Senate and House committees to hold hearings on GameStop trading fallout

Both the House Committee on Financial Services and the Senate Banking Committee announced Friday that they will hold hearings regarding “recent market instability” after a number of major online stock brokerages introduced restrictions on trades involving tech stocks commonly shorted by institutional investors.

“Hedge funds have a long history of predatory conduct and that conduct is entirely indefensible,” House Financial Services Committee Chairwoman Maxine Waters wrote in a statement. “As a first step in reining in these abusive practices, I will convene a hearing to examine the recent activity around GameStop (GME) stock and other impacted stocks with a focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors.”

“People on Wall Street only care about the rules when they’re the ones getting hurt,” incoming Senate Finance Committee Chairman Sherrod Brown wrote. “American workers have known for years the Wall Street system is broken – they’ve been paying the price. It’s time for the SEC and Congress to make the economy work for everyone not just Wall Street. That’s why, as incoming Chair of the Senate Banking and Housing Committee I plan to hold a hearing to do that important work.”

Spurred by advice on the Reddit thread r/WallStreetBets, retail investors using online brokerages have sent previously undesirable stocks through the roof — catching both brokerages and institutional investors off guard by massive unexpected losses.

The controversy over the past two weeks has largely centered on GameStop, a video game retailer with one of the most shorted stocks on any stock exchange, when its stock shot up. Firms that rely on risky bets for big payoffs, including Melvin Capital Management, tanked. MCM’s value slid 15% in the first three weeks of the year.

When an investor shorts a stock, he or she borrows the stock from a broker and sells the borrowed stocks to a third party — with an assurance that the investor will return the same number of stocks to the broker that were borrowed for the sale. Because the investor is betting on the stocks’ price decreasing, the investor can buy shares at a price lower than he or she sold them for to return to the broker and pocket the difference.

But if the price jumps, investors lose money because they have to buy shares at a higher price than the shares that they sold to the third party in order to pay back the broker. This often leads investors to buy even more shares of the stock to make up for the losses from the short — pushing the value of the stock even higher in what’s known as a short squeeze.

Multiple online stock brokerages have levied restrictions in recent days. One particular brokerage that has received a great deal of attention, Robinhood, introduced restrictions on certain stocks on Wednesday, citing “recent volatility.”

“We continuously monitor the markets and make changes where necessary,” the company wrote in a statement. “In light of recent volatility, we are restricting transactions for certain securities to position closing only, including $AAL, $AMC, $BB, $BBBY, $CTRM, $EXPR, $GME, $KOSS, $NAKD, $NOK, $SNDL, $TR, and $TRVG. We also raised margin requirements for certain securities.”

Many retail investors who had been locked out of trades cried foul and alleged that brokerages had taken actions “to protect institutional investment at the detriment of retail customers.” Several lawsuits were filed Thursday against online broker Robinhood on the grounds that the company “purposefully and knowingly manipulate[d] the market for the benefit of people and financial institutions who were not Robinhood’s customers.”

“Private funds engaging in vulture strategies that hurt workers must be stopped,” Waters said. “We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price.”