Analysis: 'Hands off': Why some U.S. investors are pulling meme stocks from brokerages

Citadel Income Fund

22/12/2021 11:00

By Svea Herbst-Bayliss and Krystal Hu
    Dec 22 (Reuters) - Jose Castillo pulled his $60,000 worth of
GameStop Corp  GME.N  shares from his brokerage last summer,
even though he had no intention of selling them. 
    The 26-year-old information technology worker, who lives in
the greater Minneapolis area, is among a growing number of
investors in "meme" stocks -- shares such as GameStop popular
with day traders -- who are withdrawing them from brokerages out
of concern the shares will be lent to hedge funds engaging in
short-selling.
    Castillo pulled the shares out of Fidelity Investments and
transferred them to his name using Computershare Ltd  CPU.AX ,
an Australian stock transfer company.
    Brokerages have been trying to reassure investors that they
only lend shares of customers who are trading on borrowed funds.
If they use their own cash, the shares are not loaned. 
    Castillo traded GameStop shares without using borrowed
funds, but he still feared his shares would be lent. 
    He said he read about the "direct registration" of shares on
Reddit, the social media platform that day traders turned to
this year after the meme stock trading frenzy took off. There,
more and more investors have announced they have taken their
shares out of brokerages through companies such as
Computershare, arguing this will help shield them from
short-selling. 
    "There is so much going on with a stock being shorted,
people started to think how can I make sure that I own it and
that somebody else isn't doing anything that I don't want with
it," Castillo said in an interview.
    A Fidelity spokesperson declined to comment.
    Paul Conn, president of Computershare's global capital
markets group, said he saw a wave of direct registration
business starting in September that was driven by day traders.
    "Retail investors have asked their broker or bank to remove
their investments from the 'street name' system and into their
own name, directly onto the company's share register," Conn
said.
    Hedge funds short shares by borrowing and selling them,
hoping they will drop in value so they can buy them back for
less and pocket the difference. Financial market experts said
the push towards direct registration was unlikely to curtail
this practice, because most hedge funds' collateral comes from
prime brokers rather than retail brokerages. 
    "The shares used to stock-loan from margined retail accounts
are minimal compared to the stock-loan inventory from prime
brokers and long lenders such as mutual funds and pension
funds," said research firm S3 Partners managing director Ihor
Dusaniwsky. 
    Monthly average trading volumes of GameStop shares have
dropped since July to their lowest levels for more than a year,
according to Refinitiv data. That was about the time that Reddit
users began to advocate for the direct registration of shares.
    The more shares are transferred out of brokerages into
direct registration providers such as Computershare, the fewer
of them are available to trade.
    Joshua Mitts, a securities law professor at Columbia Law
School, said removing shares from the market makes them more
susceptible to wild price swings, which could end up hurting the
retail investors.
    "From a psychological point of view, I can see how that
resonates. But from an economic point of view it does not make
much sense, because with fewer shares available the trading is
simply going to become more volatile," Mitts said.
    A GameStop spokesperson declined to comment.
    Popular trading apps such as Robinhood Markets Inc  HOOD.O 
and SoFi Technologies Inc  SOFI.O , as well traditional
brokerages such as Charles Schwab Corp  SCHW.N  and Fidelity,
would lose out if the direct registration trend intensified.
They benefited from this year's surge in trading of meme stocks.
    Robinhood and Charles Schwab representatives reiterated that
only shares of customers who have borrowed from the brokerages
to invest are loaned to hedge funds.
    "We have seen an uptick in recent months of clients
requesting to hold certain securities outside of Charles Schwab
as a means to prevent them from being lent out," the brokerage's
managing director of trading and education, Jeff Chiappetta,
said in a statement. 
    Many requests were made by clients who bought shares without
borrowing from Charles Schwab and would not have had their
shares lent, Chiappetta added.
    A SoFi spokesperson did not respond to a request for
comment.

    TRADING CURBS
    Retail investors started to mistrust brokerages when
Robinhood and its peers placed trading restrictions in late
January on GameStop's shares. Thousands of investors claimed on
social media that the trading curbs were introduced to protect
hedge funds that had lost billions of dollars shorting the stock
without anticipating a Reddit-fueled rally. 
    Commission-free brokerages such as Robinhood rely on payment
for order flow, under which they receive fees from market makers
for routing trades to them. This business model has also made
retail investors suspicious, especially since Citadel
Securities, which acts as Robinhood's market maker, also runs
hedge funds that engage in short-selling.
    Robinhood and Citadel have insisted that the trading
restrictions were not put in place to protect hedge funds, but
were needed because Robinhood did not have enough collateral to
execute customers' trades.
    A U.S. judge sided with Robinhood on the matter last month,
dismissing an investor lawsuit accusing the trading app and
other brokerages of wrongly preventing retail investors from
buying fast-rising "meme stocks" and triggering a sell-off.
 urn:newsml:reuters.com:*:nL1N2S91N1

 (Reporting by Svea Herbst-Bayliss in Boston and Krystal Hu in
New York
Additional reporting by John McCrank in New York; Editing by
David Gregorio and Greg Roumeliotis)
 ((svea.herbst@thomsonreuters.com; +617 856 4331; Reuters
Messaging: svea.herbst.thomsonreuters.com@reuters.net))