Capitol Report: Lawmakers demand action on GameStop saga, Robinhood ban

United States

Lawmakers and market observers are increasingly calling for congressional inquiries and regulatory actions against those responsible for growing bubbles in individual securities, including GameStop Corp. GME, -44.29%, and brokers that have halted purchases of such stocks, which posted sharp declines Thursday.

“The rollercoaster is a very enjoyable ride on the way up, but there’s always a ride down,” said Tom Cook, professor of business law at Georgetown’s McDonough School of Business. “The saddest thing we’re going to find is that young, unsophisticated investors will jump on this bandwagon based on the volatility and the upside, and they will in many cases come out as losers in a very big way.”

Even after declining by more than 44% Thursday, GameStop shares were still up more than 927% during January, a rally that appears to have been catalyzed by social-media campaigns aimed at boosting the shares of troubled companies and harming the professional short sellers who make money betting on companies to fail.

Other stocks that have seen massive gains out of proportion to company financial performance in recent months include BlackBerry Ltd. BB, -41.63%, AMC Entertainment Holdings Inc. AMC, -56.63%, Bed Bath & Beyond Inc. BBBY, -36.40%, Express Inc. EXPR, -50.79%, Koss Corp. KOSS, -27.66%, Naked Brand Group Ltd. NAKD, +0.72%, American Airlines Group, Inc. AAL, +9.30% Castor Maritime, Inc. CTRM, +14.77%, Sundial Growers Inc. SNDL, +37.32%, Tootsie Roll Industries Inc. TR, -9.50% and American Depository Receipts for Nokia Corp. NOK, -28.40% and Trivago N.V. TRVG, -22.26%.

Online brokerage Robinhood banned the purchase of new shares of all the above companies Thursday, following a decision by rival TD Ameritrade to restrict trading on GameStop and AMC shares Wednesday.

Rep. Ro Khanna, a California Democrat who sits on the House Oversight Committee, told MarketWatch that the episode reveals deep flaws in the U.S. financial services industry that require investigations by Congress, regulatory action and potentially new legislation.

“We need to regulate the hedge-fund model,” he said, agreeing with the criticisms of Wall Street that many individual investors have given as reason for propping up stocks with large short interests. “The model is, we make our money by trying to see companies go under. We’re looking for the losers of society and to facilitate their demise.”

Khanna also proposed the imposition of a financial transactions tax on large, speculative trades as a means to dampen bubbles in stocks like GameStop.

Sen. Elizabeth Warren said in a statement Wednesday that complaints from professional money managers that the rise of these stocks has unfairly stuck them with heavy losses was the height of hypocrisy.

“For years, the same hedge funds, private-equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price,” the Massachusetts Democrat said. “It’s long past time for the SEC and other financial regulators to wake up and do their jobs.”

But it’s not clear that the narrative of individual investors leveraging social media to beat Wall Street is accurate, according to Dr. Richard Smith, CEO of the Foundation for the Study of Cycles.

“I guarantee you that if we were privy to all the data on who profited the most from these bubbles, it’s not going to be the guys on WallStreetBets,” he said, referring to the Reddit group that has promoted GameStop and other stocks. “If you look at the unwinding of the trade over the next year, you’re not going to see that a bunch of retail investors picked the pockets of Wall Street.”

The view that many professional investors have had a hand in pumping up the value of GameStop and other company shares is bolstered by the fact that many stocks in question were very heavily traded Thursday, according to FactSet, even as Robinhood and other brokers blocked purchases of the stocks.

“I definitely think there needs to be a look at the equality of access,” Khanna said. “There must be clear regulations for when they can shut down so that there’s not the perception that they’re somehow rigging things on behalf of institutional investors.”

After the market closed Thursday afternoon, Robinhood responded to criticisms in a another blog post, saying that their decision was in part based on its need to satisfy regulatory requirements, “including SEC net capital obligations and clearinghouse deposits.”

The company said it would begin allowing “limited” buys of the aforementioned securities starting Friday. “To be clear this was a risk-management decision, and was not made on the direction of the market makers we route to,” the post read.

Khanna’s colleagues on both sides of the aisle agree that there should be scrutiny of brokers’ decisions to block trades on particular stocks, with North Carolina’s Rep. Patrick McHenry, the top Republican on the House Financial Services Committee, telling Punchbowl News on Thursday that he will request a hearing on whether “there has been market manipulation, fraud or any pump-and-dump schemes.”

Even the very conservative Republican Sen. Ted Cruz of Texas agreed with progressive Democratic Rep. Alexandria Ocasio-Cortez that Robinhood’s decision should be investigated by Congress.

Meanwhile, Democratic Sen. Sherrod Brown of Ohio, the incoming chairman of the Senate Banking Committee, said in a tweet Thursday that he will hold a hearing “current state of the stock market.”

At the state level, New York Attorney General Letitia James said her office would be “reviewing concerns” related to Robinhood and GameStop.

Smith argued that the SEC could move immediately to force brokers to disclose more information on what percentage of their customers make and lose money, particularly on more speculative instruments like stock options. Such regulations already exist in the European Union.

“The regulatory response that I would really hope to see would be more transparency about what’s going on behind the scenes structurally in the markets,” he said. “I believe that one of the drivers is the increasingly intimate relationship between retail brokers and market makers,” as brokers increasingly make their money from payments by market makers to direct trades their way.

There is also the possibility of enforcement actions for market manipulation, according to Alma Angotti, a managing director at the consultancy Guidehouse, who formerly held senior enforcement positions at the Securities and Exchange Commission and the Financial Industry Regulatory Authority.

As the SEC and Congress investigate the origins of the bubbles in GameStop and other stocks, if they find that investors intentionally lied about a company to draw more buyers, the SEC could move to force that person or people to disgorge their gains and pay a penalty, Angotti told MarketWatch.

“The first thing they’re going to do is investigate to make sure there’s no manipulation,” she said. “I’ve seen the progression of market manipulation from boiler rooms to online bulletin boards and now you’ve got social media.”