The Reddit, Robinhood, and Citadel saga is front page news; the name of the game is short selling. All those players are currently engaged in a modern-day version of the David and Goliath battle where the small guy is beating up the big guy at their own game.
This whole Reddit, Robinhood, Citadel saga gave me a good excuse to have a movie night at home with my youngest daughter to watch the 2010 Robin Hood movie directed by Sir Ridley Scott with Russell Crowe and Cate Blanchett in the lead roles. We enjoyed it, great cinematography, great cast, and a really good storyline. The movie tells the background story of Robin Hood and how he came to be an outlaw. In this article, I am taking you on an epic adventure traveling back in time with Robin Hood as our traveling companion and hero. At the end of this journey, we will circle back to the modern-day Reddit, Robinhood, and Citadel saga, where the name of the game is short selling.
Robin Hood. Rise and Rise Again Until the Lambs Become Lions
The movie starts with an epic battle taking place in France between the army of Richard the Lionheart who is on a full siege and assault mode on the Challus castle; the idea was to break through the castle’s fortress and ransack the place to finance the final leg of the journey home to England. Robin Longstride serves as a common archer in the army of King Richard the Lionheart, at this point in time he was quite disillusioned and war-weary. He got himself and his comrades into trouble after sharing his frank and unflattering appraisal of the King’s conduct when the king asked for his opinion. This led Robin and his comrades to be tied-up for insubordination, waiting to hear about their fate whilst the rest of the army mounts their final assault on the castle.
The King is killed during the attack; this gave Robin and his comrades the opportunity to escape, they became deserters and persona non-grata but they were alive and free. From that point in time, their quest was to make it safely back home to England. They came across an ambush of the English by Godfrey the traitor, an English Knight who was conspiring with King Philip of France to assassinate King Richard. After chasing Godfrey away, Robin decides to take advantage of the situation by having his men impersonate the dead English knights in order to return to England as wealthy noblemen instead of penniless deserters. Before they depart to sail across the Channel, Robin promised to fulfill one of the dying knights, Sir Robert Loxley’s last wish, of returning his sword to his father in Nottingham.
Robin was fascinated with the words engraved on the sword’s blade
“Rise and rise again, until the lambs become lions.”
The Legend of Robin Hood and the Charter of Rights also known as the Magna Carta
Upon his arrival in the Thames estuary, Robin continued to assume the identity of Sir Loxley as it fell upon him to inform the royal family of King Richard’s death. He witnessed the coronation of King John who was as ambitious as he was clueless, and who lost no time making himself extremely unpopular by raising taxes on the poor and by dismissing the loyal and experienced chancellor from his function to replace him with his friend Godfrey, who turned out to be a ruthless traitor who was plotting with the French King to invade England.
Robin and his companions traveled to Nottingham to hand over Loxley’s sword to his elderly and blind father. Sir Walter asked Robin to continue impersonating his son to prevent the Crown from seizing the Loxley family lands. Loxley’s widow, Lady Marian, is initially cold toward Robin but eventually warms up to his charisma, quiet assertive strength, courage, and devotion towards the people and the land.
The plot by Godfrey to help the French invade England is discovered and triggered the northern barons to assemble in the presence of King John to discuss a strategy to fight the invaders. Attending and speaking on behalf of Sir Walter, Robin declared that he would not fight under King John’s command unless the King agrees to the Charter of Rights granting more rights and protection to the barons such as the protection of church rights, protection for the barons from illegal imprisonment, access to swift justice, and limitations on feudal payments to the Crown. In those days, kings believed they were divinely appointed, and this gave them a license to use and abuse anyone and anything that suited their wants or needs. Being under the threat of civil war on the domestic front and having to deal with an imminent foreign invasion on its shores King John reluctantly agreed and signed (on 12 June 1215) the Charter of Rights also known as the Magna Carta.
