Robinhood almost imploded during the GameStop meme stock chaos

The House Committee on Financial Services released a report late last week offering a harrowing glimpse inside Robinhood during the frenzy around Gamestop stock early last year.

The stock trading and investing app was blindsided by the surge in interest from the first big “meme stock” after Redditors and other retail investors rallied around $GME and sent its price into the stratosphere.

For Robinhood, which offers individual investors a relatively frictionless way to dive into the stock market, the saga was simultaneously a massive windfall of new users and brand interest and an existential threat that almost did the company in.

Robinhood famously froze trades around GameStop and some adjacent hot stocks as the company teetered on the edge of what its platform — and its pocketbook — could handle. With demand surging, suddenly Robinhood was on the hook for more than it held in collateral to settle the sudden spike in trades.

House Financial Services Committee chairwoman Maxine Waters (D-CA) called for a deep dive into what happened behind closed doors, and the new report, “Game Stopped: How the Meme Stock Market Event Exposed Troubling Business Practices, Inadequate Risk Management, and the Need for Regulatory and Legislative Reform,” collects the committee’s findings. The report, embedded below, is culled from a number of hearings, 95,000 pages of documents and 50 interviews.

“My Committee’s investigation into the matter showed we need better market regulation to address the troubling business practices that were uncovered during our investigation,” Waters said. “Payment for order flow and gamification make it profitable for a new generation of trading apps to push retail investors to make as many trades as possible, making the markets more volatile than ever.”

The committee described Robinhood’s business as “troubling,” citing its preference for aggressive growth without adequate risk management. The report also found that the majority of financial firms the committee examined don’t have any plans in place to prepare for another risky phase of “extreme” market volatility.

According to the report:

On the morning of January 28, 2021, Robinhood had approximately $696 million in collateral already on deposit with the NSCC, leaving it with a collateral deficit of approximately $3 billion, which it was required to post to satisfy the NSCC’s clearing fund requirement or risk being in violation of the NSCC’s rules and potentially losing the ability to clear trades for their customers altogether.

[President and chief operating
officer for Robinhood’s clearing operation Jim] Swartwout confirmed that this amount came as a surprise to Robinhood and explained to Committee staff that they had anticipated and prepared for the $1.4 billion of collateral deposit requirements that represent “core” charges, but because they did not model for Excess Capital Premium charges, Robinhood therefore did not expect and had not arranged adequate funding for the additional $2.2 billion Excess Capital Premium charge. On the morning of January 28, 2021, Jim Swartwout texted Gretchen Howard at 6:29 a.m. EST, writing “Huge liquidity issue.”

Within Robinhood, the company’s executive leadership team held an all-hands to brainstorm about ways for the company to leverage the attention and its massive influx of new users, even as the team tasked with seeing its trades settled scrambled to “keep the lights on” with “things barely held together.”

Ultimately, the company secured a waiver for its collateral requirements, paused some trades and averted disaster but there’s no guarantee that history won’t repeat itself and shake out a different way. In light of the report, Waters called for “significant” legislative reforms to prevent another Robinhood-style near-meltdown.

One way Robinhood was circumspect? Knowing that the company was in store for some serious scrutiny.

“The biggest concern now is can we handle our scale,” Robinhood’s senior director of clearing operations wrote. “If we fail to deliver something like this due to us not being able to handle our own volume, it would not bode well with [the clearinghouse] or the regulators.”