B-booking, manipulating Google reviews and short selling. What’s the connection?

One story has dominated the mainstream financial media over the last week or so in the form of the way that followers of WallStreetBets, a community on the social media platform Reddit.

Have effectively created a corner, in the shares of GameStop Corporation, a video games retailer selling new and used games.

For those unfamiliar with the story, GameStop had been singled out by professional short-sellers as a business with a limited future. They reasoned that gaming is increasingly conducted online and that the distribution of games would follow suit, rendering GameStop’s bricks and mortar retail operation obsolete.

That might have been the end of the story had one of the short-sellers, Citron research not published an article outlining their thesis.

That article was picked up by WallStreet bets (WSB) many of whose 5 million members are of an age group that held GameStop in high regard. They took apparent exception to the idea that professional investors were trying to directly benefit from the demise of a store, that many of them had regularly shopped in.

Their response was initially to start buying GameStop shares and then options over the stock. Many WSB members were also owners of commission-free stock and option trading accounts and it wasn’t long before the GameStop buying took on a life of its own.

GameStop’s shares skyrocketed as result. Rising as much as 1360% in a matter of a few days, The companies market cap moved from a few a hundred million dollars to more than $13.0 billion.

A Korean hedge fund that had invested a few million dollars in GameStop long position in March 2020 was suddenly sitting on nine-figure dollar profits, needless to say, they cashed in.

However, the short-sellers weren’t so lucky Citron Research and Melvin Capital the most prominent short-sellers of in GameStop had to scramble to cover their positions.

No easy feat, because they were competing not only against the WSB traders buying GameStop but also option market makers. Whose gamma hedges dictated that they buy more shares in GameStop as well.

On top of that, it transpired that the total short position in GameStop was 140% of the outstanding equity.

In plain English that meant that the market was short of more shares in GameStop Corporation than physically exist.

That situation comes about thanks to a process known as rehypothecation, under which the same parcel of stock can be loaned out or borrowed, to support multiple short positions in that stock.

Like many other banking products, rehypothecation relies on the idea that customers don’t want or require their money, or in this case stock, all at once. However, if they do then the proverbial can hit the fan.

The practice and availability of stock borrowing is, of course, the mechanism that supports short selling via equity CFDs or Contracts for Differences if they are hedged in the market and not just B-booked by the CFD provider.

The absurd notion by certain upstarts toward gamifying the retail electronic trading industry is something which the good quality, long established and bona fide brokerages have been working hard to stop over recent years, and rightly so.

FinanceFeeds reported two months ago that Robinhood, a company that has enjoyed significant growth in both clients numbers and trading activity during 2020 as millennials with time on their hands rushed to trade stocks and equity options on the platform.

Traders using Robinhood pursued unconventional strategies that saw bankrupt companies such as Hertz effectively rise from the dead. Whilst Kodak shares saw multi-digit gains as millennials pilled into the stock on the award of a dubious-looking government contract.

This kind of trading drew accusations that Robinhood traders and those using its platforms did not understand how the markets worked or the risk that they were taking when trading in so-called zombie stocks. Yet so influential where Robinhood’s traders en masse that hedge funds started to analyse the holdings and activity of Robinhood’s client base. Data which Robinhood made freely available in aggregate on a daily basis.

However, it is not the trading tactics of Robinhood clients that has led the state to take legal action against the broker.

Rather it is what the lawsuit describes as “aggressive tactics to attract inexperienced investors, its use of gamification strategies to manipulate customers, and its failure to prevent frequent outages and disruptions on its trading platform.”

Accusations that Robinhood has roundly rejected.

However, Massachusetts is not alone in calling Robinhood to account for its actions. The US securities regulator the SEC has today charged Robinhood with misleading customers about revenue sources and failing to satisfy the duty of best execution.

Those charges relate to the controversial practice of payment for order-flow under which a broker receives remuneration from a market maker or hedge fund for routing its orders through them, rather than directly onto an exchange. Those payments help to subsidise the broker’s cost and allow them to offer commission-free trading.

Subsequently, only a few hours after Robinhood’s transgressions came to light, the SEC levied charges of making misleading statements and omissions about its sources of revenues from its client-facing websites and by extension of failing to obtain the best reasonably available terms when executing customers orders against the broker.

