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Last week we noted how a hive of millions of small, mainly young investors in the Reddit user group, r/wallstreetbets (“WSB”) targeted GME, the small, heavily shorted stock of troubled video game retailer GameStop. In a classic short squeeze, the stock price was driven up from a more or less rational price of $20 per share, to over $400.

A leading voice in this effort was “Roaring Kitty” on YouTube, and “DeepF*******Value” on Reddit. He was recently unmasked as Keith Gill, a young dad who films videos in the basement of his suburban Boston home. Here is a screen shot from one of his videos from July, 2020, where he describes his general investment approach:

In an interview with the Wall Street Journal, Gill claims, “I didn’t expect this”. According to his mother, Gill “always liked money… As a child, he would get money from those scratch tickets that people didn’t know they’d won. People would throw them on the ground….A lot of times there was still money on them.” And when all the craziness with GameStop started, the first thing his mother asked him was whether this was anything illegal or dishonest, and he assured her, “No mom, it’s not.” 

Whew, that is good to hear. With all that said, Roaring Kitty and his pals have taken a chunk out of the sophisticated Wall Street pros. Some of them, such as the hedge firm Melvin Capital, had taken a very risky position, shorting more shares of GME than were available for trading, and lost billions in the squeeze. As this story broke last week, Robinhood and similar discount brokers who were the favored platforms for the Redditors restricted buying shares of GameStop and some other stocks. [See more on that below].

Other shorted stocks, like the theater firm AMC, which were also targeted by the Redditors, doubled last week. Silver miners were also talked up, and some of them were up by 50% in just a few days.

Even silver itself, a huge commodity, leaped to a seven year high, well above its cost of production. However, silver is very controversial within the Reddit community. There are some promoters of silver, but the hardcore WSB crowd suspects the hedge funds are nefariously trying to dilute the resources of the retail investors away from GME by talking up silver. It’s complicated…

As of today (Tuesday, Feb 2) it looks like these frenzies are unwinding. Silver gapped down at the open to its previous trendline. GME had held well over 200 yesterday, though steadily declining. Today it cratered to open, and is struggling to hold above 100. As I noted last week there was no realistic hope that the super-high prices could be sustained for long. I suspect that a nontrivial amount of institutional money in the form of high frequency momentum trading algorithms piled in alongside the Redditors on the way up, and is now bailing out on the way down. I hope the little guys were able to book some of their gains along the way.  Anyway, it has been fun, and we will get to relive the whole thing again and again with two movies (from Netflix and MGM) in the works to show us what we just saw.

More on Robinhood Restricting Trading in GME and Other Stocks

One of the many controversial aspects of this whole story is that Robinhood and several other discount internet brokers restricted buying new shares of GME, and some other shorted stocks. Retail investors could sell, but not buy. Wikipedia noted that angry customers review-bombed the Robinhood app on the Google Play Store after it halted the trading of GameStop securities, pushing its ratings down to one star. (Google censored and deleted at least 100,000 such reviews, calling them “coordinated or inorganic”, to preserve a high rating for Robinhood.)

Meanwhile, big institutions were able to buy as needed to cover their short sales. This seemed like the Wall Streeters ganging up against the little guy. The case for collusion is especially strong since Robinhood (which doesn’t charge commissions on trades) gets much of its revenue from fees received for routing its trader orders through certain big Wall Street firms, including Citadel Securities. This is called Payment For Order Flow (PFOF). Citadel Securities was founded by the same Kenneth Griffith who founded Citadel LLC, which is now heavily invested in Melvin Capital, which was heavily impacted by the GME short squeeze.

Robinhood has had its hand slapped in the past ($65 million fine) by the SEC for bilking its customers in order flows. (The complaint is that Robinhood gets paid by market makers with PFOF, for allowing them to chisel the investors a little bit with each trade).

Robinhood claims that they were not under any pressure from other parties to restrict trading, but they simply weren’t able to put up enough collateral required to cover all these trades.  

Here is a figure from an article by Andreas Repeta which describes in detail how the order flow and execution works:

The short story is that some larger brokerages deal directly with the stock exchanges, and thus presumably are able to get the best trade executions for their clients. Fidelity, for instance, brags that they get the best trades for their customers and that they do not take order flow payments (PFOF).

The little guys like Robinhood hand their orders off to a complex web of investment banks and hedge funds. If Robinhood got squeezed, even a little, by the hedgies and their pals, Robinhood would be hurting. So, with its customers costing the hedge funds billions of dollars with short squeezes, Robinhood certainly had incentives to lean towards restricting trading in GME, apart from whatever its collateral issues were. There was definitely a pattern of brokers like Robinhood which feed at the PFOF trough restricting trading in GME, versus other brokers like Fidelity not restricting trading.

Hopefully the truth will come out in the upcoming congressional hearings. And we will get to see how just effective corporate lobbying money can be: according to the Washington Post, Robinhood spent $275,000 lobbying the federal government last year, and (no surprise) just posted a job opening for federal affairs manager (“This role will focus on federal advocacy and government affairs related to legislative and regulatory matters”). Citadel spent $520,000 in lobbying in 2020, and also paid Janet Yellen, our new installed treasury secretary, a mind-boggling amount (between $710,000 and $760,000) in speaking fees in 2019 and 2020.

Update: See Why Short Selling Is a Good Thing for the Stock Market and Investors Large and Small ]