Robinhood and Reddit in the spotlight during GameStop congressional hearing

Congressional hearings aren't exactly known for fact-finding and informed inquiry, but we just got a bunch of really good questions directed at Robinhood executives.

From Congresswoman Nydia Velazquez:

-- "Robinhood seems to have perfected the gamification of trading providing the user with the perception that investing through the Robinhood app offers recreational gain ... with no downside risk. ... How does Robinhood balance disclosures about the potential downside risk of investing, including substantial downside loss?"

Vlad Tenev's response: "We know that investing is serious and we're investing in all the educational tools and support to help people on their investing journey."

From Congressman Blaine Luetkemeyer:

-- "Do you think we need more legislation or did the system actually work? Was it self-correcting? The fact that someone like yourself was able to take advantage of shorting? Maybe there was over-aggressive investing that was taking place ... they didn't work because you outsmarted the system?"

Keith Gill's response: "Increased transparency could help so someone like me could have a better understanding of how those things work could be quite beneficial to retail investors."

-- "You mentioned settling trades in real time ... What are the unintended consequences if you did something like that?"

Tenev's response: "Certain market participants rely on next-day settlement to be able to take advantage of intraday netting and run up larger one-sided positions in certain stock with the knowledge they can close those positions by the time settlements happen, and I understand that could be a limitation to some of these institutions. ... I don't think these are insurmountable challenges."

Congressman Brad Sherman was trying to get Citadel owner Ken Griffin to admit that Robinhood traders get a raw deal compared to Wall Street fat cats.

Griffin wasn't having it.

Sherman was referencing Robinhood's controversial payment for order flow, in which Robinhood is paid for its customers' trades by market-makers like Citadel. FINRA fined Robinhood $1.25 million in December 2019 for sending customer trading orders to four broker-dealers without guaranteeing the best price.

"Is the Robinhood customer getting the same price as the Fidelity customer?" Sherman asked Griffin.

"Congressman, I believe that's an excellent question," Griffin responded. "The execution quality that we can provide as measured by terms of price improvement is heavily related or correlated to the size of the order we receive."

Sherman interrupted him, saying he was asking a clear question: If the orders are the same size, is it not true that one (Fidelity) is getting a better price?

Griffin wouldn't say: "Because the Robinhood community tends to be smaller in quantity..." Griffin started before getting cut off again.

"You're evading questions by making up other questions," Sherman shouted.

"The quality of execution varies by the channel of order," Griffin said. "Channels matter."

"Who gets the better deal -- a broker who pays for order flow or one who doesn't?" Sherman asked.

"Size of the order is only one factor," Griffin insisted.

MyBookie.com, an offshore gaming site based in Antigua, was accepting bets on today's Capitol Hill hearing such as whether hedge fund operator Steve Cohen or Telsa CEO Elon Musk will be mentioned, or how many times terms like "stonks" and "gamification" would be uttered.

The betting started a day ago and closed at the noon ET start of the hearing with a modest amount of wagers in "the high four figures," according to David Strauss, the site's chief oddsmaker. Still, he added, "it's more than I expected." There was a $25 cap on the amount of any bet.

Strauss said the site regularly takes bets on a wide range of news events, including the inauguration and the State of the Union address. "What’s popular betting on any televised event involving US politicians," he said. Bets could include everything from what color tie the president would wear at the inaugural to the number of applause interruptions.

The last congressional hearing it took bets on was the hearing with the CEOs of Facebook, Google and Twitter in late October.

"That had much more wagered because the election was in full swing," said Strauss. The 2020 presidential election itself was the most wagered event ever on MyBookie and other gambling sites.

Vlad Tenev apologized for failing to communicate adequately to Robinhood users, in response to pressure from Rep. Carolyn Maloney.

Maloney accused Robinhood of "vague language" and seeming to "reserve the right to make up the rules as you go along," saying that the company's statements to investors as it restricted trading were inconsistent with the explanation it later provided concerning Robinhood's regulatory requirements.

