By now, whether through social media memes or reputable news sources, you have probably read about the recent proletariat-like invasion of the retail investor on Wall Street.[1] Perhaps you only know the event as that thing that happened to GameStop; or perhaps, like me, you realized something was going on after receiving various emails from places where you hold accounts, like Robinhood or TD Ameritrade, attempting to dissuade worry about the market’s volatility and their role in the event’s fallout. Regardless of how your awareness of the events came about, it is highly likely that reading headlines raised more questions than answers, especially with regards to the event’s legal implications. This article will take a brief look at those questions, unpack the legality of not only the moves of the investors involved but also the reactionary efforts of Wall Street players like Robinhood, and finally, highlight the legal developments already unfolding following the event. Regardless of any ultimate legal conclusions, or lack thereof, however, this article will hopefully clear a layer of confusion related to the mechanics of what occurred and what regulatory watch dogs might do next.
As a refresher, this story began when users on r/WallStreetBets, a Reddit forum, coordinated a massive movement to buy stock of specific struggling companies, including GameStop (GME), Blackberry (BB), and AMC (AMC).[2] From line cooks to salesmen to high school students, these “amateur traders” were brought together by a single platform: Reddit.[3] Once thought of as just a sort of chatroom for likeminded individuals, Reddit seems to have been re-introduced to the world as a way for the average joe to play the same game as a hedge fund CEO. While there were many reasons why these various individuals decided to join the movement, however, one important reason was to force themselves into an exclusive club traditionally run by hedge funds, in an attempt to beat the hedge funds at their own game.[4] This multi-billion-dollar short squeeze, a term explained below, began on r/WallStreetBets, the Reddit page responsible for the coordinated attack.[5] Because of the efforts of this band of small-time players, GameStop stock jumped from around $20 a share to almost $400 a share,[6] or, in other words, it climbed as much as 1,650% in less than a month.[7] Let’s unpack how this happened.
Short Selling Primer
This whole event started with the use of a common strategy called short selling. For those unfamiliar, short selling is an advanced investment strategy usually used by experienced traders.[8] It begins when a trader borrows a stock, normally from a broker, she believes will decrease in value by a specific future date.[9] Then, the trader sells the borrowed stock to investors willing to pay the market price.[10] Hoping she is correct, the trader waits until the stock begins to fall as predicted.[11] When the price does, in fact, decrease, the trader will buy back the borrowed stock in order to return it to the lender; if it all goes according to plan, at the end of this cycle, the trader will have made money off the difference.[12] A simple example is this: you borrow your friend’s pen and sell it for $5. You then buy it back for $2, return the pen to your friend, and keep the $3 difference. As previously mentioned, this sort of strategy is normally used by professional investors, like hedge funds.[13]
Retail Investors Step on the Gameboard
In the events of late January, Reddit users specifically targeted stocks that were in the midst of being shorted.[14] By doing so, they pulled off what is called a “short squeeze.”[15] A short squeeze occurs when the shorted stock jumps in price, forcing traders who bet against it (i.e. those who attempted to short the stock) to quickly buy it back to cut their losses.[16] Ironically, this “scramble to buy” only serves to further increase the price of the stock.[17] Thus, when Reddit users targeted GameStop, BlackBerry, AMC, and others, their trades, coupled with the hedge fund buy backs, drove up the stock price resulting in major losses for the hedge funds and short-sellers.[18] For example, one hedge fund in particular, Melvin Capital, lost about 53% in January; others lost between 15% and 20%.[19] Nonetheless, as one news article eloquently states, “who’s the monster and who’s the hero, in this case, depends entirely on your perspective.”[20] Whether the Reddit users took it too far or whether the Wall Street professionals had it coming is open for debate.
