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There is “a push to regulate short selling and potentially to limit short selling": Duke University Law Professor

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Elisabeth de Fontenay, Professor of Law at Duke University School of Law joins the Yahoo Finance Live panel with a GME hearing preview.

Video Transcript

ZACK GUZMAN: It's going to be a can't-miss television event for a number of reasons, not just because of the usual drama of a House hearing, but also because there's a lot of unanswered questions, questions that Robinhood CEO didn't want to answer right here on this show just a couple weeks ago around what led up to Robinhood's decision to stop customers from buying GameStop shares.

AKIKO FUJITA: Yeah, Zack. And really important, because this is the first time we're going to see all the players who were involved in that frenzy that we saw back in January testify before a congressional committee for the very first time. You mentioned Vlad Tenev, the co-founder of Robinhood. He, of course, will be testifying.

But we've also got Ken Griffin from Citadel, Citadel Securities, of course, the one that executes the trades for Robinhood. And then Gabriel Plotkin from Melvin Capital. There's been a lot of questions about whether, in fact, hedge funds should maybe be forced to disclose more of their short positions.

We've also got Steve Huffman, the CEO of Reddit, who's going to be testifying, as well as Keith Gill, the man we know, Zack, as Roaring Kitty, who is now facing this lawsuit, saying that he violated securities laws by essentially pumping up the GameStop stock. So there's a lot of questions going into this. As we know with a lot of these hearings, there is a lot of show and not necessarily leading to progress.

But it will definitely point to the direction with which at least Congress is considering potential reforms that need to be addressed in light of what happened around GameStop.

ZACK GUZMAN: Yeah, a lot of questions about not just Robinhood, but really that trend that we've talked about here on the show, payment for order flow and what happens to trades after you make them on certain brokers, where they go to get executed. And you mentioned Keith Gill, that lawsuit against him, interesting to see, coming out in class action status there, kind of from a trader who had, you know, suffered losses due to the way that GameStop came back down to earth. And it's something we're going to hear in the House hearing.

But again, a lot of questions to be answered coming up at noon. I want to bring on a guest here to kind of break down how we should be framing what we're going to be hearing discussed here. Our first guest today, Elisabeth de Fontenay, Professor of Law at the Duke University School of Law, joins us now.

And professor, I guess, you know, one of the questions that I have personally around all of this is kind of, what led up to the decision here? Because we kind of know the financial problems that were there behind, you know, the liquidity issues that Robinhood faced. But what do you think politicians are going to be pressing most for when it comes to the issues they care about?

ELISABETH DE FONTENAY: So I think that there's different competing considerations here and the politicians are going in some different directions. One thing we've heard a lot about, including from some members of Congress, is a push to regulate short selling and potentially to limit short selling. Which is interesting, because to the extent that we saw any market manipulation here, it was all going in the other direction.

So that, I think, is a big one that's going to come out of this. The other is about concerns over Robinhood's business model. This approach of not charging any trading fees but instead getting revenue from getting payment for order flow. That is to say, getting paid to direct its users' trades to a specific dealer or trading venue for execution.

AKIKO FUJITA: To what extent do you anticipate any progress coming out of this hearing? In many ways, if you talk about the transparency, for example, around short sellers, a lot of that falls in the realm of the SEC. But we're talking about a House Financial Services Committee. What's the expectation for you as we go into what is expected to be a pretty fiery discussion?

ELISABETH DE FONTENAY: So I think the Congress is really going to try to set the tone for the SEC, try to essentially signal to the SEC what it would like to see from them. But of course, you're exactly right. The SEC really is the one that is at the center of all this. And it's in a very uncomfortable position.

Because as we talked about, there was some-- a lot of trading that seemed to be not tied at all to the fundamentals of GameStop's cash flows. But is the SEC really going to want to go after retail investors? That's going to be a very tough position for it to be in.

And there are so many larger questions about market structure and the financial markets, and ones that the SEC has kind of tried to avoid dealing with and getting involved in for a long time. And it feels like it's all kind of coming to a head now.

ZACK GUZMAN: On the payment for order flow front, it's interesting because Robinhood kind of pioneered that model, right, getting paid to route trades to market makers like Citadel Securities, not to be confused with. We saw that big kind of misinformation around the pressure coming from hedge funds to make Robinhood do that Citadel LLC separate-- the hedge funds side separate from the market making side.

But it's interesting because other brokers have adopted that model now. We know TD Ameritrade, e-trade, all these brokers make money doing something similar now. I suppose, you know, that's another question around whether or not Congress wants to regulate that. What do you make of maybe how it started out as a Robinhood idea, but now it's much larger than that?

ELISABETH DE FONTENAY: Absolutely. So there's really two considerations here. One is, does payment for order flow actually harm the users? So the users think that they're getting trading for free, right? They're not paying any trade fees anymore.

But the question is, are they really paying for it in a different way? Which is, they may be getting worse execution as a result of some trading venues paying them or dealers paying to execute their trades perhaps because they're going to give them worse execution. There's really not much evidence of that so far, but it is something that the SEC certainly will want to look into.

The other consideration is, is this new model for retail brokerages going to lead to too much trading by retail investors? So now that they believe that what they're doing is entirely free, you're seeing the surge in Robinhood users, and now all of the other retail brokerages are going to experience the same thing almost certainly is a reentry en masse of retail investors in the financial markets not in a buy and hold strategy but really in a constant trading strategy a good idea.

And I think we have a lot of data on performance of retail investors when they trade versus buy and hold. And unfortunately, none of it is reassuring.

AKIKO FUJITA: There is another piece to all of this, which is the social media element of it, the way in which the information can spread so quickly at such a big scale that we saw in the case of GameStop. I thought it was interesting-- Steve Huffman, the CEO of Reddit, putting out in his prepared statement, saying that all of this may look sophomoric or chaotic from the outside, but the fact that we are here today means that they've managed to raise important issues about fairness and opportunity in the financial system.

So he's talking specifically about the users on Reddit. To what extent can you even regulate that conversation? It feels like that is a whole other piece of the discussion.

ELISABETH DE FONTENAY: It is going to be extraordinarily difficult to regulate that because the just sheer number of statements that can be made when you're talking about a Reddit message board is enormous. And the idea that the SEC is going to be able to keep up with this on a continuous basis and try and intervene to stop statements that seem misleading or, like, market manipulation seems incredibly difficult.

And I think that that is something new about this development. You know, we've had the dotcom bubble in the 2000s, where lots of retail investors got involved in the markets and did not work out well for them. But here, the social media aspect of it really is new, that everything is happening so much faster. And by the time the regulators pick up on it, to some extent, it's too late.

ZACK GUZMAN: Yeah, as we highlighted on the show, it was an amazing thesis, clearly played out the way that he had predicted. Roaring Kitty, Keith Gill, going to be there in person as well. Not sure he's going to be wearing his headband as he does in the YouTube videos, but Elisabeth de Fontenay, Professor of Law at Duke University School of Law, appreciate you joining us.