Robinhood, E-trading, and the Aftermath of the GameStop Frenzy

By Rose Woolson
2/16/2021

 Robinhood is an e-trading company famous for providing commission-free stock trading on a user-friendly smartphone application. The company launched the application in 2015 with the intent of making participation in the stock market easy and accessible to the average American. With this mission in mind, Robinhood currently boasts a valuation in the billions  and plans to go public sometime later this year. However, the company’s sharp rise to success has not been without controversary. Rather, Robinhood has faced several problems and criticisms in recent years. These issues range from frequent application crashes, to paying out millions to the SEC for misleading customers, and most recently as a result of the company’s decision to halt buying on “meme stocks” that rocked the financial market this past January. With Robinhood now facing a number of lawsuits in courts across the country, the story highlights the likely changes to come in the world of securities regulation.

Robinhood’s most recent struggle, and the foundation for the company’s pending lawsuits, began on January 11, 2021 when GameStop stock rose 13%. This would be just the beginning of a trading frenzy that would ultimately see GameStop’s stock hit a high of $483 dollars, a 1,587% increase in stock value from the beginning of the month to the end. Although GameStop was not the only company involved, as AMC, Nokia, Blackberry, and more were also subject to the unexpected market buying spree, GameStop certainly saw the largest uptick in stock price and was the most discussed.  

Central to this story is that of GameStop’s rise from near obscurity to hottest stock in a matter of weeks. GameStop is a company with primarily brick and mortar locations that sell video games across the United States. Although a popular store in years past, GameStop was among a handful of companies whose consistent losses and unpopularity resulted in many hedge funds taking large short positions against the company. In essence, these hedge funds were betting that GameStop stock would continue to plummet. However, interest in GameStop rose when the company announced the addition of three new members to its board of directors, particularly Ryan Cohen, the co-founder of the popular online pet store Chewy. Then, WallStreetBets, a popular subreddit trading page, discovered and promoted the huge short positions many hedge funds had taken in the company. Armed with this knowledge and the increasing confidence in the company because of its new directors, everyday traders started buying up the stock. Much of this trading took place on the Robinhood application.

Then, in the midst and height of the trading frenzy, Robinhood restricted all users from buying, but not selling, GameStop stock.  This move quickly made Robinhood the target of online abuse, with government officials and the public accusing the site of working with hedge fund bosses to protect the wealthy from massive losses. Robinhood has denied these claims and instead insisted that the company did not have the cash to support the trading. Tenev, one of the co-founders of Robinhood, tried to quell this mounting criticism by explaining the decision to restrict users from buying these meme stocks came down to the company’s obligations to post clearinghouse deposits. Despite this explanation, the company has been hit with dozens of class action lawsuits with thousands of claimants signing up to participate.

The various lawsuits against Robinhood all take some variation of the argument that Robinhood’s decision to halt trading on GameStop has harmed Robinhood investors and unfairly restricted access to the market. However, experts on securities law have highlighted that Robinhood’s customer and user agreements grant the company nearly unfettered rights in restricting users from buying, selling, and participating broadly in the trading of certain stocks. The company’s user agreement requires all customers to sign that they “understand Robinhood may at any time, in its sole discretion and without prior notice to Me, prohibit or restrict My ability to trade securities.” Such language seems to suggest that Robinhood’s decision to discontinue trading activities on the various meme stocks were squarely within the rights of the company.

Regardless of whether Robinhood legally could deny users the ability to trade on these stocks or not, for a company founded on the idea that it was bringing the complex world of stock trading to the everyday American, such public outrage could harm Robinhood’s profitability and ultimately the company’s survival. Now, Robinhood is devoting considerable resources, including running a Superbowl commercial, in an attempt to win back public support from the traders that built and inspired the company. However, Robinhood might not have too much to fear, as the company saw a considerable uptick in application downloads post-GameStop scandal.

Moreover, even if Robinhood escapes these lawsuits unscathed, the events of this past January will certainly have a lasting impact on the way e-trading companies, social media, the public, and hedge funds interact. The SEC has already promised to “closely review actions” by regulated companies that participated in restricting access to securities trading and politicians from Rep. Alexandria Ocasio-Cortez to Sen. Ted Cruz have expressed their dismay with Robinhood’s response to the rise in meme stocks. Moreover, a hearing on the matter is already scheduled for February 18, 2021 before the House Financial Services Committees. With such a large public outcry and a shared bipartisan condemnation of Robinhood’s actions, this will likely become a hot topic of law in the months and years to come. As such, it will be critical for investors, e-trading platforms, and hedge funds alike to keep abreast of new laws and developments in this area, as it would be hard to imagine that the status quo remains after the GameStop trading frenzy. Furthermore, the way hedge funds do business and interact with the public is also likely to see a change. Citron Research, a short seller of GameStop, has already announced that the company will no longer publicly publish their short-selling reports. If other funds follow suit, the trading landscape could see a dramatic shift ahead.