Jose Castillo withdrew $60,000 in GameStop Corp shares from his brokerage account last summer, despite the fact that he had no intention of selling them.
The 26-year-old information technology worker, who lives in the greater Minneapolis area, is one of a growing number of investors withdrawing “meme” stocks from brokerages, citing concerns that the shares will be lent to hedge funds engaged in short-selling.
Castillo obtained the shares from Fidelity Investments and had them transferred to his name through Computershare Ltd, an Australian stock transfer company.
Brokerages have tried to reassure investors that they only lend shares to customers trading on borrowed funds. The shares are not loaned if they pay with their own money.
Castillo traded GameStop shares without borrowing money, but he was still concerned that his shares would be lent. He claimed to have learned about “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, an increasing number of investors have announced that they have removed their shares from brokerages such as Computershare, claiming that this will protect them from short-selling.
According to Paul Conn, president of Computershare’s global capital markets group, a wave of direct registration business began in September, driven by day traders.
Hedge funds short stocks by borrowing and selling them in the hope that their value will fall so that they can buy them back for less and pocket the difference. According to financial market experts, the push toward direct registration is unlikely to curtail this practice because the majority of hedge funds’ collateral is provided by prime brokers rather than retail brokerages. “The shares used to stock-loan from margined retail accounts are minimal when compared to stock-loan inventory from prime brokers and long lenders such as mutual funds and pension funds,” said Ihor Dusaniwsky, managing director of research firm S3 Partners.
According to Refinitiv data, monthly average trading volumes of GameStop shares have fallen to their lowest levels in more than a year since July. That was around the time when Reddit users began to advocate for direct share registration.
The more shares that are transferred from brokerages to direct registration providers like Computershare, the fewer are available for trading. According to Joshua Mitts, a securities law professor at Columbia Law School, removing shares from the market makes them more vulnerable to wild price swings, which may harm retail investors.
Popular trading apps like Robinhood Markets Inc and SoFi Technologies Inc, as well as traditional brokerages like Charles Schwab Corp and Fidelity, would suffer if the direct registration trend accelerated. They benefited from this year’s surge in meme stock trading.
Representatives from Robinhood and Charles Schwab reiterated that only shares of customers who borrowed from the brokerages to invest are loaned to hedge funds.
Many requests came from clients who purchased shares without borrowing from Charles Schwab and would not have had their shares lent, according to Chiappetta.
Retail investors began to distrust brokerages after Robinhood and its peers imposed trading restrictions on GameStop’s shares in late January. Thousands of investors claimed on social media that the trading restrictions were put in place to protect hedge funds that had lost billions of dollars shorting the stock without expecting a Reddit-fueled rally.
Payment for order flow is used by commission-free brokerages such as Robinhood to receive fees from market makers for routing trades to them. This business model has also raised concerns among retail investors, especially since Citadel Securities, Robinhood’s market maker, also manages hedge funds that engage in short-selling.
The trading restrictions, according to Robinhood and Citadel, were put in place not to protect hedge funds, but because Robinhood did not have enough collateral to execute customers’ trades.
Last month, a US judge sided with Robinhood, dismissing an investor lawsuit accusing the trading app and other brokerages of wrongfully preventing retail investors from buying fast-rising “meme stocks” and causing a sell-off.