When GameStop’s exponential 500% rise this week reversed on Thursday to collapse after trading platforms like Robinhood blocked customers from buying shares, there was no lack of outrage and theories about what was behind the decision. trading platform.
One theory in particular, claiming that the decision may have originated from external pressure from hedge funds selling GameStop shares, quickly gained the attention of a surprising group, including Senator Ted Cruz, Congressman Alexandria Ocasio-Cortez, Reddit, Fox News, CNN, and the Winklevoss twins.
It’s easy to see why the theory picked up so quickly, considering that Robinhood, like most major brokerages, actually sells its users’ order flow to Citadel, a hedge fund that this week helped inject more than $ 2 billion in another hedge fund, Melvin Capital, which saw the losses of its short position against GameStop accumulate quickly. But Robinhood is not the only one in his connection to Citadel for the flow of sales orders (as Yahoo Finance explained in detail earlier) nor was Robinhood the only one this week in suspending purchases of certain stocks by customers.
Where Robinhood’s decision to suspend negotiations may become unique, however, stems from a closer look at the real reason CEO Vlad Tenev provided in an interview with Yahoo Finance Live on Friday.
First, Tenev made no mistake in refuting the “conspiracy theory” that external hedge funds like Citadel played some role in Robinhood’s thinking.
“Based on this conspiracy theory, I think I have repeatedly said it is not true,” he told Yahoo Finance. “Our decision to temporarily restrict customers from buying certain securities had nothing to do with a market maker or a market participant or anyone like that pressuring us or asking us to do so. It was entirely about market dynamics and the clearinghouse’s deposit requirements in accordance with regulations. “
A compensation system built ‘with modern technology’
So, what are these regulations? Without going into too much detail, brokers like Robinhood usually direct trades through a clearinghouse, which helps to streamline the trading process until client trades, such as buying GameStop shares, are settled. This process usually takes a few business days to settle, and the clearing house that takes over that deal is required to provide a guarantee on behalf of the broker to help facilitate a deal as an intermediary. But when volatility hits and stocks go up and down over those two settlement days, that process can become prohibitively expensive.
This is in line with the same reason provided to Yahoo Finance by Webull, another free stock trading platform and direct competitor to Robinhood, which also briefly suspended purchase orders placed by customers on Thursday for GameStop, AMC or Koss shares. Both CEOs pointed to the same clearinghouse regulations as the reason for suspending stock purchases.
“It was not our choice,” Webull CEO Anthony Denier said in an interview on Thursday. “Our clearing firm called us and said that we would have to stop allowing new opening positions in the three names: [AMC, GameStop and Koss.]”
NEW: The CEO of Webull told us that the decision to join Robinhood to restrict the AMC and GameStop negotiations came from rising costs to settle its users’ negotiations:
“It was not our choice … it has to do with the settlement mechanics in the market.”pic.twitter.com/Micz5U6SRc
– Zack Guzman (@zGuz) January 28, 2021
In fact, the increased volatility around these stocks, including GameStop’s 300% increase this week, made it prohibitively more expensive for Apex Clearing, Webull’s preferred clearing house, to hold those shares accountable while the trades placed by customers at Webull were liquidated. “The cost of cleaning these things has increased 3 times over night,” he said.
“Our clearing firm simply cannot afford to settle these deals,” said Denier at the time. “We cannot use client funds to cover this cost due to regulation, so clearing firms have to work in their own pockets to do this and simply cannot afford the costs.”
Early Thursday afternoon, while the purchase of certain titles at Robinhood remained suspended, Webull quickly restored purchases at GameStop and AMC only after Denier said that Apex instructed him that the external clearinghouse had been able to guarantee additional financing and negotiate guarantee levels with the final intermediary in the settlement process, the Depository Trust & Clearing Corporation.
What Robinhood differs from Webull, however, is that he does not use an external clearinghouse. Instead, as a 2018 Robinhood blog post explains, the trading platform decided to sever ties with the same clearinghouse that Webull used, Apex Clearing, to build the technology in-house. The blog post celebrates the achievement, noting that its Clearing by Robinhood platform was “the only compensation system built from the ground up and with modern technology in the last decade”.
It was an interesting move, notes Denier, considering that clearing operations tend to be extremely capital intensive and heavily regulated due to collateral requirements. The advantage, however, is that a company can earn substantial revenue by adding the ability to use client assets through the process and can be a major source of revenue in the brokerage business.
In fact, Robinhood may have been the last to build that capacity, but he certainly wasn’t the first. The respective clearinghouses established by commercial 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 option order flow in the first quarter of 2020 alone, according to company documents, with $ 83 million from Citadel Securities . In the same quarter, Robinhood reported $ 91 million in payments for order flow revenue with $ 39 million from the hedge fund. The same total for Robinhood in the third quarter more than doubled to $ 190 million.
But during all of this week’s volatility, neither Schwab nor TD Ameritrade had to restrict customers’ purchase orders at GameStop, AMC or Koss – a point that brokers recently made absolutely clear when only margin requirements were adjusted accordingly. proactively.
Given the fact that neither TD Ameritrade nor Charles Schwab resorted to suspending even basic purchase orders on any title, let alone the incredibly volatile GameStop or AMC engines, the question arose: what went wrong with Robinhood’s system? And perhaps more specifically, if Robinhood made the decision to take additional responsibility for his own clearinghouse, why was the possible volatility not addressed before he had to raise a $ 1 billion emergency financing round?
“I don’t want to go into details about exactly what happened when,” Tenev told Yahoo Finance when pressed about the issue. “I think that if you look at the whole situation, it’s a new situation. A relatively small number of actions have gone viral on the Internet and, as things go viral on social media and the Internet, there is an exponential growth in interest. ”
When pressed further on whether the whole situation and the resulting collective action brought by his clients could have been avoided if Robinhood continued to use an external clearinghouse instead of opting for the prospect of additional revenue, Tenev refused to consider the idea.
“It is difficult to say the counterfactual,” he said.
This counterfactual and others will undoubtedly become issues in the investigations that will certainly follow this week’s dramatic commercial action. The United States Securities and Exchange Commission has already said that it intends to not only examine the actions of regulated participants, but also any possible market manipulation that may have raised certain securities.
“The Commission will look closely at actions taken by regulated entities that could harm investors or unduly inhibit their ability to trade certain securities,” the SEC said in a statement on Friday.
What the SEC or other regulators are able to discover when analyzing how a Reddit forum led to this week’s new market volatility is yet to be seen. For Robinhood, Tenev said he hopes the discussions will continue.
“We are constantly in communication with our regulators and legislators and we continue to do so. I’m looking forward to having conversations with anyone about this because, obviously, I think it’s highly technical and involves the mechanics of the deal, as you saw in some of your other conversations and I think Robinhood made the right decision here. “
If the free market and Robinhood’s customers are now learning about what went wrong they will agree, it will soon be clear. In the brief window in which Webull still allowed the purchase of GameStop and AMC shares on Thursday, while Robinhood did not, Denier said that the new applications increased by 2,000%.
Zack Guzman is an anchor of Yahoo Finance Live and also a senior writer who covers entrepreneurship, cannabis, startups and breaking news on Yahoo Finance. Follow him on Twitter @zGuz.
Read the latest financial and business news from Yahoo Finance
Follow Yahoo Finance on Twitter, Facebook, Instagram, Flipboard, SmartNews, LinkedIn, Youtubeand reddit.
Find live stock market quotes and the latest business and finance news
For tutorials and information on investing and trading stocks, check out Cashay