Checkmate – Robinhood and Friends Stop Trading
All of this chaos prompted Robinhood (and friends) to enter the scene, seemingly resulting in further confusion and chaos.[21] Robinhood, as a no-fee platform, has opened the door for “the ‘democratization’ of the stock market,” making it easier for retail investors to join the investment world.[22] This ease of trading is precisely why the platform was used by Reddit users to execute their buys during the event.[23] However, following the fervor of trades and the ensuing volatility of the stock market, Robinhood was forced to step in and temporarily restrict buying.[24]
Shortly after its decision to interfere, Robinhood issued a statement claiming that they were beholden to their clearinghouse obligations and had no choice.[25] Robinhood claimed that its clearinghouse had demanded that Robinhood supply $3 billion to cover the day’s trading as “a cushion for the risk created” by the frenzy.[26] A clearinghouse is an SEC-registered organization that “clears” or finalizes trades during a settlement period to ensure that the buyer and seller uphold their obligations.[27] As Robinhood explained in emails and public statements to its account holders, Robinhood’s clearinghouse was demanding payment and Robinhood needed to somehow comply.[28] The clearinghouse, as dictated by the SEC, was required to maintain certain deposit thresholds in order to help mitigate risks for members.[29] Robinhood claimed that, in order to do this, they needed to restrict trading to cover the amount required by its clearinghouse, which, according to Robinhood, increased “tenfold” during that day.[30]
To explain further, Robinhood makes a large portion of its money through margin lending to customers.[31] Margin lending occurs when customers borrow up to two times the value of their deposited cash in order to increase their stock-buying power.[32] Because this is risky, Robinhood and other lenders have “margin maintenance requirements” or requirements that customers hold minimum amounts of equity in their investments.[33] If a stock falls too much causing a loss in all or most of an investor’s equity, Robinhood issues a “margin call” requiring that the investor either deposits more cash or sells the purchased stock.[34] When the GameStop run was occurring, Robinhood was lending more and more money out to its customers through both its margin lending and its short-seller lending.[35] Thus, Robinhood “presumably saw the risk of waiting for customers to deposit as unacceptable” and, therefore, chose to halt trade.[36]
Was any of it illegal?
This entire unprecedented event prompted even those in the White House to monitor the situation.[37] Yet, it still seems unclear whether that monitoring will lead to any actual viable legal actions even despite recent investigations.[38] While some people don’t believe anything illegal occurred,[39] others, like me, are wondering if regulators will continue to come forward with charges of market manipulation.[40] Or, perhaps, even if the regulators do not ultimately bring any actions, the parties involved may raise their own calls for legal retribution.[41] However, none of the traditional signs of market manipulation, a plausible claim, appear to be present; signs include the spreading of material misstatements about the company or the creation of what appears to be inaccurate interest in the stock.[42] If anything, the Reddit users were extremely open about their tactics, writing and discussing their plans all over the forum.[43] This transparency seems to negate any claim of “fraud in the connection with the purchase or sale of a security.”[44]
Additionally, the mere act of “banding together” to buy stock is not, in itself, illegal either.[45] Rather, it comes down to intent, or whether the public had the purpose of distorting the market.[46] As one law professor points out in a recent article, raising this claim against Reddit users would be a little ironic since “hedge funds band together” frequently.[47] Now that the roles have flipped, wouldn’t it be a little unfair to condemn the Reddit users and not the hedge funds? In essence, because no lying, deceit, or fraud seemed to take place in these occurrences, the Reddit users are probably in the clear.
Nonetheless, the events prompted the SEC to release an “ominous” statement[48] on January 29, 2021.[49] In this statement, the SEC reminded the public that it will “monitor and evaluate[]” the market to “work to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation;” thus, like the rest of us, the SEC is continuing to watch and assess. [50] According to some reports, the SEC has started reviewing “posts on social media and online message boards for evidence of fraud and coordinated stock-price manipulation.”[51] Other government agencies like the Commodity Futures Trading Commission (CFTC) and the Department of Justice are also investigating Reddit users.[52]
Additionally, in its January 29th statement, the SEC hinted that it would not limit its inquiry to the Reddit users, but would also look into the actions of brokerage firms like Robinhood.[53] As previously mentioned, however, Robinhood’s excuse to appease the clearinghouse may be enough.[54] Nonetheless, the SEC will most likely investigate Robinhood especially with regards to Robinhood’s relationship with Citadel Securities (“Citadel”), a financial services giant and source of much of Robinhood’s revenue.[55] Robinhood routes almost half of its customers to Citadel for trade execution.[56] Therefore, the SEC could focus on a potential conflict of interest between its relationship with Citadel and its duty to serve its client’s best interests.[57] Again, it remains unclear whether the SEC will be able to learn the truth as to what actually occurred and, with that truth, connect any player to a viable enforcement action.
