Robinhood ticked off a series of controversial debates in January when the CEO, Vlad Tenev, announced in a press release that the platform would restrict all trading on GameStop(GME) and other stocks known as the “hot-stocks.”
Robinhood said the restrictions were made on a demand from its clearinghouse, which forced them to raise as much as $3 billion in increased capital requirements to handle the volatile and leveraged stocks.
“It’s important to analyze the concept of shorting a stock, when people think about investing they buy a stock and they wait for the price of the stock to go up and then they sell it to make a profit. Under this scenario, you can only make money if you find and buy a stock that’s going to appreciate in price,” said Abdel Kader Ben-Mohamed, Chair of the Business Department at Mercy College.
With the pandemic and with video games being easily accessible for purchase online, Gamestop could not afford their physical stores. In Sept 2019, Gamestop announced the closing of more than 200 stores.
With the downfall of sales in physical stores, Gamestop was on the brink of filing for bankruptcy.
“That was probably the thesis behind some hedge funds thinking that ultimately GameStop was going to fail, or that the price of the stock was going to be lowered,” said Ben-Mohamed.
Similarly, predictions were also made about the theater company AMC. A target steadily promoted by the online community of retail investors.
“It seemed like a logical thesis for hedge funds or institutional investors who predicted the fall of GameStop and other stocks to short the stock. The shorting of a stock is when you borrow the share and you sell it and you wait for the stock to lower in price and at certain point, then buy it back and return it.”
What Robinhood and many of the investors didn’t expect was that a major social network movement was growing in the Reddit platform.
Keith Gill (The man behind Roaring Kitty), is an American financial analyst investor who synchronically with a Reddit group, the WallStreetBets, caused the stock market to go viral.
The following stocks were promoted heavily on social media; AMC, (BB) Blackberry, (EXPR) Express, (GME) GameStop Corp, and (KOSS) Koss Corporation. In a short period, Gill and the Reddit group caused these stocks to increase ultimately in value.
These stocks are now known as the “meme” stocks.
“Regular folks basically created a buying attack on these stocks, and because these stocks were shorted heavily, they were buying and causing the stock to go up, leaving institutional investors short.”
There are different levels of tolerance in the stock market world, and the process of selling a stock short can create an unlimited potential loss.
”The problem was excessive shorting, at one point the amount of shares shorted at GameStop was 150 percent more than the amount of shares available. It could be done, but it just makes no sense if you short shares that in theory don’t even exist,” Ben-Mohamed stated.
“The moment a stock starts going up, you start losing money and whether it is your broker or custodian, they will start calling you to put more money in. Most investors buy on margin calls.”
The margin call demands additional money to bring a margin account up to the minimum maintenance margin. According to Ben-Mohammed, based on the amount of trading taking place in a given stock, more capital has to be put in as collateral for trade, or the clearinghouse. Robinhood did not have this money, causing them to take extreme measures to limit the purchase of all of the hot stocks.
Multiple speculations on social media accused Robinhood’s CEO of protecting his relationship with Wall Street business partners, including Citadel Securities. Tenev denied all allegations and apologized to Robinhood customers in a virtual hearing with the House Committee on Financial Services.