Can investors bring a claim against Robinhood and other self-directed platforms for the recent purchase restrictions on GameStop, AMC, and other securities? The internet is buzzing with talk of class action lawsuits. Our office is fielding inquiries. But – from a claimants’ attorney perspective – there are high hurdles to overcome.
The securities trading platform Robinhood is under fire – again. In December 2020, the trading platform agreed to a cease-and-desist order from the SEC, based on allegations of misleading customers regarding order execution quality and the hidden higher costs to its users compared to other broker’s prices. Robinhood agreed to pay a $65 million civil penalty as part of that agreement.
Now, retail investors are slamming Robinhood, TD Ameritrade, and other platforms for restricting purchases of GameStop, AMC, Nokia, Blackberry, and other securities. A significant portion of the news reporting this week has addressed various brokerage firms’ refusal to accept orders on those securities, and whether there’s any sort of recoverable loss associated with the refusals. Legislators are posting on Twitter and demanding explanations in support of angry investors, and the SEC is “monitoring” the situation.
There’s a lot going on, and no single answer to the question.
Share values have zoomed upwards over the past few days. Notably, this isn’t a total restriction on all trading of these shares. The platforms still allow sales. Given that the trading price surge is apparently due to retail investors rallying to snub institutional investors (like hedge funds) who have been shorting these companies, and thus profit off of falling stock value, this limited trading restriction appears to benefit the Goliaths over the Davids. The prohibition of buy orders, and allowance of sell orders, has naturally driven the stock prices down, thereby protecting those who shorted the stocks.
Isn’t this “market manipulation” by the platforms, for the benefit of the institutional Goliaths?
The restrictions have an effect on the market – but whether or not it was unlawful “manipulation” with recoverable damages will likely be played out in the courts. Here are five hurdles off the bat for retail investors wanting to sue these platforms:
First, the stock exchanges are also restricting trading activity. For example, the New York Stock Exchange instituted a number of temporary trading halts on GameStop and AMC. The halt is imposed, orders build, and when trading opens, the execution of the pent-up orders serves to move the stock price to a degree that triggers yet another market-based trading halt. The NYSE is allowed to impose halts under a number of different regulatory rules. There’s likely no wrongdoing there.
Second, some of the refusals are coming at the hands not of the brokers, but their clearing firms. The president of WeBull has gone on record as saying that his clearing firm shut down the trading in those securities. And to bolster the argument, the user agreement you signed when you opened your account probably had you expressly acknowledge and agree that the platform isn’t liable if a third-party clearing firm is causing the problem.
Third, for Robinhood, the very nature of their structure makes it difficult to fill orders on highly volatile stocks. Your user agreement probably has language that says the firm will not actually accept traditional market orders. Rather, every “market” order is really a limit order, to be filled at a price up to 5% higher than the last traded price. Thus, if the stock price is moving upward quickly, it’s possible if not outright likely that the price will never be within that 5% band, and the order will therefore never fill.
Fourth, if you’re trading on margin, the brokerage firms can and have tightened margin restrictions on highly volatile stocks. Where you might have to maintain a 50% cushion for some securities, the restriction for these securities is now far higher. It makes sense. Firms aren’t willing to loan money to buy super volatile securities. You would be hard-pressed to win a claim that the decision to not extend margin in these circumstances is an unreasonable decision. By tightening margin requirements, the firms can shut down trading without actually shutting it down.
Fifth, these account contracts generally allow the brokerage firm to use its discretion to decline trades. A quick look at Robinhood’s user agreement finds language “I understand Robinhood may at any time, in its sole discretion and without prior notice to Me, prohibit or restrict My ability to trade securities.” Contractual terms may be challenged for various reasons, and the SEC can prohibit regulated firms from certain exculpatory and other types of language. But broadly speaking – this kind of authorization to refuse trade instructions tends to hold up.
Online brokerage firms are also required to make commercially reasonable decisions and potentially reject trade instructions that don’t line up with an account’s trading objectives. Meaning, if you have marked a “moderate” risk tolerance for your account, the firm should theoretically reject a trade in AMC or GameStop since those trades under current conditions are beyond speculative.
What are the damages?
Finally – even if there are potential private causes of action for retail investors to sue the platforms for restricting purchases, there may be a high hurdle to cross regarding determining what damages may be recoverable.
Assuming that share prices keep going up, even if the firm should not have rejected your trade instruction, could you recover damages? The problem there is that the damages calculation is very speculative. Your complaint is that you couldn’t buy the stock at “X” price. Unless you have strong documentary evidence that you had the intent and ability to buy “Y” number of shares, your word alone may not be enough to carry your burden of proof. Equally problematic is the issue of when you would have sold the securities. It is highly unlikely that a court, jury, or arbitration panel is going to believe that you would have magically sold at the high point before the stock inevitably crashed to the appropriate valuation. Once again, you’d have to prove the date, price, and amount of shares you otherwise would have sold.
How about an argument, once the share value starts dropping, that the platforms’ trading restrictions caused a market drop? A drop in share value is a likely effect of the restriction. But does that mean the platform should be responsible for investment losses? Even assuming it was a violation of law for the platforms to put the purchase restriction in place, and that the restriction was proved to be the cause of losses, damages calculations are still a speculative moving target. If you can still sell your shares, the defense becomes that you failed to mitigate your losses by not selling when you could.
These problems inherent in calculating damages could be strong arguments to defeat an attempted class action case.
There are, of course, other harms caused by wild market volatility and trading platform restrictions. Public confidence in our securities industry erodes when it looks like the rules and regulations meant to protect the Davids out there are doing more harm than good. However, as should be clear now, securities regulation is incredibly complicated and can’t respond on a dime.
Based on current publicly available information, it is difficult to see a path forwards for recoverable claims by retail investors against self-directed platforms relating to the purchase trading restrictions of these securities. That situation may change as more information becomes available. More likely is that we’ll see regulation that addresses these issues and tries to ensure that pricing anomalies like these don’t happen again.
However, if a FINRA-registered broker-dealer recommended and sold you the stock, depending on the circumstances of the sale, your investment objectives and risk tolerance, and other factors, you may have a claim against the broker-dealer for your investment losses. If you have questions about your investments feel free to call us or use our online inquiry tool. We’ll be happy to speak with you and and see if we can offer assistance.
Darlene Pasieczny is a fiduciary and securities litigator at Samuels Yoelin Kantor LLP. She represents clients in Oregon and Washington with matters regarding trust and estate disputes, financial elder abuse cases, securities litigation, and appellate cases. She also represents investors nationwide in FINRA arbitration to recover losses caused unlawful broker conduct. Her article, New Tools Help Financial Professionals Prevent Elder Abuse, was featured in the January 2019, Oregon State Bar Elder Law Newsletter.