Robinhood settled those charges with a payment of $65 million dollars. Lawyers for the company said that the behaviour characterised by the SEC did not reflect the Robinhood of today.

The brokerage which has helped to transform the US equity trading landscape has raised $1.0 billion during 2020 and has been valued at $11.70 billion so the $65.0 million settlement was probably the best option with Robinhood following the old trading adage that the first cut is the cheapest.

Robinhood would no doubt have been concerned about additional reputational damage it may have incurred had it contested the SEC allegations. Allegations that might have persuaded some of the 3 million new customers it’s believed to have acquired in 2020 to look elsewhere for the brokerage services.

The SEC alleged that the prices that Robinhood achieved for customers in the period between 2015 and late 2018 were inferior to those of other electronic brokers and that because of this clients missed out on more than $34.0 million dollars even after allowing for the fact that they weren’t paying for execution.

The SEC filings were said to reveal that Robinhood received $180.00 million in payment for order flow revenues in Q2 2020 alone.

The rules around best execution for retail business often involve a degree of latitude beyond just achieving the highest or lowest price available and can include factors such as the ability to trade and settle on a venue, order sizes, aggregation and other factors which can influence the choice of trading venues and the price attained.

Now, FinanceFeeds has ascertained that Google has been actively removing negative reviews of the Robinhood app from the Google Play Store, an activity that the company confirmed to The Verge yesterday.

After some disgruntled Robinhood users organized campaigns to give the app a one-star review on Google’s Play Store and Apple’s App Store — and succeeded in review-bombing it all the way down to a one-star rating — the company has now deleted enough reviews to bring it back up to nearly four stars.

It’s not outside Google’s purview to delete these posts. Google’s policies explicitly prohibit reviews intended to manipulate an app’s rating, and the company says it has a system that “combines human intelligence with machine learning to detect and enforce policy violations in ratings and reviews.” Google says it specifically took action on reviews that it felt confident violated those policies, the company tells The Verge. Google says companies do not have the ability to delete reviews themselves.

On Apple’s App Store, Robinhood has a 4.7 rating, and we didn’t see any reviews newer than Wednesday. However, popular apps like TikTok, Uno, and Genshin Impact also didn’t have reviews from any later than Wednesday this week.

Unhappy Robinhood users aren’t just using reviews to show their ire — they’re also calling for a class action lawsuit. Later on Thursday, Robinhood said it would allow “limited buys” of certain stocks on Friday. The company said that halting purchases on Thursday was “a risk-management decision.”

Robinhood came under intense scrutiny on Thursday, after the stock trading app announced it would block purchases of GameStop, AMC, and other stocks made popular by the r/WallStreetBets subreddit, and some users have already replaced their deleted one-star reviews with new ones to make their anger heard.

There is a cost associated with stock borrowing and lending and the more in demand a stock borrow is then higher those charges are. In the case of GameStop, those fees rose to as high as 324.0% in recent days.

The stock loan industry journal the Securities Finance Times considers a stock to be hot if its borrowing charges exceed 5.0%.

Melvin Capital and Citron were able to close their short positions in GameStop but at a cost. The finances at hedge fund Melvin Capital had to be bailed out, or bolstered by a $2.75 billion injection of capital from Steve Cohen’s Point 72 and Ken Griffin’s Citadel.

The fallout doesn’t stop there, however, because retail brokers and their counterparties and service providers have also been directly affected. Margins or collateral requirements on option and physical equity positions in GameStop and a host of other stocks, that WSB members and day traders have subsequently targeted, shot up as well. To as much as 100% of the value of outstanding positions.

That‘s not so unusual but it could be problematic for a broker and their balance sheet when the collateral requirement runs into billions of dollars.

As a result, popular retail trading platforms such as Trading 212, Robinhood, TD Ameritrade and others were forced to mark GameStop, and similar securities, as closing only. Meanwhile, Bloomberg reported that Robinhood was drawing down credit lines it held with its bankers presumably to shore up its own liquidity.

GameStop shares fell by as much 50% following the retail broker’s moves, however, the brokerage firms themselves are now the target of the day traders anger.

We have always been told that millennial investors view and do things differently. If there were any doubts about the truth of that statement they have surely now been vanquished just like GameStop short sellers.