The battle between the now united English troops and the French took place on a beach below the cliffs of Dover. Robin led his troops to victory and distinguished himself during the battle saving in the process Lady Marian’s life from Godfrey’s evil intent and stopping Godfrey dead in its track when he was shamefully fleeing the battle scene. King Philip soon realized that his ‘surprise’ attack failed and sailed back to France feeling utterly defeated. The English troops rejoiced in their victory over the French and celebrated Robin Hood for his courage and leadership during the battle. King John was offended by the lack of recognition and validation he received from his troops and became resentful of the genuine and loving attention ‘his’ people gave to Robin Hood, something he never experienced first hand. He decided from that point on to compensate for his flagrant lack of authority and popularity by abusing his ‘flaky-God-given-power’.
Back in London, King John decides to renegade on his promise to implement the Charter of Rights deciding instead to reassert the fact that he was divinely appointed and would not on this basis agree to have his power curtailed. He declares Robin an outlaw to be hunted throughout the kingdom. Robin and his men flee to Sherwood Forest with the orphans of Nottingham.
And so, begins the legend of Robin Hood the one that steals from the rich to give to the poor
The Reddit, Robinhood, and Citadel Saga. The Name of the Game is Short Selling
Fast forward to today and the news about GameStop, Robinhood App, and the Citadel Hedge fund. It all started with a Reddit Chat Group called Wall Street Bets who has more than 2 million subscribers. This group noticed that a lot of the big hedge funds had very heavy short positions on GameStop, as a matter of fact, 140% of the stocks were short! [Feel free to be shocked]
Disclaimer. Before I continue with this article please note that I am not a financial advisor, banker, or any kind of financially qualified person; the rest of this article should not be taken as financial advice.
Question: Can you sell something that you don’t own? Answer: in the real world the answer is no, but in the world of finance the answer is yes you can. That is what short selling is; it is the ability to borrow a stock that you don’t own in order to sell it back at a profit later on hoping in the meantime that the stock price has tanked, allowing you to buy it back at a price that is lower than the price you paid to borrow the stock. Once you have pocketed your profit you return the stock to the owner. Sounds fishy?! Absolutely, except that in the financial world you are allowed to do that.
When you have a short position, you are betting on the company to fail. The big wall street players have been playing this game very successfully for years until a few weeks ago when they got a taste of their own medicine. That medicine was administered by a bunch of amateur investors who got together on the Reddit chat group where they agreed to buy en masse shares of GameStop forcing the price to go up. The increase in prices forced the big guys to buy back their short positions at a much higher price than they paid which cost them billions of dollars in losses. The price of GameStop skyrocketed to the moon, making millions of dollars of profit to the small guys! At its lowest GameStop’s share price was $2.50 and at its highest, it went over $350.
The big guys on wall street were stunt, they had no idea that a bunch of ordinary people could get together, get into the stock market arena, call them out on their short positions, and play quite successfully the same game that was reserved till now to the big guys!
When the going gets tough change the rules of the game!
The story should have ended there with winners on one side (the small guy for once) and losers (the big guys) on the other side licking their wounds. Except that when the going gets tough for the big guys they change the rules!
The plan worked extremely well for the little guy until the big guys started to freak out. One Hedge fund company called Melvin Capital lost 30% of its money and was on the verge of bankruptcy; this triggered two players Citadel and Robinhood App to come into the arena to ‘rebalance’ the game.
Citadel is another hedge fund company, they came to the rescue and bailed out Melvin Capital from Bankruptcy. Robinhood is an App where you can trade stocks for free, [attention, attention, alarm bells ringing, there is no free lunch anywhere. Right?! So, how does Robinhood LLC make their money if all their customers can trade for free?! There must be a catch somewhere]. To everyone surprise and shock, Robinhood stopped trading stocks of GameStop to try to stem the bleeding and protect the big hedge funds from incurring further losses. Robinhood market themselves as being an App for the people, they push forward the message that through their App ordinary people can get on their phones, participate in the stock market and make money. Shutting down trading because they didn’t like what was happening to these Hedge funds with short positions seemed like the exact opposite of what those Apps were supposed to be doing, taking from the poor and giving to the rich. It is interesting to note that a ‘citadel’ is defined as a fortress where people could shelter for safety. It looks to me that Citadel is acting as a fortress to protect its own i.e., the big guy.
