” TLDR: There isn’t really any sort of conspiracy going on between RH and Citadel, and what you see circling on social media is simply misinformation. This is due to the fact that barely anyone understands what goes on behind the scenes when a trade executes, and i think a lot of people are attributing this to malice when all it boils down to is incompetence.

Now when you click buy or sell on your screen, although it seems instantaneous, trades actually take 2 business days to settle. 100 years ago, when people traded, they would would go to the Buttonwood Tree (where the NYSE currently is) and you would pay someone cash for the stock, and in exchange you would get a stock paper certificate. Obviously we don’t deal with that anymore given the amount of volume traded today. That’s why companies like Depository Trust & Clearing Corporation (DTCC) was started. They pretty much have a monopoly on this (they settle over 95% of trades that happen today). They guarantee that when you sell a share, you will receive funds from the other party buying it. And in order to guarantee that, they require deposits from custodians, also known as clearinghouses. Remember how I said trades take 2 days to settle? Well, from now till then, before the money actually exchanges hands, someone has to step in to fund those trades — the clearinghouse does that. RH, TD, Scwab et al are simply brokers that sends your orders to those clearinghouses.

So, to summarize, the flow looks like this: investor -> broker -> clearinghouse -> DTCC

Now, when someone buys a stock, the broker has to front a certain amount of money to their clearinghouse, which in turn has to front that amount to DTCC. Typically, that is anywhere from 1% to 3% of the notional value of the trade. So if you were buying a share of AAPL, the clearinghouse, until the day of settlement, will require your broker to deposit 1-3% of the trade which they will send to DTCC, who holds it as collateral. Now, because stocks like GME and AMC are so volatile, DTCC has raised that collateral rate to 100%. That means that when you buy a share of GME, say at $350, your broker has to deposit $350 to their clearinghouse, which is then held as collateral by DTCC. Multiply this by billions of shares being traded, and your broker is on the hook for fronting hundreds of billions of dollars, which sits at DTCC for 2 whole days. This is exactly why RH had to block buying, because they simply are not well-capitalized and did not have the liquidity to do that.

So, what if DTCC doesn’t raise collateral rates to 100%? Then what you have is the potential for counterparty risk. If say GME gaps up to a $1000, companies like Melvin Capital that are short it may not have enough money to cover their short position. Their broker will close out all their remaining positions, and call them up for the remaining amount that they are owed. If they cant’, the broker will most write that off as a loss, and if you multiply that over many times, they will have to go to their clearinghouse to cover it for them. If you multiply that even further and the clearinghouse can’t cover that debt, then there will be total counterparty shutdown. The person that sold Melvin Capital the shares for them to go flat on their position will not be able to receive that money.

Now to answer many questions which have been circling online:

Why did RH allow selling but not buying? Why not stop both buying and selling?
Firstly, locking people out of selling shares they own is worse than just disallowing people to buy. It would be a sure lawsuit waiting to happen. Secondly, the deposit that RH has to front to their clearinghouse is only required for buys. No deposit is required for sales — hence why they didn’t block selling.

Why did RH liquidate some of their customers’ shares without their consent?
When you sign up for RH it auto-signs you up as a margin account. Due to RH’s cash crunch, they most likely had to liquidate some of their customer’s positions to put up the appropriate margin requirements to their clearinghouse.

Why did brokers like TD / Fidelity allow trading of GME?
If you recall, TD shut down trading early in the week. Then a couple days later it was RH and Webull that shut down trading. And almost immediately TD allowed buying again. Different brokers use different clearinghouses. TD, Fidelity, and RH clear on their own. Webull, SoFi, TradeStation and many app-based platforms go through Apex clearing. So most likely, just as the huge influx of buying started, Apex clearing had to suspend buying, while around the same time TD and Fidelity’s 2 day settlement with their own clearing had finished, and so they were well capitalized to allow buying.

What about RH’s relationship to Citadel? Doesn’t Citadel in turn have a relationship with Melvin Capital?
Yes, RH does sell orderflow to Citadel, and yes it does seem like a stinky conflict, but they aren’t in bed together on this one. It’s a sexy narrative people are spinning up that is nothing more than coincidence. Many people misunderstand what Citadel actually does, and that is they are market makers ie liquidity providers. They are profiting off the bid-ask spread. When John Doe sells his stock, he isn’t exactly selling to Jane Roe — Citadel is on the other side of it. Take for example a $100 stock. There is a bid-ask spread of say $1 (so $100-$101). You sell at the bid at $100, Citadel buys it from you. At the same time Jane Roe puts in a buy at the ask ($101). Citadel sells it to her and pockets the $1. The higher the volatility of the stock, the wider the bid-ask spread, and the more money Citadel makes. Yes, this short squeeze is actually making Citadel money.

So yes, RH did “lie” to us by saying that they were protecting their customer when they disallowed buying. They were just protecting themselves / had a liqudity crunch. There isn’t some sort of financial cabal going on between the RH and institutional short sellers.” – naandri, teamblind