On Monday, the Securities and Exchange Commission released a detailed report on the January GameStop short squeeze. The short squeeze was driven by investors on social media site Reddit. Initially, the event captured headlines and was framed as an epic battle of average investors against Wall Street giants.
The SEC’s report includes information that seems to contradict the current narrative on subreddits like r/WallStreetBets and r/SuperStonk. For instance, amateur investors on Reddit still believe that numerous hedge funds haven’t covered their short positions on GameStop. Meanwhile, the report finds that GME “had sharp price increases concurrently with known major short-sellers covering their short positions after incurring significant losses.”
The 45-page report was highly anticipated on investing subreddits. Some amateur investors expected the SEC to recommend changes to the way short positions on stocks are recorded. Others braced for the report make it more difficult for individuals to buy stocks altogether. Neither of these predictions came true, though. The report recommends no action but instead suggests that the markets worked exactly as anticipated during the short squeeze.
Enthusiasts on Reddit continue to push for what they call the “mother of all short squeezes”. This mythical-sounding event is the goal of directly registering shares through Computershare and aggressively holding on to GameStop shares even as they rise in value. It seems unlikely that Monday’s report will do much to stop Redditors from chasing the MOASS, as they call it.
Payment for Order Flow
At the center of retail investors’ complaints about the January short squeeze is their belief that brokerage app Robinhood colluded with Citadel Securities to keep users from buying GameStop shares. For a brief window in late January, Robinhood users were unable to purchase GME stocks. The allegations center around the app’s use of a compensation agreement called payment for order flow. This means that Robinhood gets paid by allowing large clearinghouses to execute trades.
As a result, clearinghouses clear a small profit margin on the difference between the buying and selling prices of stocks. Retail investors point out that this could lead to a conflict of interest for apps that use the payment for order flow business model.
Some Redditors have claimed that Robinhood’s decision to halt GME trading in January was something that Citadel forced them to do. This assumption is driven by Citadel Securities’ extremely aggressively short position on GameStop. The fund lost millions of dollars in the squeeze, fueling online speculation.
The SEC’s Findings
The SEC report doesn’t offer any evidence that Robinhood and Citadel engaged in any unlawful behavior. Instead, the report points out that the cessation of trading was a result of Robinhood’s clearinghouse demanding $7 billion from its members. This event caused a sudden pause in trading on January 27, 2021, in the middle of the most intense period of the meme stock boom.
This move is called a “margin call,” and it serves as a form of insurance for the clearinghouse. At the time, the financial institutions settling the trades feared that the unusual amount of money going to previously low-cost stocks could result in the collapse of one of the members.
Crossing a Line?
The regulator didn’t leave payment for order flow unmentioned, however. In the report, the SEC notes “These payments can create a conflict of interest for the retail broker-dealer.” The conflict of interest that the SEC singles out is that forces from the market reward fee-free brokerages for encouraging amateur investors to keep trading. This is the case even when the best call for those individuals might be to hold their shares.
One example of this is the “gamification” of trading seen on some brokerage apps. “Consideration should be given to whether gamelike features and celebratory animations that are likely intended to create positive feedback from trading lead investors to trade more than they would otherwise,” the Commission concludes.
SEC Chair Gary Gensler spoke on this topic last week in prepared remarks during SEC Speaks. At the time, the Chair pointed out that these design elements could “cross a line” and become recommendations for purchases. If lawmakers determine that retail brokerage apps are recommending stocks, then their legal obligations to their users will need to clear a much higher set of standards.
The SEC’s report includes no recommendations for changes to current laws. Gensler told reporters that the report’s purpose is to highlight issues that need further consideration. Most of all, Gensler insists, “making markets work for everyday investors gets to the heart of the S.E.C.’s mission.”
Retail investors on sites like Reddit were largely unimpressed by the Commission’s findings. As one user succinctly puts it, “The Report basically says ‘All good, keep on trading’. OK, I did not expect anything from them so, I will keep on hodling [sic] and registering.”