In addition to the SEC’s evaluation, Robinhood and friends’ decision to stop trading was met with cries of manipulation by the general public, with many believing that the move was meant to protect the hedge fund and short-sellers, not the retail investors.[58] On the other side, some accused Robinhood of threatening “traditional players in the finance industry” (i.e. hedge funds) by denying “their customers the chance to profit from the volatility.”[59] However, legal experts point out that brokerages “have broad powers to block or restrict trades” that are clearly defined in signed customer agreements.[60] Essentially, this means that the legal bar is high for those seeking retribution, given Robinhood’s formidable contractual defense.[61]
Nevertheless, a new class action was filed in Texas on January 29th against Robinhood and TD Ameritrade, claiming that they “arrived at a ‘common understanding of what must be done, which they carried out with conscious parallelism.”[62] Conscious parallelism refers to “price-fixing between competitors without an actual agreement between the parties.”[63] In this suit, firms are accused of “violating customer contracts, breaching fiduciary responsibilities, and violating laws on anti-competitive practices and price-fixing.”[64] Other class-actions arising out of these events are making similar claims.[65]
Finally, even if none of these lawsuits pan out, this unprecedented event has not escaped the scrutiny of legislators. For example, multiple prominent legislators have called for increased stock market regulations as well as investigations of Robinhood.[66] Even Republican Senator Ted Cruz and Democratic House Representative Alexandria Ocasio-Cortez (aka A.O.C.) seemed to be on the same side for once (something many never thought possible) as both condemned the moves of Robinhood.[67] Whether this was simply a political statement issued to appease constituents without real intention of legislative follow through remains to be seen. Nonetheless, the House Financial Services Committee held a virtual hearing on February 18 to move forward with at least the appearance of action.[68] At this hearing, the committee heard from Robinhood CEO Vlad Tenev and Reddit CEO and co-founder Steve Huffman, among others.[69] Robinhood and Citadel Securities definitely received the brunt of the House’s questioning at this hearing, with Reddit escaping largely unscathed.[70] As is typical, however, representatives clashed over possible solutions to prevent a repeat event.[71] Thus, the next steps Congress may take remain a mystery.
Regardless of the outcomes of private suits, political statements, or SEC threats of enforcement actions, it is clear that the impact of these events will remain for years to come.
[1] See Matt Phillips & Taylor Lorenz, ‘Dumb Money’ Is on GameStop, and It’s Beating Wall Street at Its Own Game’, N.Y. Times (Feb. 1, 2021), https://www.nytimes.com/2021/01/27/business/gamestop-wall-street-bets.html.
[2] Allison Morrow, Everything you need to know about how a Reddit group blew up GameStop’s stock, CNN Bus. (Jan. 28, 2021), https://www.cnn.com/2021/01/27/investing/gamestop-reddit-stock/index.html.
[3] See Phillips, supra note 1.
[4] See Morrow, supra note 2.
[5] Id.
[6] See GameStop – Stock Price History, GME, Macrotrends (2021), https://www.macrotrends.net/stocks/charts/GME/gamestop/stock-price-history.
[7] See id.; see also Pat Regnier, Stonks Are Bonkers, and Other Lessons From the Reddit Rebellion, Bloomberg Businessweek (Feb. 4, 2021), https://www.bloomberg.com/news/features/2021-02-04/gamestop-gme-how-wallstreetbets-and-robinhood-created-bonkers-stock-market.
