Robinhood Controversy: Facts, Myths, and Alternatives

Robinhood and Alternatives
February 22, 2021

The buzz around investment today is very much simplified. People invest their money by purchasing stocks or shares of a company or buying mutual funds. With time, the value of your stock could increase, then, you can earn more money by selling the stock for a higher price.

This process has become as easy as the tap of a button as there are now several investment app choices.

Platforms such as Acorns, TD Ameritrade, Cash App, Betterment, Stash, Robinhood, etc., make it easy for even beginners in the world of investing to know how exactly to proceed. Speaking of these investment platforms, it is the latter that this article is focused on.

Robinhood has been at the center of the media for the past few weeks over restricting trade on certain securities.

The most controversial among these restricted securities is the video game retailer, GameStop. However, not everything one sees and hears from the media should be swallowed; hook, line, and sinker.

This article is a breakdown of the facts and myths in the whole Robinhood controversy. And yes, we’d also take a look at other investment alternatives for those who are seeking the safest and most beneficial investment platform.

The Facts

What exactly is this whole fuss about?

It all began with an army of individual traders who converged on the social networking app, Reddit, to buy the shares and squeeze hedge funds that bet on the decline of a particular stock. The stock in question here is that of video game retailer, GameStop.

As a result of the actions of these Reddit individual traders, GameStop’s shares rose ecstatically over two weeks in January by more than 14,300% (from about $20 to $483). The stock has since fallen to around $50.

Robinhood, a popular trading app, became the platform for these traders from the Reddit forum WallStreetBets to jump on the GameStop shares. The traders had one aim — to squeeze the Wall Street hedge funds that bet on the collapse of the GameStop stock. The traders who mobilized on the Reddit WallStreetBets forum egged one another to buy the shares so that the hedge funds could lose out.

Robinhood, however, stepped into the mix by briefly suspended trading in GameStop and other popular stocks at the end of January. This stirred up allegations that there might have been some form of market manipulation in that the hedge funds and others may have pushed Robinhood and other trading platforms to stop the rout.

Why did Robinhood restrict investors?

Certain regulations require that the company keeps a substantial amount of money to run its stock trades and process the trades through its clearinghouse — the part of the company that sends shares and money back and forth to other clearinghouses to complete trades. However, Robinhood didn’t have this amount of money at the time.

Because of the level of volatile trading on the platform, the amount of money needed for Robinhood to process trades through its clearinghouse became overwhelming.

The next best response was to stop trading the volatile stocks. Robinhood CEO Vlad Tenev explained the situation further in a January 31st episode of the Good Time Show with Tesla CEO Elon Musk via the exclusive audio-only Clubhouse app.

“At 3:30 a.m. Pacific, our operations receive a file from the NSCC, which is the National Securities Clearing Corporation,” he said during the show. “So, they gave us a file with a deposit, and the request was around $3 billion, which is about an order of magnitude more than it typically is. We had no choice in this case. We had to conform to our regulatory capital requirements.”

Tenev said that the company also raised $1 billion in emergency capital to make sure customers’ trades can happen.

Who was affected by the whole episode?

Several people lost money on GameStop. The majority of these include the Wall Street hedge fund professionals who made reasoned risky bets that fell through. Also affected are members of the r/WallStreetBets who jumped on the trend of gambling with the stock after being encouraged by co-members of the subreddit.

The subreddit took to Twitter to state that GameStop’s decision to freeze trading favored the Wall Street hedge funds while it frustrated individual traders. “Individual investors are being stripped of their ability to trade on [the Robinhood app],” the tweet said. “Meanwhile, hedge funds and institutional investors can continue to trade as normal.”

The Myths

Evil bots responsible for the hype

The frenzied trading in the GameStop’s made it to a hearing in Congress on Thursday, February 18, as US politicians quizzed executives from the trading app Robinhood, Reddit, and other people of importance in the controversy. The hearing came mainly on allegations that market manipulation and other types of criminal misconduct might have prompted the rapid rise in prices of GameStop’s stocks last month.

Steve Huffman, the co-founder, and CEO of Reddit had this to say at the hearing:

“We have since analyzed the activity in WallStreetBets to determine whether bots, foreign agents, or other bad actors played a significant role. They have not. In every metric that we checked, the activity in WallStreetBets was well within normal parameters, and its moderation tools were working as expected.”

His statement indicates that Reddit disagrees with the notion of robotic activity in influencing certain posts on the platform in connection with the stocks. Whether he is right or wrong remains a myth for now.

No agenda to mobilize investors

Keith Gill, who goes by DeepF——Value on Reddit and Roaring Kitty on YouTube, was an early advocate for the GameStop trade. He invested hours of content about the stock into his YouTube channel. Gill was also at the hearing. However, he defended his social media posts saying he was an individual investor acting only on publicly-available information.

“The idea that I used social media to promote GameStop stock to unwitting investors is preposterous,” Gill’s testimony said. “I was abundantly clear that my channel was for educational purposes only, and that my aggressive style of investing was unlikely to be suitable for most folks checking out the channel. Whether other individual investors bought the stock was irrelevant to my thesis – my focus was on the fundamentals of the business.”

However, a lawsuit slapped on Gill Tuesday disagrees with his testimony. The proposed class action against Gill was filed in a federal court in Massachusetts. The suit said Gill was actually a licensed securities professional who manipulated the market to profit himself.

“Gill’s deceitful and manipulative conduct not only violated numerous industry regulations and rules but also various securities laws by undermining the integrity of the market for GameStop shares,” the suit said. “He caused enormous losses not only to those who bought option contracts but also to those who fell for Gill’s act and bought GameStop stock during the market frenzy at greatly inflated prices.”

The lawsuit seeks to prove that Gill’s use of multiple identities to promote GameStop on written and video social media is not a myth.

The Alternatives

Other investing apps and services also had issues with clearing trades similar to Robinhood. Cash App, for instance, tweeted on February 2 that “the clearing broker who processes our trades, Axos, has temporarily halted buys of $AMC & $NOK.

This was not Cash App’s decision — we disagree with this move wholeheartedly. We hope to make these stocks available for purchase again as soon as possible.”

Before then, Webull also tweeted on January 28th that it had begun restricting trades on shares of GameStop, AMC, and Koss citing the “extreme volatility” of the stocks in limiting user transactions to closing positions. However, the investing app later removed those restrictions the same day.

TD Ameritrade made their announcement on January 27th that restrictions would be put on the trading of stocks for GameStop, AMC, and others. The company said it made the decisions “out of an abundance of caution amid unprecedented market conditions and other factors.”

Other investing platforms that joined in limiting trading because of market volatility include Charles Schwab, Interactive Brokers, E-Trade, and Public. However, it is salient to note that these brokerage firms only made the move on the heels of clearinghouse demands to increase their capital requirements significantly to accommodate all the trades they would be processing.

2 Comments

  1. Mikhail

    Thanks for the detailed review of events! I’ve heard rumors of recent hype around GameStop and stock games, but didn’t go into details.

    Reply
  2. Stanislav

    Thanks for insight

    Reply

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