The Committee on Financial Services of the United States House of Representatives has scheduled a hearing on “recent market volatility involving GameStop [Corporation (GME)] stock and other stocks.” The hearing will be held virtually, starting at 12 noon Eastern Time on Thursday, Feb. 18, 2021. Among those called to testify are Vladimir Tenev, CEO of online trading firm Robinhood Markets, Inc., and Steve Huffman, CEO and co-founder of social media community and online forum site Reddit.

The committee is chaired by Representative Maxine Waters, D-Calif. The press release announcing this hearing states: “Since becoming Chairwoman of the House Financial Services Committee, Congresswoman Waters has transformed the Committee to focus its agenda on fairness, protecting consumers and investors, and accountability for large financial institutions. She has made it a practice to call Committee hearings with CEOs of big financial institutions and companies to hold them accountable.”

Previous Statement by Representative Waters

Representative Waters released the following statement on Jan. 28, 2021, in the wake of the GameStop stock trading controversy. In it, she casts hedge funds as an enemy of ordinary American savers and investors:

“Hedge funds have a long history of predatory conduct and that conduct is entirely indefensible. Private funds preying on the pension funds of hard working Americans must be stopped. Private funds engaging in predatory short selling to the detriment of other investors must be stopped. Private funds engaging in vulture strategies that hurt workers must be stopped.

“Addressing that predatory and manipulative conduct is the responsibility of lawmakers and securities regulators who are charged with protecting investors and ensuring that our capital markets are fair, orderly, and efficient. As a first step in reining in these abusive practices, I will convene a hearing to examine the recent activity around GameStop (GME) stock and other impacted stocks with a focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors.

“We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price.”

Robinhood and Payment for Order Flow

In addition to singling out hedge funds for criticism, it is likely that Robinhood CEO Vladimir Tenev will face hostile questioning about his company’s actions in the GameStop affair. In particular, the committee memorandum notes that payment for order flow (PFOF) has been Robinhood’s chief source of revenue since its inception and that its decision to restrict trading in GameStop and other stocks may have been influenced by its business ties to investment firms that were caught in short squeezes on these stocks.

The committee memorandum also notes: “In December 2020, the SEC charged Robinhood with making misstatements about the firm’s receipt of payment for order flow and for failing to comply with its duty to ensure that customer trades were executed on the best possible terms. Robinhood’s failure to satisfy its best execution obligations resulted in more than $34 million in aggregate customer losses. Robinhood was censured and agreed to pay $65 million to settle the action.”

Robinhood and Gambling Addictions

In addition to concerns about the impacts of payment for order flow, the committee memorandum also notes that ”some attribute the current controversy itself to ’gamification’ of investing and to the increasing role that social media and technology play in capital markets.”

The memorandum adds: “Gamification involves tactics used to engage customers to transact, such as increasing use of notifications, prizes, and other psychological tools and design elements to increase rapid trading and short-termism, instead of a more cautious approach. Robinhood in particular has been accused of using gamification to increase usage of its app, possibly to the financial detriment of its clients. Examples include designs to appeal to younger users, including digital confetti to celebrate transactions, colorful illustrations, and its allowance for users to tap up to 1,000 times daily to improve their waitlist position for Robinhood’s cash management feature. This has led to criticism that gamified online trading platforms such as Robinhood encourage behavior similar to a gambling addiction.”

The memorandum concludes: “Regulators have expressed concern about Robinhood’s investment platform. On Dec. 16, 2020, Massachusetts regulators filed a complaint against Robinhood for its ‘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.'”

Significance for Investors

It is possible that the hearings may lead to additional legislation and regulation concerning the securities markets, but this is by no means certain. One thing that is certain: extended questioning about payment for order flow, the incentives that it creates, and the degree to which Robinhood engages in gamification are all matters that are bound to tarnish that company’s image, but not necessarily to dissuade a significant number of Robinhood’s clients or potential clients from using its platform.