The equity market plumbing worked as we expected in the face of a bubble in GameStop stock: Rep. French Hill

Rep. French Hill, (R-AR) House Financial Services Committee Member, joins the Yahoo Finance Live panel to discuss yesterday's Congressional hearing on GameStop.

Video Transcript

AKIKO FUJITA: Lawmakers on Capitol Hill assessing the next steps in their investigation into the GameStop trade after that marathon hearing yesterday before the House Financial Services Committee. Let's speak to representative French Hill. He's a Republican Congressman from Arkansas, sits on that committee.

And this was a very long hearing yesterday. A lot of discussions about the market mechanics. You went into this saying this was a fact-finding mission. What's the conclusion after the five hours? Is this about a company that simply just got in over its head or are there fundamental flaws in the market mechanics that need to be addressed?

FRENCH HILL: Well, from listening to it yesterday my personal view is the equity market plumbing worked as we expected. And so it really, in the face of a bubble in GameStop stock or AMC stock, functioned just like we hoped it would. And so that was my major takeaway.

However, it was good to hear the CEO of Robinhood acknowledge that they did not have sufficient capitalization in their clearing process to absorb the shocking amount of trades that came through in that bubble. He apologized for that. And I made recommendations that their customer service should really change and reflect a more traditional way to help customers through tough times.

ZACK GUZMAN: Congressman, you say the system worked as it should. But I had a feeling there were a few retail investors out there who might have been blocked out from buying some of these shares that might differ from that opinion. And obviously, Robinhood, we should point out, was not the only brokerage that had some issues. You know, there were other ones. But they were the only one there on your panel.

So I mean, when you dug into it, was it surprising to not hear that many specifics behind what happened? I only counted one question that really got into that idea on a minute-by-minute basis. I mean, what more would you have wanted to learn about what preparations could have been made at Robinhood to prevent having to block buys?

FRENCH HILL: Well, the CEO, Vlad Tenev, suggested it was a Six Sigma event based on the run-up in GameStop prices. And that's possible. You're right to note other brokerage firms were engaged at the same time. But large capitalization, large amounts of capital held for clearing purposes are essential. And Robinhood, while they had plenty of net capital as a broker dealer, had insufficient deposits at the depository trust company where all the shares were cleared every day in order to meet their margin call on the next morning.

So I would say risk management is a takeaway. But we have laws that cover that. We have policies that cover that. All brokerage firms are treated exactly the same.

And Robinhood just was not prepared to deal with the requirements they had. But they got it fixed. But retail investors were inconvenienced on their platform, because they did not have the ability to process those trades on the second day.

AKIKO FUJITA: Is it your sense that the mechanism with which these trades are executed, and specifically the time that's needed to settle the trade-- was that part of the problem too? We heard Vlad Tenev say that, look, the technology is there to really reduce the time so it's more immediate. If that's the case, potentially Robinhood didn't need the kind of collateral which it had to raise, because they just didn't have the money.

FRENCH HILL: Yeah, it's a good point. That's a much longer process point. You know, we used to have trade plus five days settlement when I first started my career in stock and bond trading. And now we're at T plus two days to settle.

As we move towards blockchain and we move towards other settlement technologies and the whole ecosystem is redesigned, we will be able to move to same-day settlement. But we're not there yet. And so I thought there was a good discussion about that. But that's really something to talk about in future hearings. What are the conditions precedent necessary to move trading from T plus two to either T plus one or same-day?

ZACK GUZMAN: Congressman, the other issue at hand in, I guess, the plumbing of these trades was the discussion around payment for order flow-- which again, you know, Robin Hood may have pioneered that payment for order flow kind of methodology there, or business practice. But other brokerages quickly followed suit. We know how much TD Ameritrade and others make on it.

But there wasn't necessarily-- I don't know, maybe I'm wrong. Were you satisfied with kind of the discussion and the answers you got around that, and kind of the pushback against the conflict of interests in payment for order flow?

FRENCH HILL: I have no doubt that that's going to be a topic at a future hearing. But the SEC, the Securities and Exchange Commission, has blessed payment for order flow for, I would say, certainly over 10 years. So it's nothing that was pioneered by Robinhood.

The payment for order flow accomplishes a couple of things. Number one, multiple brokers in the exchanges-- I'd say up to 40-- compete for best execution on retail trades. And so the whole effort is to have competition to give the customer the best price at that millisecond of the trade.

Secondly, payment for order flow has allowed different models, at Schwab or TD Ameritrade or Robinhood now, to offer lower-cost access to account and lower-cost trading-- down to zero commissions now-- that's been help to, I think, a lot of consumer households to lower the agency costs and trying to plan their long-term investments. But to your point, it could use more discussion. And make sure that members of Congress and the public understand just what's going on in this area called payment for order flow.

AKIKO FUJITA: What other questions do you have on the issue, though? I mean, it sounds like you think that this should remain in place, that this is not something that needs to be addressed in its current form but there's more explanation that's needed. Is that a fair assessment?

FRENCH HILL: Well, there could also be more transparency around it on how that works, what customers' expectations are, how you assure best execution every day. Brokerage firms could better disclose perhaps what they're paid in order flow, and make sure retail customers and institutional customers understand that to make sure there's not a clear conflict of interest.

And then in my view, in these app-based fintech platforms, you know, how you qualify an investor for access to margin, access to option trading, and certainly access to low-dollar stocks is important. That's a big part of compliance at most brokerage firms. And my view was, after listening to Mr. Tenev, that he's going to relook at that at Robinhood and make sure that they're doing that in the right way. And you can't base that always every day on just an algorithm based on boxes checked by an individual client.