What is interesting about Robinhood is that they make their money through Citadel by selling them user data. Citadel pays Robinhood money for real-time information on what Robinhood’s users are buying and selling. Remember my point earlier about there is no free lunch, there must be a catch somewhere. [Feel free to feel shocked and outraged]
People should not underestimate the importance of this event, because it is without the shadow of a doubt a populist revolution aimed at the financial industry. The little guy is saying, “The system is rigged. We can play that game too. We want a piece of the pie.” This event has caused an onslaught of reaction, on one side you have those cheering and applauding the small guy and on the other side, you have the big guys going on TV and crying foul! The double standard is quite outrageous. It is classy to game the stock market if you are wealthy but if you are a regular Joe and you game the stock market you are trashy.
After enduring a beating across social media, Robinhood took to its own blog on 28 January, and CEO’s Twitter account to explain why it had halted trading of some of the stocks.
“Amid this week’s extraordinary circumstances in the market, we made a tough decision today to temporarily limit buying for certain securities. As a brokerage firm, we have many financial requirements, including SEC net capital obligations and clearinghouse deposits. Some of these requirements fluctuate based on volatility in the markets and can be substantial in the current environment. These requirements exist to protect investors and the markets and we take our responsibilities to comply with them seriously, including through the measures we have taken today.” Robinhood CEO
SEC net capital obligations and clearinghouse deposits are rules about how much money brokerage have to have on hand to ensure that they are essentially good for the transactions their consumers want to make. In order to be in compliance, a brokerage must have sufficient net capital at all times prior to, during, and after purchasing or selling property securities to protect its customers and fulfill its obligations; it must have cash flow.
Robinhood’s explanation for suspending trading and putting a limit buying of some of their stocks is that it was to comply with their regulatory obligations; in other words, it was a risk management issue. My question is: how often does a brokerage house have to suspend trading in order to comply with its basic regulatory obligations? Can we reasonably infer that it was the broker’s own conduct and operation that made their exposure so risky that they put their customers and their own operation at risk, so much so that they had to halt trading?
The Reddit, Robinhood, and Citadel Saga. Class Action v Robinhood, the battle is now happening in Courts
A class-action lawsuit was filed in the Southern District of New York by Brendon Nelson, Plaintiff Class Action against Robinhood Financial LLC, Robinhood Securities LLC, Robinhood Market Inc. Plaintiff demands trial by jury.[Feel free to clap and cheer, if you so wish].
Nature of the legal action:
1. Breach of contract. Robinhood an online brokerage firm purposefully, willfully, and knowingly removed the stock GameStop from its trading platform in the midst of an unprecedented stock price, thereby depriving retail investors of the ability to invest in the open market. Robinhood breached its customer agreement by among other things failing to disclose that its platform was going to randomly pull a profitable stock from its platform. Robinhood failed to provide adequate explanations to their customers and knowingly put them at a disadvantage compared to customers who used other trading platforms.
2. Breach of the implied covenant of good faith and fair dealing. Robinhood failed to exercise trades and actions requested by their customers and was therefore in breach of the implied covenant of good faith and fair dealing. Robinhood unfairly interfered with the rights of plaintiffs and members of the class to receive the benefits of the customer agreement.
3. Negligence. Robinhood was grossly negligent and wrongfully breached his fiduciary duty to the plaintiff and the members of the class causing losses and damages that would not have occurred but for Robinhood’s gross breach of duty of care.
And so, begins the legend of Reddit and the small investor.
To be continued …
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