Robinhood Markets, a free, online stock trading platform, is under scrutiny for its role in the recent market volatility involving stocks such as GameStop Corp. and AMC Entertainment Holdings Inc. The company has been hit with lawsuits and potential regulatory enforcement after it halted trading in 11 stocks after their stock prices skyrocketed.

If you have been following the news, you are likely aware that a group of everyday investors recently united on social media to send GameStop’s stock price soaring to astronomical levels, climbing a staggering 1600 percent in the month of January. The high trading volume caused significant losses for hedge funds and other firms that bet the stock price of the struggling company would continue to fall. The market volatility rattled Wall Street and ultimately caused Robinhood to temporarily halt trading. The platform’s users were furious that they were shutout from buying the hot stocks and capitalizing on potential gains, while hedge funds continued to buy and sell shares.

Robinhood Defends Actions

While many have speculated that Robinhood restricted trading in GameStop to protect its hedge funds partners, the company maintains that it was actually protecting its own interests. On January 28, 2021, Robinhood released a statement on its blog and social media. The company defended its decision to restrict trading, citing its regulatory obligations. It wrote:

Amid this week’s extraordinary circumstances in the market, we made a tough decision today to temporarily limit buying for certain securities. As a brokerage firm, we have many financial requirements, including SEC net capital obligations and clearinghouse deposits. Some of these requirements fluctuate based on volatility in the markets and can be substantial in the current environment. These requirements exist to protect investors and the markets and we take our responsibilities to comply with them seriously, including through the measures we have taken today.

SEC Statement on Market Volatility

The Securities and Exchange Commission (SEC) also released a statement, although it did not mention any of the entities by name. Instead, the SEC stated that it was “evaluating the extreme price volatility of certain stocks’ trading prices over the past several days,” noting that it “has the potential to expose investors to rapid and severe losses and undermine market confidence.”

SEC Acting Chair Allison Herren Lee further stated that the agency is working closely with its regulatory partners, including FINRA and the stock exchanges, to “ensure that regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing.” She added:

The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities. In addition, we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws. Market participants should be careful to avoid such activity. Likewise, issuers must ensure compliance with the federal securities laws for any contemplated offers or sales of their own securities.

Congress Scrutinizing Robinhood for Conflicts of Interest

Members of Congress on both sides of the aisle have called for investigations into Robinhood’s handling of the recent trading turmoil. "The public deserves a clear accounting of Robinhood's relationships with large financial firms and the extent to which those relationships may be undermining its obligations to its customers," Sen. Elizabeth Warren wrote in the letter to Robinhood CEO Vlad Tenev.

In her letter, which copied the SEC and FINRA, Sen. Warren asked Robinhood to describe its relationship with Citadel Securities, a hedge fund that serves as a market maker for Robinhood. Warren also wants to know whether the trading platform held any talks with Citadel Securities (or its affiliates) before deciding to restrict purchases of GameStop. Warren also asked Robinhood to provide information regarding what user data it shares with Citadel Securities and how much money it makes from the relationship.

The House Financial Services Committee has also called Tenev to testify at a hearing on the recent market volatility. The hearing is scheduled for February 18, 2021.

Key Takeaway

At this point, it is still unclear if Robinhood will face legal liability for violating securities regulations and/or consumer protection laws. It will likely come down to whether the company placed the interests of its corporate partners ahead of its users. To defend its actions, the startup will likely have to provide further details regarding the decision-making process that precipitated halting GameStop trades and disclose the nature of its relationship with Citadel Securities and other financial backers. Robinhood must also take steps to rehabilitate its reputation as a platform for the “little guy” to participate in the stock market.

If you have questions, please contact us

We will monitor developments involving this situation and provide future updates or alerts. If you have any questions or if you would like to discuss these issues further, please contact me, Dan McKillop, or the Scarinci Hollenbeck attorney with whom you work, at (201) 896-4100.