Was There a Systemic GameStop Price Manipulation?

The pandemic we are currently experiencing has created unprecedented market conditions with unpredictable results. In one of those events, seemingly out of nowhere, a company that many institutional investors were betting would end up bankrupt surged 1000% within a period of two weeks. This stirred up a frenzy of retail investors, united by the common cause against the institutional investors who had “shorted” the stock, creating a highly polarized environment with social underpinning. These events activated the reflexes of the trading mechanism’s cogs in an effort to control the irrational price action under the pretense of the “safety of retail investors.” Several brokers halted intraday trading of GameStop, allowing only the sale of the stock, but in later days slowly accepted a reduced number of shares to be traded. The majority of media outlets focused on the coordination of millions of retail investors flocking to GameStop shares, however, the brokers are currently being investigated for market manipulation.

The story, though, goes deeper. Why would a broker risk its reputation and legal sanctions to manipulate the market and keep a surging stock low? The main broker at issue is Robinhood: one of the fastest growing brokers that apparently is striving to “democratize trading” and also serves the highest market cap of traders instigating the surge of GameStop. However, the profit centers of Robinhood are relatively opaque as they advertise themselves as a zero-fee broker. The way Robinhood makes their revenue is by payment-for-order-flow (PFOF), which essentially means that they sell the market moves of the (retail) investors on its platform to interested parties, usually institutional investors. One of these institutional investors is Citadel, which constitutes 40% of Robinhood’s total revenue. Things got more complicated when Citadel invested $2bln in equity of Melvin Capital amidst the GameStop frenzy. Melvin Capital was one of the main “short” sellers of GameStop, which resulted in a 53% loss of the total value of the firm that equated with the amount Citadel invested. This points towards a conflict of interest between Robinhood, Citadel and Melvin Capital, and any regulatory action for the benefit of retail investors must take place by a regulatory authority such as the SEC.

Things got even more complicated: the CEO of Robinhood, Mr. Tenev, in an interview with Elon Musk highlighted that it was not his choice to halt trading, but rather the National Securities Clearing Corporation’s (NSCC) choice. NSCC is a corporation that serves to make clearing of orders easier and more effective, but also provides risk management to brokers. As Mr. Tenev explained, the NSCC called him at 3AM demanding $3bln in cash to be transferred to them to balance the outstanding orders and the cash collaterals. It is worth noting that Robinhood is valued at $5bln and has received $2bln in VC funds. This suggests that $3bln would be an impossible amount for Robinhood to come up with. Mr. Tenev mentioned that after negotiations and implementing the trading halt they managed to agree to $700mln.

As it seems, the story of the rise and fall of GameStop stock is complicated and demonstrated a weakness in the system. But some questions remain unanswered: can this private authority – the NSCC – enforce measures to brokers, thus moving the market at will? If so, is the individual who takes the decisions regarding the type of measures absent of conflicts of interest? How are the amounts calculated and how could they flexibly be reduced by 80%? Did executives act on the conflict of interest that arose? Retail investors that feel they were defrauded will continue to demand answers to these questions and more.