The Quick Version
Robinhood, TD Ameritrade, and other online platforms have prevented retail investors from entering buy orders in Gamestop, AMC, Nokia, Blackberry, and other securities. Those investors are understandably angry at missing out on the opportunity to buy and ride the stocks up (presuming they were to continue to climb in price). Do the firms have the right to refuse the orders? Have the investors suffered compensable losses?
There are no quick or easy answers. In short, the exchanges themselves shut down trading off and on for these securities. In other instances, the clearing firms shut down the trading. Accordingly, the inability to process an order may have had nothing to do with the brokerage firm. Where the firms themselves shut down trading, the opening account documents typically gave them the power to do so at their discretion.
We’re not aware of any evidence the firms abused their discretion. But, presuming there is such evidence, proof of damages could well be an insurmountable hurdle in prosecuting a claim. We believe that an investor would have to show written proof of their intent to buy a security on a certain date and time at a certain price, and written proof of their intent to sell those shares at a date, time, and price. We do not believe that any arbitrator, judge, or jury would take an investor at their word that they lost money because they would have traded if they’d only had the chance.
While we understand a lot of people are angry at what’s happened with the online brokerage firms, we don’t currently see a viable claim to be brought. For a more thorough explanation of our thought process, read on:
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 singular 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 are at least currently still allowing sales. Given that the trading price surge appears to have been in large part 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.
Can investors take action against the platforms for the purchase restriction? 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.
But isn’t this “market manipulation” by the platforms, for the benefit of the institutional Goliaths?
We see five hurdles for retail investors wanting to sue these platforms:
First, not all of the refusals to execute trades are the result of the firms’ refusal to accept buy orders. The New York Stock Exchange has instituted a number of temporary trading halts on the securities. If you look at the NYSE’s web page, you’ll see that it has continued to shut down trading for both GameStop and AMC and it seems that trading in those securities is open for only a few minutes at a time. 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 cycle shows no signs of stopping. The NYSE is allowed to impose those halts under a number of different regulatory rules. There’s 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 account probably had you expressly acknowledge and agree that the brokerage firm isn’t liable if a third-party clearing firm causes the problem.
Third, for Robinhood, the very nature of their structure makes it difficult to fill orders on highly volatile stocks. If you review the contract you signed with them to open your account, you’ll see 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 have tightened margin restrictions on highly volatile stocks, and GameStop, AMC etc… are no exception. 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, consider the contractual agreements that users of these online platforms must agree to when opening accounts. These 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.
Beyond this argument that users authorized the platform to refuse a trade order, for any reason, online brokerage firms are still 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 and are instead pure gambling.
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. Investors are understandably angry that they can’t buy shares, and are losing the opportunity make money (presuming that unfettered buying will only continue to drive the stock price up). But, even if the firm should not have rejected your trade instruction, can you recover damages? The problem there is that the damages calculation is purely speculative. Your complaint is that you couldn’t buy the stock at “X” price. Unless you have documentary evidence that you had the intent and ability to buy “Y” number of shares, you’d have to ask the arbitrators to take your word for it that you would have bought in at a certain price. Equally problematic is the issue of when you would have sold the securities. No 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 have something in writing to show that you would have sold on date “X” at price “Y.” The problems inherent in calculating damages could also well serve 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 that are supposed 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. Current market movements on GameStop, AMC, and these other stocks have nothing whatsoever to do with investing, and everything to do with emotion and gambling. We believe that it’s almost certain we’ll see regulation that addresses these issues and tries to ensure that pricing anomalies like these don’t happen again.
If you’re reading this because you feel like you fell victim to the trading in these stocks, know that you have our sympathies. We’re sorry you suffered the experience you did, and we do wish there was something we could do to help. We don’t currently see a viable claim to be brought, so we simply offer the explanation above and hope that it allows you to avoid similar issues in the future.
If you have other questions about your investments, please do not hesitate to reach out to the securities litigators at McCarthy, Lebit, Crystal & Liffman Co., LPA. We’ll be happy to speak with you about your situation and determine whether we can offer our assistance.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.