Cases Allege Online Conspiracy ‘Bigger Than Robinhood’
Back in June, the parents of University of Nebraska student Alexander Kearns found an ominous note on his computer: “How was a 20-year-old with no income able to get assigned almost a million dollars-worth of leverage?” Earlier that day ‒ June 12 ‒ a despondent Kearns had taken his own life after logging into the online brokerage app Robinhood and viewing the balance on his account: negative $730,165.
Online brokerage firms including Robinhood, Charles Schwab, E*TRADE and more than a dozen other free or low-cost brokerages, hedge funds, and clearinghouses are fast becoming targets of class-action lawsuits. These cases are crying foul regarding trading restrictions imposed after stock prices for heavily shorted companies such as GameStop shot up, fueled by young day traders who took advantage of the well-publicized “short squeeze.”
Robinhood, the app popular with retail investors and online day traders, currently faces at least “46 putative class actions and three individual actions” related to the trading restrictions placed on the brick-and-mortar video game retailer GameStop last month. In a recent regulatory filing, Robinhood disclosed information requests from federal prosecutors, the Securities and Exchange Commission, states’ attorneys general and various financial regulators regarding the firm’s decision to restrict trading in stocks involving GameStop.
According to the filing, the Financial Industry Regulatory Authority (Finra) and the SEC are investigating Robinhood’s trading platform and how information about options trading and cash positions is displayed to customers, nothing new for the firm. In December, Robinhood paid a $65 million fine to settle SEC allegations the firm misled customers about the actual costs associated with trading and made money at the expense of its customers. Robinhood did not admit or deny the SEC’s findings.
Research has found that the more actively small investors trade stocks, the worse the outcome, even more so when they move into stock options. A few minutes can mean the difference between winning and losing thousands of dollars, particularly on Robinhood, where an unusual number of technology issues and a lack of technology to support customers have been reported, according to some of the firm’s employees. Scott Smith, who tracks brokerage firms at consulting firm Cerulli, recently told The New York Times, “They [Robinhood] encourage people to go from training wheels to driving motorcycles. Over the long term, it’s like trying to beat the casino.”
Robinhood’s technical issues may well have played a role in Kearns’ death. The company has suggested that the figure did not represent Kearns’ actual indebtedness but instead a temporary account balance due to incomplete trades. The Kearns family has filed a wrongful death suit against Robinhood.
Robinhood was founded in 2013 with financial backing from several Silicon Valley firms and promised no fees for trading or account minimums. Approximately half of Robinhood’s customers are first-time investors, and like Kearns, many of them are young – their average age is 31. Their youth, combined with a general lack of investing experience, could be putting them at greater risk for overwhelming losses. Some disgruntled investors have even gone to the company’s Menlo Park, Calif., headquarters to confront staff concerning their losses, prompting Robinhood to install a glass barrier at the company’s front entrance.
While legal experts say the odds that these lawsuits will overcome a motion to dismiss could be somewhat long, this is likely just the beginning of short squeezes arising from social media chatter.
“This is the first time that anybody ever really fought back,” Tom Gorman, partner at Dorsey & Whitney, recently told Investment News. Noting that hedge funds will probably keep that in mind for some time, Gorman went on to say, “That changes the dynamic about what happens with some of these [public]companies that are in difficult financial positions.”
Gorman said that as a result of the recent events, more people than ever will likely be trading stocks, for better or worse. “This is the beginning of a new segment in the market,” he said.