SEC succumbs to political pressure on GameStop report

The U.S. Securities and Exchange Commission (SEC) released the much-awaited GameStop report on Monday. The report came as a shock as it denies the existence of naked shorts (with respect to GameStop), no broker faced liquidity issue and accepted that the short interest could technically go above 100% for a trading security. The final nail on the coffin was; the report concludes that the reason for the GameStop spike was the coordinated efforts of retail traders and not due to shorts covering their positions.

The Preface

Between January 22nd, 2021 and January 29th, 2021, GameStop and other meme stocks grabbed the attention of the entire financial world when their stock price rose more than 1900% in a matter of days. This lead to a congressional hearing where firms/individuals believed to be responsible were asked to testify. SEC was ordered to publish a report on this event, due in the Summer of 2021. After multiple delays, the SEC finally released the report – literally squashing every claim the retail traders put forth.

Liquidity Issue

Although Robinhood’s CEO Vlad Tenev testified that there were no liquidity issues, he later acknowledged it was indeed the case, due to which Robinhood had to restrict its users from buying. The SEC report says that its staff did not observe any liquidity issues or difficulties with counter-parties.

Gamma Squeeze and Naked Shorts

All D.D.’s of Redditors and the extensive media coverage were sure that it was short/gamma squeeze that caused the spike, but the SEC says that their staff didn’t find any evidence of this. Their staff also didn’t find any evidence of Naked Shorting.

Its footnote confirmed that, “In a “naked” short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard two-day settlement period. As a result, the seller fails to deliver securities to the buyer when delivery is due. Because direct measures of naked short selling do not exist, fails to deliver can be used to learn about naked short selling. Naked short selling can have negative effects on the market.” And according to rule 10b-21, naked short selling is illegal.

On-Page 29 & 30 – the report clearly states that “While a short squeeze did not appear to be the main driver of events, and a gamma squeeze less likely, the episode highlights the role and potential impact of short selling and short covering.” Meaning – It was not a short or gamma squeeze.

page 29 of the report
Page 30 of the report
Trading restrictions

During the January event, the most controversial element was when brokers such as Robinhood restricted users in buying GameStop and other meme stocks but accepted them to close their positions, causing a massive crash later. The report denies that the NSCC had no part to play in this decision by brokers to place these restrictions. The SEC staff also observed differing practices among broker-dealers when notifying customers about trading restrictions. Some broker-dealers announced customers when they imposed trading restrictions through various methods, including emails, pop-up messages when accessing the account or trying to transact in a restricted security, posts on dedicated customer service sections of the platform, and social media posts.

Dark Pool

The report also acknowledged the well-known fact that a vast majority of the trades were internalized (80% approx). Citadel securities (55%) and Virtu Americas (28%) controlled these trades.

The report also acknowledges that much of the retail order flow in GameStop (GME) was purchased by wholesalers and executed off-exchange. Such trading interest is less visible to the wider market—and payments to broker-dealers may raise questions about the execution quality investors to receive. Further, though wholesalers increasingly handle individual investor order flow, they face fewer requirements concerning their operational transparency and resiliency than exchanges or ATSs.

The report also revealed that trading of GameStop was halted a whopping 19 times on January 28th 2021.

Conclusion

So what’s the takeaway from this report? There are just two possibilities; Either the staff who observed these events need to be replaced as there are so many contradictions in their observations. For example, the staff had observed no liquidity issues by any of the brokerages, while Robindood’s CEO Vlad Tenev had acknowledged this to the mainstream media.

Another example, the report recognized the massive amount of short interest before the sequence of events but denied that short interest was the driving force for the spike; as below

Or Political pressure; This report was delayed multiple times before it was finally released on Thursday. Citadel’s CEO Ken Griffin is a major donor for the Republicans who spent more than $61 million to boost Republicans in last year’s elections. There might also be many democrats who support Ken Griffin’s ideology. For example, David Scott of the democratic party recently said he is putting together a bill that would provide strong enforcement powers to the Government, including fines and jail sentences targeting the retail crowd on social media (predominantly the Reddit crowd). So political pressure is a major possibility.

The report raises more questions than answers. For example, there were no answers to how a broker can restrict a customer from buying GameStop but allow them only to close or sell their positions; what are the consequences of doing such a thing? On the one hand Gary Gensler vows to protect retail investors, but on the other, a report like this get published.

On October 25th, It will be interesting to see SEC’s stand on a lawsuit Citadel had filed against it.

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