[8] James Chen, Short Selling, Investopedia (Jan. 28, 2021), https://www.investopedia.com/terms/s/shortselling.asp.
[9] Id.
[10] Id.
[11] Id.
[12] Id.
[13] See id.
[14] See id.
[15] See Short Squeeze, Nasdaq (2021), https://www.nasdaq.com/glossary/s/short-squeeze.
[16] Id.
[17] See Cory Mitchell, What is a Short Squeeze?, Investopedia (Jan. 28, 2021), https://www.investopedia.com/terms/s/shortsqueeze.asp#:~:text=What%20Is%20a%20Short%20Squeeze,pressure%20on%20the%20stock’s%20price.
[18] See Morrow, supra note 2.
[19] Nir Kaissar, GameStop Furor Inflicts Lasting Pain on Hedge Funds, Bloomberg Op. (Feb. 1, 2021), https://www.bloomberg.com/opinion/articles/2021-02-01/gamestop-gme-short-squeeze-inflicts-lasting-pain-on-hedge-funds.
[20] Chen, supra note 8.
[21] See Peter Rudegeair et al., Robinhood’s Reckoning: Facing Life After Game Stop, Wall St. J. (Feb. 5, 2021), https://www.wsj.com/articles/robinhoods-reckoning-can-it-survive-the-gamestop-bubble-11612547759.
[22] Misyrlena Egkolfopoulou & Sarah Ponczek, Robinhood Crisis Reveals Hidden Costs in Zero-Fee Trading Model, Bloomberg Wealth (Feb. 3, 2021), https://www.bloomberg.com/news/articles/2021-02-03/robinhood-crisis-reveals-hidden-costs-in-zero-fee-trading-model.
[23] See Regnier, supra note 7.
[24] See Robinhood CEO Says Restricted Buying Protects Firm and Customers, Bloomberg Tech. (Jan. 28, 2021, 10:11 AM), https://www.bloomberg.com/news/videos/2021-01-29/robinhood-ceo-says-restricted-buying-protects-firm-and-customers-video.
[25] See What happened this week, Robinhood (Jan. 29, 2021), https://blog.robinhood.com/news/2021/1/29/what-happened-this-week.
[26] Rudegeair et al., supra note 21.
[27] Akhilesh Ganti, Clearinghouse, Investopedia (Apr. 1, 2019), https://www.investopedia.com/terms/c/clearinghouse.asp.
[28] See What happened this week, supra note 25.
[29] See id.
[30] Id.
[31] Daniel Tenreiro, Why Robinhood Halted GameStop Trading, Nat’l Rev. Cap. Matters (Jan 28, 2021), https://www.nationalreview.com/2021/01/why-robinhood-halted-gamestop-trading/.
[32] See id.
[33] See id.
[34] See id.
[35] See id.
[36] Id.
[37] See Abram Brown, Founder of WallStreetsBets Discusses Why The Group Unleashed Chaos On GameStop-And Why He’s (Really) Exiled From Reddit, Forbes (Jan. 28, 2021), https://www.forbes.com/sites/abrambrown/2021/01/28/founder-of-wallstreetbets-discusses-why-the-group-unleashed-chaos-on-gamestop-and-why-hes-really-exiled-from-reddit/?sh=2600c9d4211c.
[38] See Maggie Fitzgerald, Here’s what to expect from Thursday’s GameStop hearing with Robinhood, Citadel and Reddit CEOs, CNBC.com (Feb. 17, 2021), https://www.cnbc.com/2021/02/17/gamestop-hearing-what-to-expect-from-robinhood-reddit-and-citadel.html.
[39] See Kaissar, supra note 19.
[40] See, e.g., Mark DeCambre & Andrew Keshner, Is GameStop’s surge market manipulation by a mob of Reddit users, a savvy group of investors – or both?, MarketWatch (Jan. 31, 2021), https://www.marketwatch.com/story/is-gamestop-stock-being-manipulated-by-social-media-users-or-is-it-free-speech-legal-experts-weigh-in-11611636278.
