Capitol Report: Experts to take aim at Robinhood model during GameStop Senate hearing

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Washington will keep the spotlight on Robinhood and other zero-commission brokers when the Senate Banking Committee holds a hearing on the GameStop saga Tuesday at 10 a.m. Eastern, with expert witnesses set to warn of the dangers of financial speculation.

Banking Committee Chairman Sherrod Brown, an Ohio Democrat and a longtime critic of Wall Street, will oversee the questioning of several witnesses who will paint the sudden rise and extreme volatility in meme stocks like GameStop Corp GME, +40.64% as evidence of the need for fundamental reform of the U.S. system for retirement savings and stricter oversight of securities dealers.

Rachel J. Robasciotti, founder and chief executive of the social-justice focused investment advisory firm Adasina Social Capital, plans to tell the committee that the social-media-fueled rise of shares of GameStop, AMC Entertainment Holdings Inc. AMC, +15.47%, Express, Inc. EXPR, +62.60% and other meme stocks is a classic “market disruption” akin to the mortgage-backed security bubble of the late 2000s that reflects Americans’ desperate desire to secure sufficient retirement wealth.

Read more: The SEC could cripple Robinhood’s business model by enforcing existing rules, experts say

Americans “know that Social Security benefits their parents receive aren’t enough to cover most retirees’ basic needs,” she plans to say. “So they are forced into the stock-market casino with their life savings.”

Zero-commission online broker Robinhood has remained at the center of the discussion over the state of retail investing since it became one of the favorite brokers used by a group of social media users who promoted GameStop shares, with many seeing outsized gains on risky options bets that paid off when other investors, who were betting against the company, were forced to close out their short positions.

GameStop shares have whipsawed from roughly $17 per share to start the year, to an intraday high of $483 in late January to below $40 just a few weeks later. They are up roughly 80% in March at more than $180, according to FactSet.

Robinhood upended the retail brokerage industry by offering zero-commission trades and relying instead on a controversial practice called payment for order flow as their major source of revenue, and its competitors have largely copied the model.

Robinhood says that it has “democratized finance” by enabling anyone with a smartphone and a few extra dollars to begin building wealth in the stock market, while critics argue that the typical American is more harmed than helped by smartphone applications that make it so easy to trade stocks and risky options with such frequency.

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“Any retail brokers’ claims that trading democratizes access to wealth only takes advantage of people’s fears,” Teresa Ghilarducci, an economist at the New School will say Tuesday, according to prepared testimony. “Safe and professionally managed diversified investments, not trading apps, are the path to economic security.”

The state of Social Security will likely be a topic of attention during the hearing, given that the government insurance program represents 58% of wealth for nearly retired Americans in the bottom half of the income spectrum, while directly owned stocks make just up just 8%.

Other panelists plan to defend Robinhood’s business model and are hopeful that it could lead to a situation where more lower-income Americans are able to build wealth through stock ownership.

Robinhood’s model “reduces costs for consumers, makes securities trading simpler and easier, increases consumer choice, and lowers barriers to participation in the market for the common stock of companies listed on stock exchanges,” according to the prepared remarks of Andrew Vollmer of the Mercatus Center at George Mason University. “It therefore opens the securities markets and equity securities ownership to a much larger part of the population and to people with less income and wealth than those who are typically associated with participation in the equity markets.”

Following the example of the February House Financial Services Committee GameStop hearing, senators are likely to probe the question of whether financial regulators should make rule changes to avoid a repeat of the events of Jan. 28, when Robinhood and other brokers restricted purchases of GameStop shares and other meme stocks because their volatility triggered massive calls for collateral from the clearinghouse that guarantees U.S. equity trades.

During the House proceeding, Democrats displayed their skepticism of the practice of payment for order flow, whereby market makers pay stock brokers like Robinhood to route customer orders their way. Though proponents say these arrangements enable zero-commission trades, expect Democrats to question whether it represents a conflict of interest that should be reformed by regulators.

Another issue that is likely to get attention is that of “gamification” features  in Robinhood’s app that critics say encourage more frequent use of the app than is financially beneficial. 

 In December, Massachusetts securities regulators filed a complaint against the company for “aggressively marketing itself to Massachusetts investors without regard for the best interests of its customers” and for “use of strategies such as gamification to encourage and entice continuous and repetitive use of its trading application.”

The Financial Industry Regulatory Authority last month announced that it would be reviewing app-based broker dealers’ practices with respect to gamification, and whether features in these apps count as marketing securities that are unsuitable for investors.

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