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Legal Blowback After Robinhood Halts Trading of Certain Stocks
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Legal Blowback After Robinhood Halts
Trading of Certain Stocks
The financial crisis of 2008 rocked financial
markets and triggered a regulatory response that changed banking forever.
Lawmakers around the world created new financial consumer protection and
banking oversight policies that imposed extensive data collection, management
and reporting requirements on financial institutions. Financial regulators
quickly followed suit by passing new rules to implement these laws. These
included the extensive General Data Protection Regulation in Europe, as well as
the growing field of Know-Your-Customer laws worldwide, which laws require
financial firms to collect, track and monitor massive quantities of personal
digital information.
In the United States, the centerpiece of the
federal response to the crisis was the passage of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, which introduced a slew of regulations to
solidify the securities and credit markets. The uncertainty that has come with
the regulatory changes and oversight has simultaneously upset market positions
within securities trading and provided new opportunities for upstarts in the
trading space.
Robinhood Markets, one such upstart, has been
grabbing headlines consistently over the past few months. Many of these stories
have revolved around the platform's disruptive impact in the environment of
securities trading and how regulators are reacting.
Over the past decade, financial
technology has revolutionized banking, securities and commodities
marketplaces by making securities transactions easier and easier for more and
more people. While this has opened exciting new opportunities for innovation,
it has also sowed the seeds of chaos. As technology and financial markets come
together, groundbreaking opportunities arise, but cultures also clash. New
technologies disrupt marketplaces, and disruption is seldom well-received in
the worlds of finance and securities.
Founded in 2013, Robinhood is a platform that
has established a multibillion-dollar valuation by introducing millennials to
equities, options and securities trading. In addition to traditional
securities, Robinhood users have the option to trade in nontraditional
commodities, like cryptocurrencies. Because Robinhood was able to offer
brokerage services on a commission-free basis, the startup was able to capture
substantial market share from the likes of Charles Schwab and TD
Ameritrade.
Robin Hood is a prime example of a financial
technology startup that has been able to ride the waves of a shifting
securities regulation environment in a manner that has broken new ground in
trading practices. Like many groundbreakers, however, Robinhood has not been
free from scandal. In December of last year, the Securities and Exchange Commission
charged Robin Hood for alleged repeated misstatements to customers that
included a failure to accurately disclose revenue sources. The agency's order
found that Robinhood’s claim that trading on the platform was “commission-free”
and that its services matched or beat its competitors’ was misleading because
the platform’s other costs were substantially higher than those of other
brokers.[1]
The regulatory action against it has placed
Robinhood under increased scrutiny regarding how the platform executes, clears
and settles trades. This scrutiny came to a head just days ago in its
controversial decision halting sales of securities such as GameStop and AMC and
decisions with regard to other stocks.
In late January, after GameStop had been
heavily bet against by some big Wall Street hedge funds, members the Reddit
community “WallStreetBets” decided to buy the stock and thus push its stock
higher. Hedge funds that had sold the company short were forced to cover their
losses by buying the surging stock, pushing its price even higher.
GameStop shares had skyrocketed from under
$20 as late as January 12 to as high as $483 on January 28.
Robinhood deemed Gamestop and other stocks
which were being driven into a frenzy by news and rumors circulating across the
web and social media as “meme stocks.” On January 28, it made the unprecedented
move of preventing prevent its users from purchasing shares in GameStop, Bed
Bath & Beyond, American Airlines, Koss Corp and other popular companies.
Users on the Robinhood platform were able to sell positions in these companies
but could not purchase shares.
The decision sent shockwaves across the
markets and has since elicited a reaction that is leaving investors and
regulators alike scratching their heads over the future of both the Robinhood
platform and the securities traded through it.
Robinhood justified its action as necessary
to solve technical challenges regarding maintaining deposits with
clearinghouses in a manner that complied with existing
regulations.[2] Still, the platform has lost the trust of much of its
userbase of small investors by preventing them from trading freely on the
market. Calling the move “highly unusual and concerning,” some experts have
alleged that the decision was made in order to benefit big Robinhood clients
rather than out of necessity.[3]
Lawsuits have been filed by Robinhood users,
one such plaintiff alleging that he was “unable to get fair market value for
his options contracts and the manipulation has caused the price of” the stock
to fall.[4] These lawsuits, however, will face the general challenge that
allows brokerages broad discretion in limiting trades to handle unusual
situations and the specific challenge that Robinhood’s customer agreement
clearly states that it can suspend trading at any time.[5]
Moreover, few securities rules exist to this
date that directly govern the abilities of trading firms to stop trading.
Senator Elizabeth Warren of Massachusetts has written Robinhood to demand
explanation of Robinhood’s decision.[6] While her letter cited many
concerns, including Robinhood’s being unduly influenced by its biggest
customers, the purported unfairness of the arbitration clause in its terms of
use, its history of regulatory trouble and the genuineness of Robinhood’s
explanation as to its motives,[7] the letter did not cite a single federal
statute or securities regulation.
Lawmakers are poised to look into the matter
and have scheduled hearings to uncover the causes behind the events of late
January. Robin hood's CEO, Vlad Tenev, is expected to testify before the House
Financial Services Committee on February 18. There is almost certain to be
fallout from the questions Tenev will have to answer.
While the contours of how Congress and the
SEC will react are to be determined, it seems clear that congressional and
regulatory actions will be taken to ensure that any repeat of what happened to
Gamestop and the others will be more carefully regulated and scrutinized in the
future.
[1] https://www.sec.gov/news/press-release/2020-321
[2] https://blog.robinhood.com/news/2021/1/28/an-update-on-market-volatility