viral on social media and the internet do, there is an exponential growth in interest.

When asked if the big picture and the resulting class action lawsuit brought by his clients could have been avoided had Robinhood continued to use an outside clearinghouse instead of going with the prospect of additional income, Tenev refused to think.

“It’s hard to tell the counterfactual,” he says.

This and other counterfactuals will no doubt become questions in the inquiries that will certainly follow this week’s dramatic trade action. The United States Securities and Exchange Commission has previously said it intends to review not only the actions of regulated participants, but also any possible market manipulation that may have raised specific securities.

“The Commission will closely review actions taken by regulated entities that could disadvantage investors or otherwise unduly hamper their ability to trade certain securities,” the SEC said in a statement on Friday.

What the SEC or other regulators are able to find out by examining how a Reddit forum led to the new market volatility this week remains to be seen. For Robinhood, Tenev said he hopes these talks continue.

“We are in constant communication with our regulators and with lawmakers and we continue to do so. I look forward to having conversations with anyone about this as I obviously think it’s very technical and involves some settlement mechanisms like you’ve seen in some of your other conversations and I think Robinhood made the right decision here.

Whether the open market and Robinhood’s customers are now learning what went wrong will soon be clear. In the brief window where Webull still allowed purchases of GameStop and AMC shares on Thursday when Robinhood did not, Denier said new apps were up 2,000%.

Zack Guzman is an anchor for Yahoo Finance Live as well as a senior writer covering entrepreneurship, cannabis, startups, and breaking news at Yahoo Finance. Follow him on twitter @zGuz.

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