Robinhood Fallout - Changes Are Coming...

What we learned from this crazy week

The real life Wall St. drama that continued to play out this week in GameStop is quickly becoming one of the most riveting stories I’ve ever seen.

The twists and turns that occurred in real time had my head spinning. It was impossible to keep up. To quote Don Henley - “the more I know, the less I understand”. Every time you thought you understood one aspect of the story, three new new curveballs came whizzing past. At this time we still have more questions than answers.

How It Started…

This didn’t occur over night. The pro and con arguments concerning GameStop were out there for the world to see. It just took some time to get the attention it warranted to go viral.

Last summer, a smart YouTube poster who goes by the name Roaring Kitty did a deep value dive into GameStop. He provided a well thought out thesis as to why it was undervalued and shared it with his followers. While a user name like “Roaring Kitty” doesn’t sound like a legitimate voice in the financial world, all one had to do was listen to his logical thoughts on GameStop to understand. You may not have agreed with his findings, but you had to respect his process. (YouTube link here. NYTimes article here)

On the other side of this trade, you had people betting against shares of GameStop. Hedge funds like Citron Research was one of them. They made their research public and had their own thesis as to why the shares would decline in value. When the stock started rallying, they went public again stating why they believed shares were overvalued. They then became the poster child for the short side that was about to get squeezed.

What Happened Next…

GameStop shares started to rise as news broke that Chewy’s founder, Ryan Cohen, joined the GameStop board. Cohen’s involvement turned heads as he has a proven track record in the industry. He also has a very loyal following on the internet—not to the level of an Elon Musk or Chamath Palihapitiya, but he’s on his way.

As more attention was focused on GameStop, the internet buzz grew to a fevered pitch. Reddit’s WallStBets and their community took to the story and ran with it. Roaring Kitty’s thesis was becoming mainstream, but more importantly so was the short interest story and the fact that this was one of the most shorted stocks on the exchanges.

This changed the entire narrative of the story. What started as a major difference in views on just one stock turned into a crusade of long vs short, rich vs poor, the suits vs the common man and good vs evil.

Where We Are…

Over the past few weeks the shockwaves caused by this one story had an enormous ripple effect on Wall St. The buzz about stocks that are heavily shorted brought on a deluge of new participants to the market. We saw individual stocks become targeted and attacked by a savvy group of traders like a wolfpack hunting its next meal. I talked about it here and here a few posts ago, and these trades have only gained momentum since.

Volumes exploded in stocks that had huge short exposure. Stocks such as AMC, Nokia, Tootsie Roll, Bed Bath and Beyond and Koss Corporation joined the most active list. Prices in some of these shares went, as they’d say, “to the moon”. Some shares doubled or tripled over the course of a day.

As this mania grew into a full blown inferno, so did the narrative. The buyers were sticking it to the establishment. The shorts were referred to as “the suits” and “the man” - and who doesn’t want to stick it to the man. It was becoming a revolution, as they called it, and many new traders were making a lot of money off of these quick moves.

While I’m not 100% on board with this narrative, it is understandable.

Some History…

For years well known people within the industry have been able to go on financial TV, hold conferences or pitch their stock ideas to investors. A hedge fund is permitted to take a position and promote their thesis and ideas to the public. A well respected idea and manager can move stocks as investors try to ride their coattails.

Some of these managers have become infamous and often tell their stories to an audience of curious investors. Bill Ackman is one of those managers. In December 2012, he gave a 342 page slide presentation promoting one of his new short ideas at the Sohn Conference to a throng of followers. His big short idea was the stock Herbalife.

His report caused shares of Herbalife to sell off over 12% that day. It also sparked the interest of a rival hedge fund manager, Carl Ichan. Ichan took the other side of this trade. He then took to CNBC to report his reasons behind his new position. This led to one of the most entertaining and watched battles to occur on live financial TV.

The two titans of the industry took to CNBC to argue their positions in Herbalife. One was long and the other short. The argument practically stopped trading on the floor of the NYSE as everyone looked on in amazement. I remember, because I was there.

The battle was ugly and became personal. It’s not unlike what we are seeing now except for one huge difference. It’s not a battle of titans. It’s a battle between the “regular” guy and gal vs the perceived titans of Wall Street.

The New Twist..

When describing the struggles between the rich and poor or the haves and have nots, there is no better illustration than Robin Hood. So it’s no coincidence that the trading platform Robinhood has come to represent the small investor. It’s one of the best known and most utilized trading vehicles for those under 30 and has now become the center of this story.

As this new leadership of stocks continued “to the moon”, they experienced excessive volatility and saw their volumes soar to over 1000 times their daily average. Behind the scenes the venues responsible for clearing these trades were met with their own challenges.

Trades don’t settle in real time, it still takes trade date plus two days (T+2) for the buyer and seller to technically receive their funds once a trade is consummated. When trading on margin - meaning borrowing funds you don’t have to buy or sell short a stock - these venues take on risk and when it becomes excessive they can change their rules as to how they manage that risk. (A more in depth and great explanation can be found here from Barron’s)

As a result of their risk factors, they changed the rules as to what stocks can and can’t be traded and infuriated an already skeptical public. So Thursday morning without warning trading in shares of $GME $AMC $NOK $KSS among others became restricted on Robinhood as well as a few other venues.

