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Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail… ( EventID = 111207 )

On Thursday, February 18, 2021, from 12:00 p.m. (ET) full Committee Chairwoman Waters and Ranking Member McHenry will host a virtual hearing entitled, “Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide.” – – – – – – – – Witnesses for this one-panel hearing will be:

• Kenneth C. Griffin, Chief Executive Officer, Citadel LLC

• Steve Huffman, Chief Executive Officer, Co-Founder, Reddit

• Gabriel Plotkin, Chief Executive Officer, Melvin Capital Management LP

• Vlad Tenev, Chief Executive Officer, Robinhood Markets, Inc.

• Jennifer Schulp, Director of Financial Regulation Studies, Cato Institute

• Keith Gill

I. Overview In January 2021, retail investors on social media site Reddit’s “WallStreetBets” subchannel (“subreddit”) collectively executed an investment strategy to induce a short squeeze in stocks such as GameStop, AMC and KOSS, as well as other securities they identified as being heavily shorted by hedge funds. Meaning, social media users collectively drove the stock prices up, forcing short sellers who bet the stock price would go down, to purchase shares at an increased price. Reddit user, Keith Gill, notoriously discussed GameStop stock on Reddit under the username “DeepF*ckingValue.” Initially, this squeeze led to heavy losses for some short sellers, particularly hedge funds, and led to substantial financial gain for some retail investors. Robinhood, and other broker dealers, placed restrictions on transactions in these stocks, which received public and regulatory scrutiny. Eventually, the stock prices started to decline and many investors were faced with steep financial losses. For some, the January short squeeze raises questions regarding whether legislators and regulators should take a closer look at existing rules governing short sales and related disclosures, as well as the conflicts between the practice of payment for order flow and firms’ best execution obligations. It also raises important questions about the efficacy of anti-market manipulation laws and whether technology and social media have outpaced regulation in a manner that leaves investors and the markets exposed to unnecessary risks.

II. Short Selling When an investor shorts a stock, they borrow the stock, typically from a broker, and then sells it to another investor. When the time comes for the borrower to return the borrowed stock, the borrower will purchase the stock in the market and return the stock to the lender. In a successful short sale, the market price of the borrowed stock will fall below the amount it costs to borrow the stock. When this happens, the borrower is then able to purchase the stock in the market at an amount lower than it cost the borrower to borrow the stock, return the stock to the lender, and keep the difference as profit. Some investors, such as hedge funds, engage this trading strategy when they are betting that the price of the securities will decline and expect they can profit from that decline. Others use this strategy to hedge against other market risks. The U.S. Securities and Exchange Commission (SEC) has repeatedly noted that short selling provides liquidity and price efficiency. The SEC has, however, implemented various rules to curb abusive short sale practices. These are discussed below, in detail.

III. Short Sale Rules and Laws Against Fraud and Market Manipulation A. Regulation SHO On July 28, 2004, the SEC adopted a new Regulation SHO, under the Securities Exchange Act of 1934 (Exchange Act), which implemented changes in how short sales are regulated. One important function of Regulation SHO is that it restricts short sales that are referred to as “naked short sales.” Generally speaking, a naked short sale refers to selling short without having first borrowed the stock. It is important to note that naked short selling does not always violate Regulation SHO. In fact, the SEC has noted that, in certain circumstances, naked short sales may contribute to market liquidity. For instance, broker dealers that are market makers provide liquidity to the market by being ready to buy or sell a security, even in the absence of a buyer or seller, and even when there are market shortages. Due to the time it can take to buy or borrow a security, a market maker may short a security without first making arrangements to borrow it. Later, in 2010, the SEC amended Regulation SHO to include the alternative uptick rule. The alternative uptick rule places restrictions on short selling during periods where a stock’s price significantly declines. More specifically, the rule restricts short sales…


Testimony of Kenneth C. Griffin
Founder and CEO of Citadel and
Founder and Principal Shareholder of Citadel Securities
Before the Committee on Financial Services
United States House of Representatives
February 18, 2021


I first participated in the financial markets as a retail investor. In the late 1980s, while attending college, I traded stocks and options.
My passion for investing led to my founding of Citadel in 1990. Today, Citadel is one of the
world’s leading alternative investment managers. Our capital partners include pension plans,
university endowments, hospital systems, foundations and research institutions.
In 2002, my partners and I founded Citadel Securities. Today, Citadel Securities is one of the
world’s preeminent market makers. We have been a leader in using technology to transform our
market infrastructure, particularly for retail investors.
With the balance of my time, I’d like to address three important matters – (1) the retail investing
landscape; (2) Citadel Securities’ important role within our markets; and (3) opportunities for
further market improvement.

Technological innovation advanced by market makers has dramatically improved the efficiency
with which buyers and sellers come together. In tandem, U.S. equity market structure
enhancements have driven greater transparency and more competition among market
participants. Today, retail brokers are legally obligated to route orders based on best execution,
which is determined by a number of regulatory factors, including price improvement, customer
experience and platform resiliency.
Many brokers charge market makers a set fee to execute retail trades – a longstanding,
transparent and regulated practice known as payment for order flow or PFOF. Retail brokers
have used PFOF to reduce the costs of trading and it is a key reason why retail investors are able
to trade for free or low commissions today.
Altogether, faster execution, better pricing and reduced fees have made the cost to invest in
America lower than ever.

Citadel Securities has been deeply committed to our role in the retail markets. We invest
hundreds of millions of dollars each year to serve our customers. In the last week of January, the
importance of these investments was on full display.
During the period of frenzied retail equities trading, Citadel Securities was the only major market
maker to provide continuous liquidity every minute of every trading day. When others were
unable or unwilling to handle the heavy volumes, Citadel Securities stepped up. On Wednesday,
January 27, we executed 7.4 billion shares on behalf of retail investors. To put this into
perspective, on that day Citadel Securities executed more shares for retail investors than the
average daily volume of the entire U.S. equities market in 2019.
The magnitude of the orders routed to Citadel Securities reflects the confidence of the retail
brokerage community in our firm’s ability to deliver in all market conditions and underscores the
critical importance of our resilient systems.

Recent events have highlighted clear opportunities to improve our markets. One takeaway is the
importance of modernizing the settlement process, including shortened settlement cycles and
transparent capital models. As we have seen, longer settlement periods expose firms to more risk
in the time between execution and settlement, requiring higher levels of capital. Settlement
cycles should be shortened from T+2 to T+1. Transparent clearing house capital requirements
will enable brokers and market makers to better prepare for potential capital demands and
minimize the risk of associated market interruptions. Both of these enhancements are well within
reach today.

As we move forward – and consider how to further improve our capital markets – it is important
that we build on the tremendous progress of recent years. Individual investors are better served
by America’s markets than ever before, and it is critical that our markets continue to be a force
for fairness and integrity worthy of investor confidence and participation.
I appreciate the opportunity to appear today and look forward to discussing the retail market
structure with the Committee.