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Provided that SEC Reg SHO requirements are met, short sales in themselves do not violate any SEC or FINRArules. Were there any SEC or FINRA Rule violations? As volatility of stocks like GameStop have risen dramatically, DTCC is now requiring 100% collateral on the settlement of these stocks. Clearing Brokers therefore require firms like Robinhood to post collateral with them. All street-side trades received by the Clearing Broker for all its clients are compared and netted in the clearing system, resulting in a single net settlement on settlement day at DTCC.īecause of the risk that a broker (or a Clearing Broker) might go bankrupt between trade date and settlement date, DTCC requires Clearing Brokers to post collateral based on the volatility of the securities being settled. The retail investor trade is executed on an exchange, and the Clearing Broker also has responsibility for settling the exchange or “street-side” leg of the trade. Provided the investor has sufficient cash in his/her account on settlement date, the Clearing Broker is required to deliver securities to the investor’s account. Purchase (and sale) trades done by retail investors through brokers such as Robinhood, are “given up” by the online broker to a Clearing Broker. There may well be fewer lenders willing to lend at the higher price level and the stock “trades special” at higher fees.

May decide to recall the borrow in which case the Prime Broker/Hedge Fund either have to find another lender or buy back the stock and close the short position.

Demands a higher fee to keep the borrow in place.

Demands more collateral to cover the credit risk, including a wider spread.

Might incur higher fee to keep the borrow in place.

Puts up more collateral with the stock lender, due to price rise.

Note: that as Hedge Funds need to put up more collateral, they may have to sell other assets to raise cash.

Probably pay higher fees to keep the borrow in place.

Put up more collateral with the Prime Broker.

The Prime Broker has to collateralize the stock borrow with the Institutional Investor, with a spread or haircut in addition to the market value.Īs the price of the stock rises: Hedge Funds The Hedge Fund pays a borrow fee and has to put up collateral to the Prime Broker under Fed Reg T. Borrows are generally “open”-the borrower can return the securities, or the institutional lender can recall the securities at any time. Hedge Funds and other investors can sell short, in compliance with SEC Reg SHO, provided that their Prime Broker is able to borrow the stock, typically from an Institutional Investor.

This article outlines the credit risk and settlement mechanics underlying these events, and outlines potential regulatory issues. Once retail customers were allowed to resume trading, GameStop and other stock prices rebounded sharply. Robinhood raised $3.4 billion of additional capital from its investors, and was able to resume new trading activity. Note: GameStop and similar stocks fell 44% on Thursday 01/28. As a result- Robinhood and other firms had to curtail trading. Responding to the high volatility in these stocks, on Thursday 01/28 the Depository Trust & Clearing Corporation (DTCC), put up the collateral required for member firms to clear trades, to 100% of the market value of the trades.

Note: Melvin received a $2.75bn of new capital from Citadel and others on Thursday. This causes the Hedge Funds to book losses on their short positions and have to put up more collateral to support the trades. Reddit forums such as WallStreetBets mobilized day traders and retail investors to aggressively buy these stocks. Hedge Funds such as Melvin Capital reportedly have large remaining short positions of $11.7bn in these stocks (estimated 136% of GameStop’s market value for example) after having already lost $19bn in the past few weeks.

The price action is the result of a short squeeze.

For the week, GME was up 400%, ranging from $69.40 on Monday to a peak of $438.67 on Thursday morning.

On Friday January 29, GME was up 68% for the day, closing at $325 with a market cap of $22.7bn.

The New York Stock Exchange (NYSE) saw large swings in the stock price of GameStop (NYSE: GME) and similar stocks with relatively small amounts of revenue and negative earnings.

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