The House Financial Services Committee held a hearing, chaired by Chairwoman Maxine Waters, on March 17, 2021, titled “Game Stopped? Who Wins and Loses When Short Sellers, Social Media and Retail Investors Collide, Part II.” Committee members heard from seven witnesses, including Better Markets’ Dennis Kelleher.

Below are a few highlights from the nearly five-hour hearing.

Market structure:

During the hearing, Mr. Kelleher repeatedly detailed in his testimony: that public, transparent exchanges and all investors are hurt by the current market structure because a small number of HFTS siphon away order flow.

Mr. Kelleher also noted that 47% of all trading is flowing into dark markets, some of which are using legalized kickbacks to brokers like Robinhood. Dark markets are making the big incumbents firms like Citadel rich but that money is coming from pockets of retail investors.  Importantly, he also pointed out that the other 53% isn’t all on “lit” public exchanges because, among other reasons, about 20% of that is “hidden orders.”

Payment for Order Flow:

Mr. Kelleher said that Robinhood’s “primary function is not to get people to invest, but to get people to trade,” arguing that the system of payment for order flow, where brokers are paid by HFT/market makers to buy their order flow and execute those customer orders before anyone else (like public exchanges) even get to see them.  That is a huge conflict of interest.

He also said that Robinhood’s routing to internalizers for payment for order flow is harmful to the market broadly and argued that so-called price improvement based on the NBBO is misleading, if not outright fraud, and the SEC should immediately ban it and, if it doesn’t, then Congress should.

In response to a question by Rep Juan Vargas on whether payment for order flow should be banned, Sal Arnuk, Partner/Co-Founder, Themis Trading LLC, agreed that the SEC should intervene so investors are protected from HFT/market making firms.

Gamification:

Mr. Kelleher said that features on the Robinhood app, like the use of push notifications and colorful and engaging graphics are “scientifically designed to short circuit and cut out the thoughtful process that people engage in balancing risks and rewards.”

He added that “commission-free” and game-like trading is not an altruistic endeavor designed to “democratize access to the financial markets” and make trading more “delightful” to app users.

He further noted that:

Vicki Bogan, a Professor at Cornell University specializing in behavioral science, detailed how this works in her written testimony and testified at the hearing that this gamification of trading is in the best interest of firms like Robinhood and not the investor.

Protecting Retail Investors:

There was also a significant discussion about the need for further regulation to protect retail investors. While some argued that individuals should be free to invest as they thought appropriate regardless of if they were manipulated by gamification or ripped off by predators like HFT firms and executing brokers, others, including Dennis, talked about how the playing isn’t level, the markets are rigged, and that the system favors more sophisticated investors.

Alexis Goldstein with AFR noted that rebalancing the economy would help all individuals:

Better Markets tweeted that the answer to adviser standards of care is clear and simple: a uniform fiduciary duty. Dodd-Frank authorized it, but the SEC caved to the financial industry with the weak so-called “best interest” rule – a misleadingly labeled rule that essentially restates the inadequate suitability requirement which has more loopholes than rule. We also added the following:

Read Mr. Kelleher’s opening statement here, his complete testimony here and go to Better Markets’ dedicated webpage for more resources here.  And, don’t miss Dennis’ slides in his testimony (Appendix C) that visually depict how the market is rigged to always rip off retail investors here.