That’s not correct.
They would have to pay any dividends that the stock issues, if it’s a dividend-paying stock (which I believe GME is not).
The interest they are paying to the person they borrowed the stocks from.
A covered short is a position where you already own the shares you’re short-selling (contrast with naked short).
It’s kind of unrelated to the original comment. AFAIK, brokers will only force a sale in a margin call situation, which should only apply to naked shorts.
Which at some point they are going to be forced to do by a margin limit.
I’m confused. If you own the shares you’re short-selling isn’t it just a regular sale?
Here’s another absolutely hilarious explanation along with some idea of when, as a degenerate redditor, you should go ahead and dump your GME shares:
Click through and read, you will be edumacated thereby and also amused. If you’re a staunch hater of rich people, you will laugh and laugh and laugh.
The situation here has nothing to do with covered shorts. If the shorts were covered, there couldn’t be a short squeeze because the people who are subject to getting squeezed would just use their cover to fulfill their obligations under the short. Methinks you don’t know what you are talking about.
The first sentence is nonsense. The second sentence has as much relevance as noting that my shirt is red.
Big institutional investors (and here, we are talking huge. Thinks billions and billions or perhaps a trillion or more) of investable assets get fees for lending stock, Those fees are tied not only to the value of the shares but also how hard it is to locate shares to borrow. When a stock attracts a lot of short interest, it becomes very hard to locate shares to borrow and the fees stock lenders can get on them rise dramatically.
But a lot of stock comes from everyday investors and smaller institutions. If they want to use margin or to trade options, these investors have to sign margin account agreements with their brokers that allow the brokers to lend their stock and keep the fees. It’s a good source of revenue for broker-dealers.
Class action lawsuits are generally filed on behalf of plaintiffs in exchange for contingency fees, which must be approved by the court, that they receive only if they win. There is no crowdfunding lawyers necessary. There are also advantages to being the first law firm to file suit. Unfortunately, I believe that these lawyers are going to learn very quickly that Robinhood’s account agreements likely all mandate individual arbitration so the class action suit will be dismissed.
Correct.
Some broker-dealer arranged the stock loan and holds the investor’s margin account. The customer’s agreement with broker says that if the account drops in value and the customer’s net equity is too low (that is, if the account drops below the “maintenance margin” level), the broker can place a margin call or begin to just liquidate the account at its option to raise the net equity level. In a fast moving market, like with GameStop, the broker might skip issuing a margin call altogether and just begin to sell the customer’s stock. So the broker-dealer will buy as much GameStop as it can to close the short position and stop the bleeding, then sell as much of the client’s other holdings as is necessary to pay for the GameStop stock and bring the account back to the maintenance margin level.
Here’s an example: customer has 1000 shares of Widget Co. worth $1000 per share ($1 million total). Customer shorts 2000 shares of Game Stop for $50 per share (so he owes $100,000 in stock and gets $100,000 in cash). Net equity in the account is $1 million, since the Game Stop short is currently neutral.
Game Stop rises to $500 per share. The customer now owes the broker Game Stop stock worth 1,000,000. He only has a total of .1.1 million in assets in the account, and the account has a net worth of only $100,000 - $1 million of Widget Co. stock, and $100K of cash minus the debt of $1 million in Game Stop stock). So the net margin in the account is only $100K, or a bit more than 5% of the value of the stocks in the account. This is below the firm’s maintenance margin requirement so the firm can: (1) either issue a margin call, or (2) start closing positions. A short squeeze is where the broker decides it will buy the Game Stop stock to cover the short and sell the Widget Co stock to fund the Game Stop purchase. The customer is all but wiped out.
This is really complicated but suffice it to say that sometimes the same share of stock is borrowed by more than one person at a time. Imagine you borrow the stock from a long term investor. You sell it Harry. Harry puts it in his brokerage margin account. His broker in turn lends the stock to Sally. Sally sells the stock to Jerry. Jerry’s broker lends the stock to Willy, etc. There is no theoretical limit to open short interest. There is a practical one though, because if Jerry bought the stock in a cash account, his broker wouldn’t be able to lend it out, and the chain would stop with him. There is actually a whole sub-industry dedicated to finding short sellers the stock they need to borrow.
Well, the revenue from the sale is fixed. The expenses are not fully determined until they close the position. The income (positive or negative) will be the difference between their revenue from the sale and their cost to cover the short.
In general, stock loan agreements are open ended but callable on a short notice. When the agreements are not open ended, they are usually renewable unless notice is given that the loan is being terminated. Investopedia is describing an edge case as though it’s normal.
If this gets the SEC and Financial Services Committee looking into it we might see a great big change and some smart person might find a way to argue that individual arbitration clauses aren’t enforceable in the face of outright law violations. It will be fun to watch, and yes, the redditors have enough money to buy a pet law firm purely to pursue this stuff–and I’m pretty sure they’ll find that to be a worthy investment in the future.