Tenev acknowledged that the company erred.

Tenev pledged to learn from the experience so that the company won't "make the same mistakes in the future."

Chairwoman Maxine Waters tried to set the tone of the hearing early by using an aggressive style of questioning, zeroing in on Robinhood and Melvin officials by demanding they answer questions in a yes-no format and cutting them off when they sought to provide longer answers.

Waters' tactics are an indication of how uncomfortable the hearing may soon become for some of the witnesses.

Robinhood CEO Vlad Tenev is being forced to explain his app's decision to only ban purchases of GameStop, and not sell orders as well.

In short, Tenev said customers would have gotten very angry (even more upset than they were) if sell orders were banned.

"Preventing customers from selling is a very difficult and painful experience where customers are unable to access their money," the Robinhood boss said. "We don’t want to impose that type of experience on our customers unless we have no other choice."

Tenev repeated that the decision to restrict purchases of GameStop, AMC and other stocks was "purely driven" by surging deposit and collateral requirements imposed by its clearinghouse, not at the behest of hedge funds.

He added that buy orders lead to greater capital requirements than sell orders.

Last week, a trader filed a complaint against Fidelity accusing the company of preventing him from unloading Reddit stocks before they imploded. The trader said this cost him $830,000.

Reddit trader Keith Gill, also known as "Roaring Kitty" on YouTube, kicked off his testimony before the House Financial Services Committee with a few points of clarification.

"A few things I am not. I am not a cat. I'm not an institutional investor, nor am I a hedge fund. I do not have clients and I do not provide personalized investment advice for fees or commissions. I'm just an individual..."

That kitty clarification, made against the backdrop of Gill's "Hang in There" cat poster, was a nod to the widely shared (and yet still very funny!) moment in a Texas virtual courtroom when a lawyer unwittingly appeared on screen with a cat face filter.

Gill, who goes by "Deepf----ingvalue" on Reddit, described his role in the GameStop saga to the committee. He was one of the leading forces on the subreddit WallStreetBets driving GameStop's stock up last month. He described himself as casual day trader with a genuine belief that GameStop was undervalued, rejecting any accusation he intentionally pushed investors to the stock to influence the market.

Ken Griffin and Vlad Tenev will face questions over payment for order flow, which they will argue benefits retail investors by making it free to trade and giving them access to deep markets.

Payment for order flow is the controversial practice of broker-dealers – including market makers like high-frequency trading firms – paying Robinhood and other free trading apps for executing the trades with them.

Critics say payment for order flow creates a conflict of interest that allows market makers to trade ahead of retail investors. And that this practice ultimately helped fuel GameStop (GME) mania because it paved the way to free trading and incentivizes brokerages to get people to trade frequently. (More trade orders on Robinhood means more payment for that order flow).

Robinhood was fined $1.25 million in 2019 by Wall Street's self-regulator for "failures" related to routing orders without guaranteeing the best price.

Jennifer Schulp, director of financial regulation studies at the Cato Institute, lauded retail investing — equities trading by individuals using brokerages such as Robinhood — in her opening testimony during Thursday's hearing.

“Investing in the stock market ... provides a path to wealth for individual investors," Schlup said.

She noted that stock ownership has traditionally been "skewed towards the already wealthy, and it is highly correlated with race, education and age." But with the increase in popularity of retail stock trading during the pandemic, "investors who opened accounts for the first time in 2020 were younger, had lower incomes and were more racially diverse," suggesting growing equality in investing, Schulp said.

The volatility in GameStop (GME) shares are not necessarily an indication that guardrails need to be put up around retail investing, Schulp added.

"The fact that Gamestop traded temporarily, and perhaps still trades, above fair estimates of the company's value is not, by itself, a reason for concern," she said. "Stock prices move in and out of alignment all the time. And markets are no strangers to bubbles."