The Outrage and Conspiracies..

Shares of $GME were up 18% Monday, 93% Tuesday, 135% Wednesday and now, out of the blue, the Robinhood platform restricted activity in those names. Users of their platform were only permitted to sell what they own. There was no new buying or trading permitted.

You have got to be kidding me.

Meanwhile, other platforms could still handle their trades. Platforms that didn’t cater to this new, young crowd. The perception was that the “elite” will be able to sell their shares and cover their short positions at a lower price. While the Robinhooders would drive the price lower as many would have to bail out to try and lock in profits or limit losses because they have no other choice.

Well that doesn’t sound fair, and due to the surprise nature of the announcement, only led to true outrage about a rigged system that was against the little guy.

As a result, rumors swirled all day. This had to be the establishment pressuring the platforms that they have a vested interest in to shut out the general public. Assumptions were that the same hedge funds getting hurt by the short squeeze were behind the move to stop the rally. If true, they were winning and controlling the narrative by gaming the system.

As expected, shares of $GME sold off after the buying restrictions were enacted. The stock closed lower by 44% that day. Recent owners were left angered and confused. They banded together in their internet circles with the rallying cry to hold and fight on.

The outrage was widespread as this became the top story on every news network. All fingers pointed to Robinhood as the poster child of this mess. Now, in the eye of the public, they’ve become no different than those establishments that their platform intended to differentiate itself from. By time the clearing house issues came to light and were discussed, the damage was done.

The optics were so bad that it even united people across the political aisles. When politicians like AOC and Ted Cruz can agree on a topic you know things have turned upside down.

Mammoths of FinTwit were united in their outrage too. Elon, Chamath, Barstool’s El Presidente - Dave Portnoy and Mark Cuban all came out with strong opinions on the matter supporting the little guy. Some were more vocal than others.

The theme was to rail against the establishment. The same group that was permitted to legally profit from their own advice on stocks, seemingly changed the rules when the everyday investor was united in a cause attempting to do a similar thing and stick it to the so called man.

Some even went so far to say these new rule restrictions were needed to protect investors from themselves.

This is laughable.

While there will always be a need for more financial literacy and avenues for new investors to learn, don’t tell me what I can and can’t do with my money.

Losing money, as sad as it is, will be the best learning experience ever. I don’t recommend it, but having been there myself in the dot-com bubble, I did learn a life lesson or two.

My friend JC Parets went much deeper with his thoughts on that topic than myself. It’s definitely worth a read.

What’s Next..

Who only knows what twists and turns this ongoing saga takes?

The fact that Robinhood has become the focal point of this story and has sought more cash for its balance sheet has me concerned. While I understand that the clearing rule had become an issue, the fact that on Friday they prohibited trading in another 50 stocks that didn’t have similar activity is puzzling.

Once again - the more I know, the less I understand.

The rules - many that have been in place since 1934 - have to be revisited quickly. They are outdated and don’t take into account how things are spread across the internet at lightening speed. If restrictions are made on the public stirring up interest in certain stocks, then it should also fall in line with industry communication standards.

Trading settlements - the fact I can order most anything to my house within minutes, that businesses learned to adapt to work from home on the fly, but trades still take T+2 to settle is an enigma. This isn’t 1968 when the NYSE had to close on Wednesday’s to catch up on the settling of trades. The technology is there to expedite this process. This needs to be addressed.

Financial Literacy - no this doesn’t have to be forced down people’s throats, but it needs to be discussed. Venues need to have better communication to inform and teach the new and casual investor. Schools need to teach the basics about credit and investing at an early age. In hindsight, I would’ve gotten more out those classes than I did out of Latin (In fairness to Latin, it does come in handy with the NY Times crossword).

Future books and movies - Agents are salivating to pitch their clients for key roles. I can already picture Adam Driver as the Robinhood CEO or Matthew McConaughey as Dave Portnoy. They will be epic and they will happen.

The Blame Game..

Lastly, one thing that is guaranteed to happen is the inevitable finger pointing.

Every story needs a villain. Rightly or wrongly, Robinhood has gone from hero to villain over night. Calls for the head of their leader, Vlad Tenev, will ring out. I hope he can survive this, but there is blood in the water and the sharks are hungry.

Congress will call on hearings and bring in figureheads throughout Wall St. to “investigate”. They will parade them in front of the cameras and yell from the hilltops to get their soundbites on TV. They will blast those clips home to their constituents to show they were fighting for the common man. It happens every crisis.

There will be changes. The conversations around improving the financial landscape should be welcome. We already saw Citron change their tune when it came to investing and others may follow.

Sadly it always takes a major event to drive necessary change. Sometimes we didn’t even know we needed things to change. Ironically, that is the one constant.

Great references besides the linked articles within the post..

The Compound Show with Downtown Josh Brown

Odd Lots Podcast - GameStop Mania: The Score of a Lifetime

We Bell CEO explains why trading was restricted - Yahoo!Finance

Robinhood CEO Vlad Tenev - CNBC

Commonly heard terms this week..

Short Squeeze, Gamma Squeeze,