[41] See, e.g., Jack Martin, New Class action against Robinhood alleges oligopoly manipulation, CoinTelegraph (Feb. 3, 2021), https://cointelegraph.com/news/new-class-action-against-robinhood-alleges-oligopoly-manipulation.
[42] See id.; See also Market Manipulation, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/glossary/market-manipulation.
[43] See Bruce Brumberg, Reddit and GameStop Lessons: Former SEC Enforcement Chief Explains Stock Manipulation and How to Avoid Trouble, Forbes (Feb. 4, 2021), https://www.forbes.com/sites/brucebrumberg/2021/02/04/reddit-and-gamestop-lessons-former-sec-enforcement-chief-explains-stock-manipulation-and-how-to-avoid-trouble/?sh=2a0fa8e92859.
[44] See id.
[45] See id.
[46] See id.
[47] Id.
[48] Id.
[49] Statement of Acting Chair Lee and Commissioners Pierce, Roisman, and Crenshaw Regarding Recent Market Volatility, SEC (Jan. 29, 2021), https://www.sec.gov/news/public-statement/joint-statement-market-volatility-2021-01-29.
[50] Id.
[51] See Bruce Brumberg, Investigations Into GameStop Trading and Former SEC Enforcement Chief Provides Insights, Forbes (Feb. 9, 2021), https://www.forbes.com/sites/brucebrumberg/2021/02/09/investigations-into-gamestop-trading-and-reddit-former-sec-enforcement-chief-reveals-insights/?sh=3d9d68f95efe.
[52] See Kelly Anne Smith, GameStop Post- Game: Congress, Regulators Probe Robinhood and Reddit, Forbes Advisor (Feb. 18, 2021), https://www.forbes.com/advisor/investing/gamestop-robinhood-investigations/.
[53] See id.
[54] See What happened this week, supra note 25.
[55] See Douglas MacMillan & Yeganeh Torbati, Robinhood and Citadel’s relationship comes into focus as Washington vows to examine stock-market moves, Wash. Post (Jan 29, 2021), https://www.washingtonpost.com/business/2021/01/29/robinhood-citadel-gamestop-reddit/; see also Kelly Anne Smith, supra note 52.
[56] See MacMillan & Torabi, supra note 55.
[57] See Smith, supra note 52.
[58] See, e.g., Chris Mills Rodrigo, Class-action lawsuit filed against Robinhood for restricting trading, TheHill (Jan. 28, 2021), https://thehill.com/policy/healthcare/536320-class-action-lawsuit-filed-against-robinhood-for-restricting-trading.
[59] Martin, supra note 41.
[60] Chris Dolmetsch et al., Robinhood users suing over trade limits face high legal bar, Yahoo! Fin. (Jan. 28, 2021), https://finance.yahoo.com/news/robinhood-customers-sue-over-removal-164733860.html.
[61] See id.
[62] Martin, supra note 41.
[63] Conscious Parallelism, Cornell LII, https://www.law.cornell.edu/wex/conscious_parallelism.
[64] Martin, supra note 40.
[65] See id.
[66] See Scott Eidler & Rachelle Blidner, Senate Democrats seek investigation of Robinhood online brokerage app, Newsday (Jan. 31, 2021), https://www.newsday.com/news/nation/robinhood-gamestop-stocks-schumer-1.50137176.
[67] See Lisa Lerer & Astead W. Herndon, When Ted Cruz and A.O.C. Agree: Yes, the Politics of GameStop Are Confusing, N.Y. Times (Feb. 18, 2021), https://www.nytimes.com/2021/01/31/us/politics/gamestop-robinhood-democrats-republicans.html.
[68] See Kelly Anne Smith, supra note 52.
[69] See id.
[70] See Matt Egan et al., Robinhood and Reddit in the spotlight during GameStop congressional hearing, CNN Bus. (Feb. 18, 2021), cnn.com/business/live-news/robinhood-gamestop-reddit-hearing-congress/index.html.
[71] See id.
