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A US federal hearing on the apparent surge in retail trading in GameStop and subsequent short squeeze has raised the spectre of reporting of short positions under Dodd-Frank.
Amid a barrage of questions to witnesses regarding the ethics of short selling and securities lending, hedge funds were described by House representatives as market “bullies” accused of market manipulation and damaging the finances of American families.
While some House representatives urged the Securities and Exchange Commission (SEC) — currently investigating the events of January — to propose further financial regulations, others, along with witnesses called to testify before the hearing, said a “big government” approach would hurt the democratisation of finance.
A memorandum for the hearing released by the US House Committee on Financial Services gives an indication of the flavour of regulations that the House has in mind.
The document details dormant sections of the 2011 Dodd-Frank Wall Street Reform and Consumer Protection Act, brought in after the financial crisis, which would oblige firms to record and publicly disclose short selling data at a minimum of once a month.
The SEC was meant to revisit the requirement after Dodd-Frank but the reporting rules were instead left to gather dust.
In the wake of the GameStop ‘meme stocks’ drama, the committee, which oversees the country’s financial services sectors, held the first of three hearings on “predatory” short selling and its impact on retail investors.
US congresswoman and committee chair Maxine Waters said she wanted the hearing to “focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors”.
The virtual hearing took place yesterday and ran for more than five hours as House Representatives from across the country interrogated the witnesses remotely.
Speakers called to testify were Robinhood CEO Vlad Tenev, hedge fund Citadel CEO Kenneth Griffin, Reddit CEO and co-founder Steve Huffman, Melvin Capital CEO Gabriel Plotkin, Cato Institute director of financial regulation studies Jennifer Schulp and day trader Keith Gill who is credited with rallying the retail interest in GameStop through Reddit forum WallStreetBets.
The absence of an SEC representative was due to the fact that a permanent head of the federal agency has yet to be confirmed by the new President of the United States, but the appointee is expected to appear at the next hearing picking over the bones of the January trading frenzy.
In her opening statement, Schulp emphasised that “the temporary volatility in these stocks did not represent a systemic risk to market function”.
The market’s “core infrastructure” was resilient and only a small part of the market was affected, Schulp added, and the fact that GameStop’s share price rose so sharply is not by itself a reason for concern.
“Stock prices move in and out of alignment all the time and the market is no stranger to bubbles” and the market’s mechanisms, including the “tool of short selling”, generally work well to handle these circumstances, Schulp said.
Regarding the ongoing SEC investigation and whether it will recommend new regulations, Schulp said that the agency has far more information at its disposal than the general public and may choose to introduce new legislation.
But Schulp told committee members that “by no means should these events lead to more restrictions for retail investors”.
During questioning, fault lines in the House of Representatives were exposed as members grappled over who, if anyone, was to blame for the volatility. Nydia Velazquez, a representative of New York, came down hard against the practice of short selling. “Too often, I have seen abuse [short selling] and it ends up hurting ordinary workers and families,” she said. “I first saw it against the people of Puerto Rico, and now I am seeing it against GameStop.”
Velazquez noted that large investors, including hedge funds, have to disclose if they own 5 per cent or more of a company’s shares but no such rules exist for short positions. When asked by the representative whether he would support short selling disclosure regulations, Plotkin said he would accept whatever new regulations, if any, were imposed on the markets.
Blaine Leutkemeyer, a representative of Missouri, said short interest in a stock of more than 100 per cent — 140 percent at its peak in GameStop — that, as an “outsider”, looks like stock manipulation. “Don’t you think there should be a limit on something like that?” he added.
Citadel’s Griffin acknowledged the short interest in this instance was “exceptional” but advised against seeking a legal cap on the amount of times a share can be lent and short sold.
Georgia’s Barry Loudermilk spoke out against further regulations as a result of the GameStop saga.
“There seems to be a trend in Washington to never let a crisis go to waste,” he mused, adding that there was no rush to introduce “big government” regulations. Loudermilk then asked Schulp whether the markets performed exactly as intended, to which she replied in the affirmative.