How do Robinhood and the other trading platforms fit into all this? It sounds like they restricted trading the stock on their platform. Would they have been hurt in some way had they not restricted the trading? It seems to me that they wouldn’t be, any more than the owner of say a flea market is hurt if someone is selling an old rusty frying pan for $100, but maybe I’m missing something. What might explain their actions?
Honestly, you don’t make very much money in the future when all your customers go broke. I suspect Robinhood was worried that their new customers would go long on Game Stop, the floor would drop out, and then those people would lose 90% of their money and vow to never trade stocks again…Futhermore, Congress would threaten hearings about why Robinhoood didn’t stop these poor investors from making stupid financial decisions.
There is also the very real possibility that some of these customers were buying on margin and they are worried that they have too much exposure to a highly precarious position. If that were their only concern though, they could have just declined to extend margin on the Game Stop or to allow it to be purchased in margin accounts.
Half of all Robinhood account holders have stock in GME–and Robinhood started selling people’s shares WITHOUT a sell order. That has to be a big fucking no-no somewhere, right? Good lord.
Well, securities arbitration agreements essentially only come into effect when there are securities law violations and the Supreme Court has upheld binding arbitration agreements several times. I don’t see this happening.
According to redditors, Robinhood is owned by Citadel, a hedge fund that stands to lose money from this short squeeze.
I do not personally know the veracity of this information.
Here’s one thing I never understood about short sales (this applies to all short sales, even if the short interest is minimal). It would seem that the result of short sales is that there are more shares owned by people than actual shares in existence. For example, if a brokerage borrows X number of shares from Bob and lets Joe sell them to Mike, then both Bob and Mike think they own X number of shares, even though only one set of X shares actually exists. That works fine for trading purposes, but what about company ownership? Who gets to vote in shareholder elections for the BOD and the like? If there’s a shareholder lawsuit, who is a shareholder for purposes of the lawsuit? And so on. It’s hard to imagine that a company which issued 1 million shares is required to recognize 1 million plus X shares as being valid just because some brokerage decided to lend some out.
I just see a screenshot of an error message. I don’t know what the underlying order was or why it could not be cancelled. One possibility is that the guy was shorting Game Spot, he was subject to a margin call, Robinhood was covering the short position due to a breach of the maintenance margin requirement, and Robinhood wouldn’t let the person cancel the buy order that Robinhood placed to mitigate its risk. I don’t take a random posting on the internet as gospel.
I would say that, absent an agreement to the contrary, a broker could not just sell a customer’s securities held in a cash account without the customers’ permission. That would be unauthorized trading. I don’t see anything in Robinhood’s account agreement which gives them the power to say, “I’m afraid I can’t do that, Dave.”
The “holder of record” gets to vote the stock. If you hold the shares in a margin account you will start out as the holder of record. But, your broker retains the right to loan the shares out, as explained in the margin agreement. If the broker loans your shares out, the holder of record becomes the person who borrows the shares. But the borrower is going to sell them immediately and thus someone in the open market will buy them and become the holder of record. That person will get to vote the shares.
The holder of record also collects the dividends. You think you will collect the dividend because you own the stock in your account but what you get instead is a payment in lieu of dividends. I understand that this can have meaningful income tax consequences because dividends are taxed more favorably than payments in lieu.
ETA: Robinhood’s margin agreement says:
RHS MAY HYPOTHECATE THE SECURITIES IN YOUR ACCOUNT. All securities now or
hereafter held by RHS, or carried by RHS in any account for you (either individually or
jointly with others), or deposited to secure same, may from time to time, without any
notice, be carried in RHS’s general loans and may be pledged, repledged, hypothecated or
re-hypothecated, separately or in common with other securities for the sum due to RHS
thereon or for a greater sum and without retaining in RHS’s possession or control for
delivery a like amount of similar securities. Any securities in your margin or short account
may be borrowed by RHS, or lent to others.INDUSTRY REGULATIONS MAY LIMIT, IN WHOLE OR IN PART, YOUR ABILITY TO
EXERCISE VOTING RIGHTS OF SECURITIES THAT HAVE BEEN LENT OR PLEDGED TO
OTHERS. You may receive proxy materials indicating voting rights for a fewer number of
shares than are in your account, or you may not receive any proxy materials.
I bought a few contracts that expire tomorrow really cheaply in case it collapses on the option expiration date.
Isn’t the cost contingent on two factors; the cost they will have to pay to buy replacement shares for the ones they borrowed and sold and the amount of time they held the borrowed shares before replacing them?
Yes, there are other expenses to selling short that are partially a function of how long the short is outstanding. There are also trading commissions. Look, I’m trying to explain short squeezes to the broad world. Be thankful I didn’t simplify to the point of spherical cows. 
This Twitter thread details the entire story: