- - Thursday, February 4, 2021

GameStop has captured the nation’s attention. As widely reported, the gaming retailer’s stock price explosively increased last month from less than $20 to an intraday high of nearly $475. As a result, hedge funds lost billions of dollars in their risky bets against GameStop. Other investors — including ordinary members of the public — profited from their losses. In this latest cultural battleground, sore losers have started name calling. 

Billionaire hedge fund manager Leon Cooperman accused GameStop investors of “sitting at home, getting their checks from the government.” Others have accused them of being “market manipulators” and even “insurrectionists.” When hedge funds behave this way, they simply call it “arbitrage.” Reality check: Hedge funds offered up a free lunch, and the public ate it.

But maybe there does need to be an investigation — not of the public, but of Wall Street? Did an industry-owned firm take regulatory actions that harmed GameStop stock price without first disclosing its intent to the public?

The story starts with the trading app Robinhood and other brokerage companies. As the price of GameStop was rising, and hedge funds’ losses along with it, these brokerages prohibited their customers from buying stock. These actions weren’t like a 15-minute trading halt on a stock exchange, which allows for the market to breathe during times of high volatility. The public was just disallowed from buying, indefinitely. Some have alleged foul play, accusing brokerages of engineering an artificial collapse in stock prices.

On Feb. 18, Robinhood co-CEO Vlad Tenev will reportedly testify to Congress about these allegations. His defense will be simple: Under Dodd-Frank regulations, brokerages could either restrict the public from buying GameStop or go bankrupt. He explained as much to Elon Musk, who grilled him in a public discussion. He’s right. But with anything involving financial regulation, the details are complicated. A quick history lesson might help.



Following the 2007-09 financial crisis, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, having several laudable public policy goals in mind. An important one was ending “too big to fail” scenarios — a problem where some of the world’s financial plumbing was owned by its largest financial firms. If those firms failed and were not bailed out, then they could pull down the entire financial system along with them. One of the ways Dodd-Frank addressed this issue was through central clearing. The basic idea? Have a central firm own the plumbing. Then, to use the plumbing, a firm must post deposits to protect the system from credit risk.

Owned collectively by Wall Street firms, the Depository Trust & Clearing Corporation (DTCC) and its subsidiary National Securities Clearing Corporation (NSCC) play this role for the stock market. Brokerages make deposits when they use the financial plumbing to settle your stock trades. In the case of GameStop and other high-volatility stocks, executives significantly increased deposit requirements to clear those purchase orders.

In his interview with Mr. Musk, Mr. Tenev claims that the NSCC originally requested $3 billion, “an order of magnitude more than what it typically is,” before ultimately settling for $1.4 billion. Brokerages lacked the capital to allow the public to buy more GameStop, so they drew on lines of credit and restricted purchasing.

NSCC executives might have seen a threat to financial stability and acted in good faith. Even so, they disclosed this information to the clearing members before the public. Increased deposit requirements, such as Margin Liquidity Adjustment Charges, should be broadly disclosed to all market participants because they have a material effect on stock prices. For this reason, selective disclosure by public companies is banned by the Securities and Exchange Commission (SEC) under Regulation Fair Disclosure (Reg FD). In this case, institutional traders with insider access to news would know that the prices of GameStop and other affected stocks would plummet on market open. And plummet, they did.

These actions’ results and their selective disclosure heighten the public’s suspicion that markets are rigged against them. Congress and the SEC should investigate. And the willingness of the powers that be to marginalize members of the investing public as “insurrectionists” demonstrates their fatal conceit: that their failures are not their own, but the result of conspiracies against them. Some have even proposed restricting the public’s freedom to trade and discuss stocks online.

Instead, Congress and the SEC should make financial markets freer and fairer. First, let the hedge funds and brokerages who can’t manage their risk fail. If their failures could cause market dysfunction, then limit their leverage. Second, allow for more public involvement and innovation, not less. Third, enhance regulation to ensure that access and disclosure is provided equitably to all market participants — including the public.

• Christopher M. Russo is a research fellow with the Mercatus Center at George Mason University. Prior to joining Mercatus, he advised top policymakers at the Federal Reserve on monetary policy and sovereign debt management.

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