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March 23, 2021

Key Highlights: Dennis Kelleher’s Testimony at March 17 House Financial Services’ GameStop Hearing

Better Markets’ Co-founder, President and CEO Dennis Kelleher testified at the March 17 House Financial Services Committee Hearing titled “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, Part II.”
In addition to submitting detailed written testimony before the hearing, Dennis gave a five-minute opening statement at the beginning of the hearing when he talked about how important these issues are to the economy, jobs and growth – protecting markets and investors are, ultimately, kitchen table issues that everyone has a stake in. He said:
“A growing, thriving economy is the very purpose of the markets: capital allocation and formation to fuel economic growth, rising living standards, decreasing inequality, and making the American Dream available to more people.”
Over the course of the four-plus hour hearing, Dennis also answered questions from lots of Committee members. You can watch this short video of only those parts of the hearing where he testified. You’ll see that Committee members asked Dennis questions about conflicts of interest, payment for order flow, gamification, dark markets, trading, retail traders, Citadel, among other issues.
If you’d rather read than watch, below is a recap of some of the questions by Committee members and Dennis’s answers. We have indicated the time stamp for each Q&A below in the video.
5:09—Rep. Nydia M. Velazquez asked Dennis whether he was concerned about the gamification of the Robinhood app.
Dennis replied that, “We should all be concerned about the gamification of the Robinhood app. Its primary function is not to get people to invest; it’s to get people to trade; and it wants people to trade because the more people trade, the more payment for order flow it receives, the more revenue it gets, the richer they get and the bigger the IPO that they’ve got in the pipeline coming. That’s what gamification is about.”
He added that one of the big problems is that this is a “game-like mechanism that’s meant to cause people to drop their defenses, to not think at all about losses and risks, and to only think about games and trading.” He recommended that people read the testimony of his fellow witness, Professor Vicki Bogan from Cornell University, who has studied these pernicious gamification aspects and the important issues they raise. 
Payment for order flow:
Payment for order flow was a top topic during the hearing. In addition to extensively covering these issues in his written testimony (including in slides at Appendix C), Dennis made several important points on the issue.
9:59—Rep. Brad Sherman noted that payment for order flow was banned in the UK almost a decade ago and its markets continue to function well. He asked Dennis if there is any reason the U.S. shouldn’t take a similar step: banning any payment to brokers when acting as an agent for directing order flow.
Dennis replied that payment for order flow “can be banned and should be banned.” He went on to say that intermediaries would still be well-compensated but, if payment for order flow was banned, it would drive more trading to the public markets, which are now less liquid and have less trading. He noted that 47 percent of all trading is flowing into dark markets, some of which are using legalized kickbacks to brokers like Robinhood. He said dark markets are making the big incumbent financial firms rich but that money is coming from the pockets of retail investors.
18:33—In response to a question from Rep. Juan Vargas, Dennis said that there’s no need for the Congress to take action because the SEC could and should take the position right now that payment for order flow violates or facilitates the violation of the best execution duty.
22:36—Later during the hearing, Rep. Jesus Garcia asked Dennis if the payment for order flow model entrenches big players. Dennis noted that it does, adding that the fact that those big players have almost no disclosure obligations and very few regulations makes it even worse. He added that:
“You know, one thing that hasn’t been brought up that is a major problem is the Citadels of the world are a big part of the shadow banking system. There’s a lack of transparency, there’s a lack of regulation, there’s a lack of oversight, there’s a lack of accountability.” 
Retail investors:
Several committee members wanted to hear from Dennis and the other witnesses regarding potential challenges facing retail investors.
16:53—Rep. Jim Himes asked Dennis to explain what happens when retail investors trade a lot. Dennis answered that retail investors “lose and they lose consistently.” He explained that this is because they are paying more for every one of their orders because we have an order routing system that is “intentionally complex and designed to extract the maximum amount of wealth from the retail investor.”
Rep. Himes continued his line of questioning about retail investors, noting that they also lose because they don’t have “teams of PhDs studying stocks that they are buying.” Dennis agreed, using a baseball analogy to explain how brokerages and financial firms have natural and institutional advantages over retail investors. He explained it this way:
“It’s like sending the local little league team up against the New York Yankees or the Boston Red Sox or the LA Dodgers. Frankly, you have these institutions that have maximum informational advantage, maximum technological advantage, maximum sophistication; they get to use all of that which they have paid billions [of dollars] for the purposes of extracting wealth [from retail traders and the buy side generally].”
Citadel dominance:
20:18—Rep. Al Lawson noted that with respect to Citadel, some have raised concerns about a single market maker managing such a large volume of retail order flow, and what that means in terms of prices. He noted that others have questioned whether Citadel has such dominance in the financial market that it poses a systemic risk to the entire U.S. financial system. He asked the witnesses to speak to these concerns.
Michael Piwowar, Executive Director, Milken Institute, said that he “didn’t have any concerns that Citadel market-making business poses any systemic risk to the system.”
Dennis disagreed, saying:
“I don’t think there’s any circumstance under which Citadel Securities is not a systemically significant firm, and FSOC should investigate it. In addition, the SEC should not exclude companies like Citadel from regulation SCI, which is supposed to have resilient infrastructure. But the SEC inexplicably excluded broker dealers like Citadel from that regulation and those requirements. So there’s a risk on the infrastructure side, and there’s a risk on the systemic institution side.
“If Citadel shut down today, even for a day, that means 26 percent of all U.S. equities volume in 8,900 listed securities would stop. It executes 47 percent of all U.S. listed retail volume. It represents 99 percent of the traded volume of 3,000 listed options.
“To say that the system would work perfectly fine if all that evaporated today and competitors would come into the market—that may ultimately happen — but until it ultimately happens, you’re going to have a systemic event. And to deny that is to deny reality.”
Also see:
13:22—During questions from Rep. Ed Perlmutter, Dennis talks about short selling, securities lending and the problems caused by “rehypothecation” or lending and relending the same security.
21:25—Dennis tells Rep. Sean Casten and the rest of the committee that the SEC should consider “taking fraudulent action for people who claim price improvement off of NBBO because it’s at best misleading, if not a fraudulent claim, and knowingly so.”
21:48—Rep. Rashida Tlaib asked Dennis several questions about whether or not the current regulation of private equity met his standard of transparent, well-regulated and policed companies and markets. Hear his answer on the video, but here’s a hint: “No.”
24:29—Dennis replied to Michael Rep. San Nicolas’ questions about short selling, private equity and fair market value.
View the complete hearing and visit Better Markets’ website for Dennis’s testimony, opening statement and other resources, including fact sheets on payment for order flow and Citadel as well as a blog post on market structure.


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