A federal investigation into the meme stock frenzy that gripped Reddit investors in early 2021 has led to a host of recommended policy changes from the House Committee on Financial Services and calls for better treatment of all retail investors.
The majority staff report titled “Game Stopped” was released Friday by Committee Chair Maxine Waters, a Democrat from California, and Al Green, a Democrat from Texas who serves as chair of the Subcommittee on Oversight and Investigations.
According to officials, the combination of institutional investors betting against meme stocks and retail traders purchasing them en masse created a trading frenzy that drove historic market volatility that reached its peak in January.
In response, Waters called for a federal probe of the circumstances and practices that led to the volatility.
“Last year’s meme stock market frenzy raised important questions about the fairness of our financial markets, the gamification of trading, the treatment of retail investors and so much more,” Water said in a statement. “In response to those events, my committee held multiple hearings — including the first of them with CEOs from Robinhood, Citadel Securities and many others — to get to the bottom of the role these companies played in the volatility and disruption in the stock market in January 2021.”
The 138-page report released this week is the result of a 16-month committee staff investigation that included more than 50 interviews with representatives from 19 financial institutions and the analysis of more than 95,000 pages of documents.
Waters said the investigation revealed the need for better market regulation to address the “troubling business practices that were uncovered.”
“Payment for order flow and gamification make it profitable for a new generation of trading apps to push retail investors to make as many trades as possible, making the markets more volatile than ever,” Water said, noting that significant legislative and regulatory reforms are needed to modernize the regulatory framework protecting the market and ensuring that this kind of frenzy won’t happen again.
Four key findings were unearthed via the investigation, including the committee determining that Robinhood exhibited troubling business practices, inadequate risk management and a culture that prioritized rapid growth above stability.
“Robinhood’s disproportionately high order flow and unique formula for calculating PFOF rebates strained several market makers and introduced risk to the stock market. Robinhood’s PFOF formula became a point of contention between Robinhood and Citadel Securities during the meme stock market event,” the report said. “Robinhood asserted to the public and testified to the committee that the company was ‘always comfortable with [its] liquidity’ leading up to its historic trading restrictions, despite the actions undertaken by Robinhood’s executive leadership to respond to liquidity issues it faced in the days leading up to the meme stock market event.”
The committee also found that broker-dealers facing the most severe operational and liquidity concern executed the most expansive trading restrictions amid the frenzy; that most of the firms they spoke to lack explicit plans to change their policies for how they will meet their collateral requirements during extreme market volatility; and that the Depository Trust & Clearing Corporation does not have detailed, written policies and procedures for waiver or modification of a “disincentive” charge it calculates for brokers that are deemed to be undercapitalized.
The DTCC, which waived $9.7 billion of collateral deposit requirements in late January 2021, has regularly waived such charges during periods of acute volatility in the two years before the meme stock event, according to the study.
The committee staff recommends policy changes so that regulators “can better understand the influx of retail traders; enhance supervision of retail facing “superbrokers”; and strengthen capital and liquidity requirements and oversight.”
“The report reached multiple key conclusions, including the finding of existing deficiencies with the current market regulatory structure,” Green said in a statement. “My hope is that the report’s findings will lead to improvements in the functioning and regulation of the U.S. securities markets and result in a more fair and secure system for all investors.”
The full report can be found here.
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