On June 24, Congress published its report on the GameStop “Meme Stock Market Event” as part of its now-completed investigation into meme stock volatility and regulations that could mitigate it. The investigation spanned 16 months, featured over 50 interviews with 19 institutions, and encompassed 95,000 pages of documents.
The core findings of the report ultimately boil down to Robinhood acting irresponsibly, failing to properly anticipate risk posed by volatility despite historic outages and instead prioritizing growth even as it risked becoming illiquid, all of which forced it to halt Gamestop stock trading on January 28, 2021. The report also highlights how an Elon Musk tweet caused a historic spike in user activity which the company debated capitalizing on.
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“Robinhood exhibited troubling business practices, inadequate risk management, and a culture that prioritized rapid growth above stability during the Meme Stock Market Event,” reads the first key finding of the Congressional report.
Robinhood observed a massive spike in activity after Elon Musk tweeted “Gamestonk!!” and a link to the Wall Street Bets subreddit on Jan. 26, 2021.
In response, one product manager said “we could probably interact with this movement to promote RH growth, but thinking we should stay far far away from this entirely.”
Despite all this, however, growing Robinhood and addressing volatility and strain on operations were still treated as mutually exclusive internally. One product manager telling Robinhood’s Head of Data Science there was “conflict brewing” and they “have to keep the growth flywheel running.” The Head of Data Science replied “haah dont worry, we need to survive first,” before adding “I am firmly in the growth camp.”
According to the report, the next morning, Robinhood employees continued to monitor market activity and observe volume and volatility. Robinhood’s chief executive, Vlad Tenev, was concerned about the company being able to maintain “adequate liquidity” and said as much to the company’s chief financial officer Jason Warnick.
“Just make sure our liquidity stays green jason :slightly_smiling_face:,” Tenev said in a chat on Jan. 27 included in the report. “And we’ll be fine.”
“On it!” Warnick replied.
The GameStop short squeeze wasn’t the first time the company suffered outages that hurt its customers, the report highlights.
From 2018 to 2020, millions of Robinhood customers dealt with technology outages. At its worst, as the report lays out, Robinhood shut down between March 2-3, 2020 and locked out its entire customer base as the COVID-19 market meltdown began. Before GameStop’s trading frenzy, Robinhood had failed to act on FINRA recommendations made after historic fines for systemic supervisory failures that caused its March 2020 outage. Part of those recommendations included updating a stress test to anticipate peak collateral obligations to clearing agencies that might restrict customer access if Robinhood didn’t have adequate liquidity to sustain trader activity on its platform.
Tenev insisted this was an “unmodellable” event but the report found that because of this failure to update its stress test with FINRA’s recommendations, calculations made days before to predict clearinghouse collateral obligations during volatile trading periods were incomplete and “grossly underestimated.”
As the trading week began, Robinhood tooks steps to focus on “accommodating rapid growth, even as it faced severe operational strain in its internal systems and nearly missed a deadline to its options clearinghouse that would have prompted a liquidity crisis within Robinhood,” the report states. As systems started to be strained, Robinhood’s executives held an all-hands meeting asking people to “discuss ways to handle Robinhood’s rapid growth during the rising volatility, which many in the company saw as a commercial opportunity.”
By the end of the day on January 27, the day before Robinhood halted buying GameStop stock, an internal discussion between the director of account operations and the head of market operations remarked on how it was “funny” that they were reliving the systemic crisis of March 2020 with larger volumes but “public perception is fine” because “no one knows there are issues.”
All this, the report laid out, was linked to Robinhood’s business model: payment for order flow (PFOF), where market makers who buy or sell securities from broker-dealers earn a profit by selling orders for more than they are purchased, then offer broker-dealer a share of those profits. Robinhood’s business model, however, isn’t solely PFOF, but is also centered on growing its user base through “commission-free” trading as well as a lax policy towards margin trading (using loans to buy stocks), as well as gamification of its platform. During periods of volatility, all this comes together in that Robinhood earns higher than normal rebates on orders because it calculates rates on the spread between a purchase and sale instead of as a flat fee, but also because users are encouraged to keep trading with instruments they often don’t understand and money they often don’t have. Because Robinhood only relies on a limited number of market makers, it was not able to actually fulfill its equities orders.
In other words, the report concludes, Robinhood handled the Gamestop stock volatility so poorly partly because of its own failure to properly anticipate market volatility. It had little interest in doing so and was more interested in growing its user base, growing payment for order flow revenue, and entrenching traders on its platform with gamification.