Robinhood’s Fall From Hero to Zero Amidst the War Against Wall Street

How the once beloved trading app betrayed their users, and is now facing a class action lawsuit for market manipulation

But is it fair? Let’s find out. Hi Ms. Wheatley, you’ve probably heard about the stock market saga that has been making headlines throughout the week; the meteoric rise and fall of the GameStop stock, Reddit users banding together and taking on Wall Street’s biggest hedge funds, and how Robinhood sparked anger from Tesla CEO Elon Musk, U.S. Representative AOC, and millions of everyday investors across the world.

In fact, the popular stock trading platform Robinhood—known up until recently for their “let the people trade” mentality through being the first to introduce commission-free trading, are now facing a class action lawsuit after they’ve restricted traders from buying shares of GameStop promoted by WallStreetBets, a popular Reddit group for investors. The lawsuit claims that Robinhood’s actions illegally manipulated the market against its users.

So, will the people win this lawsuit? What are the consequences that Robinhood are facing? What even is a class-action lawsuit? Before we get to these questions, let’s take a look at what exactly led us to this point in history.

The Origins

As you probably know, GameStop is a retail gaming company that has been slowly declining in sales, as more people resort to online downloads instead of buying games in-person. As a result, hedge funds and large institutional investors felt that the price of the company was overvalued, and that eventually—GameStop would face the same fate as Toys”R”Us and Blockbuster, which had to file for bankruptcy.

So those big institutional investors shorted the company, essentially betting that its stock price would go down. However beginning last year, GameStop had a series of surprisingly positive news that began driving up the price of the stock as investors began to believe that maybe things could turn around. This included a 519% jump in online sales, the billionaire co-founder of Chewy acquiring a 9% stake in the company, and a new multi-year deal with Microsoft.

At that point, a user on Reddit’s WallStreetBets discovered that large institutional investors actually shorted more shares than what exists on the market, with a staggering 138% of tradable shares being held short. This meant that there weren’t possibly enough shares on the market to buy, in the event that the stock price begins going up. Now you might be wondering: How on earth are you able to short more stocks than even exist on the market?

Well, anytime you short a stock, you’re actually borrowing it from Person A, and then immediately selling it to Person C, with the expectation of being able to buy it back from Person C in the future at a cheaper price, so that you can eventually give it back to Person A while you profit the difference in profit. But shares like this can actually be borrowed multiple times. There’s nothing stopping Person C from loaning the stock to Person D, who also wants to short the stock by loaning it to Person E, etc. This continues while the same stock is shorted multiple times, transferring from one person to another, until eventually more stocks are shorted than actually exist for sale.

The Revolution

The Reddit community saw this, and they knew that the good news combined with the increased demand to buy the stock would cause a lot of these institutional short sellers to lose money. When hedge funds are unable to find enough shares to buy, so that they can return it to whomever they borrowed it from, they would be forced to pay at whatever price the market would want. However, the hedge funds caught on to this, and they saw the stock price rising up. So they doubled down, sunk billions of dollars into an even heavier position to stay afloat, creating this game of “who sells first?”; individual investors who could potentially make billions of dollars, or hedge funds which could go bankrupt.

Now due to this unique situation, there’s been a few serious implications for us—the retail investors, that we’ve never seen before. First, the trading of these trending stocks have been halted multiple times, due to “extreme volatility”. This happens when stocks increase so much, so quickly, that it completely detaches from the company’s fundamental value. When that happens, the New York Stock Exchange has the right to temporarily suspend trading to give investors some time to cool off. Turns out, trading for GameStop was halted for volatility 9 times on Monday and 5 times on Tuesday.

But, where do you draw the line between everyday investors recognizing a market inefficiency in a public forum for everyone to see, and market manipulation? This is going to be extremely difficult to regulate, because it becomes impossible to figure out where to draw the line, and at which point you’re liable for what you say online. Is it based on the size of their audience? Is it based on their influence? If everyone collectively agrees on a certain sentiment, who is to blame? Is it the person who started it? Or do you go after the entire group, or maybe the website the group is hosted on? Then once you go beyond that, how do you actually prove damages, or intentional wrongdoing? What if you just happen to like the stock? It’s probably going to be a very lengthy battle if they try to regulate what someone can and cannot say in a public forum about their investments.

The Intervention

Secondly, what about Robinhood and their alleged price manipulation? Robinhood restricted their users from being able to purchase certain stocks— only allowing them to sell their positions, thereby inadvertently causing the price for those stocks to drop substantially. That completely eliminates the natural function of the stock market, where people are free to buy and sell a stock for whatever they feel its worth. Because of this, users are alleging that Robinhood is guilty of price manipulation, as defined by the SEC.

1. Intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the prices of securities, or

2. Intentional interference with free forces of supply and demand

3. Can be designed to drive a stock’s price up or down

Even the SEC says that this affects the integrity of the entire stock market, and investors are going to be less likely to participate if they feel that the market is rigged against them. Instead, the price of the stock should be determined by the collective judgement of the buyers and the sellers. This is the reasoning behind the class action lawsuit against Robinhood, claiming that they’ve halted orders in order to slow growth and bail out their larger institutional partners—not their customers, to whom they should owe fiduciary duty to.

After the market closed, Robinhood responded by saying that this was done as a financial requirement to meet SEC net capital obligations and clearing house deposits, as well that this decision was “not made on the direction of any market maker we route to or to other market participants”.

The Corruption

So why does no one believe Robinhood’s response? Mainly due to Citadel, who routes Robinhood’s order flows. Here’s how it works: When you place a trade on Robinhood, they’re not the ones that executes that trade, instead they instantly outsource it to Citadel, who pays Robinhood for the right to execute your trade. But Citadel recently lent $2.75 billion to Melvin Capital, who is on brink of bankruptcy because they had shorted GameStop, lost $13 billion, and the stock wasn’t going down.

Many people argue that this is a conflict of interest and blatant price manipulation to protect Citadel, who loaned money to Melvin Capital, who is losing money because of WallStreetBet traders buying GameStop stock on Robinhood.

What is a Class Action Lawsuit?

A class action lawsuit is a legal action filed by more than one individual against a single defendant. It’s designed for situations in which several people have suffered similar injuries as a result of a defendant’s actions.

Class action lawsuits are often filed against government agencies, financial institutions, retailers, or employers. Most of the time, they are brought by one individual on behalf of many people, with one plaintiff representing the entire class. Class actions are often lengthy, complicated and multinational cases.

In Canada, class actions were first established in Quebec in the 1970s, followed by Ontario in 1993. Nowadays, all provinces except P.E.I. have a class action procedure.

How do Class Action Lawsuits Work?

Class actions are initiated through 2 ways: An individual seeks out a law firm with a complaint of harm, or it’s law firms that determine there’s a problem and seek out class members who’ve been affected.

Once initiated, a lawyer files a class action lawsuit on behalf of the party, and looks to receive certification from a judge. Through a certification hearing, the court must certify the proceeding as a class action, as well as approve a representative litigant and the parameters of who is a member of a class.

The members are notified after the class has been certified. They’re all automatically included in the lawsuit unless they opt out. Most class action suits don’t proceed to trial, and instead a settlement is agreed upon. Each plaintiff receives a portion of the settlement, which can consist of cash, refunds or some other compensation.

Who’s in the Class?

“It’s a common misconception that you have to sign up or register to be part of a class, but Canada has an opt-out system”

You don’t have to do anything to join a class action—if you fit within the court’s definition of the class, then you’re automatically included, unless you follow the instructions the court gives on how to be excluded. However, in order to assist the lawyers representing the class, it is very helpful to provide details and information. If the class action is successful, you will need to file a claim in order to receive any compensation.

What Does it Cost to be a Class Member?

Nothing! Financial responsibilities for a class action are taken by the law firm, meaning class members don’t have to pay lawyer fees nor are they financially liable if the class action is not successful. However, should the plaintiffs win, the law firm and lawyers gets paid a percentage of what the class wins.

Pros and Cons of Class Action Lawsuits

Several benefits of class actions include the fact that the cost of litigation is significantly reduced, plaintiffs who would’ve otherwise received nothing due to high attorney costs have a chance to receive compensation, all members of the party are treated consistently, and larger classes will motivate defendants to settle, since there are many plaintiffs.

Disadvantages include the fact that plaintiffs cede their rights to sue individually, individual class members may receive a small amount as compensation—while the law firms receive a substantial portion, the quality of the legal representation affects all members of the class, and class action lawsuits are complicated and often take several years to even reach a settlement.

Class Action Against Robinhood

Robinhood’s actions were done purposefully and knowingly to manipulate the market for the benefit of people and financial institutions who were not Robinhood’s customers

A Robinhood customer filed a class-action lawsuit against the stock-trading app Thursday after the company restricted its users from buying shares of GameStop, AMC Entertainment, and other stocks promoted by Reddit’s WallStreetBets community. The lawsuit, filed in the Southern District of New York, claims that Robinhood purposely manipulated the market.

Thousands of investors are using an online service called DoNotPay.com to automatically join this class action. By Friday afternoon, around 26,000 people had joined the class action, 4,000 had filed complaints with the SEC and 400 had entered arbitration through DoNotPay. The users detailed their losses, specifying exactly when their trades were halted, and forwarded the information to the law firm representing the class action.

Will the People Win?

Unfortunately, probably not. Robinhood’s terms of service provide them the right to block, cancel and restrict transactions, delete user accounts, and even includes an arbitration clause. Robinhood’s user agreement states it “may at any time, in its sole discretion and without prior notice to Me, prohibit or restrict My ability to trade securities.”

However, a positive that came out of Friday was the SEC seemingly siding with the everyday investors, stating:

“The Commission is working closely with our regulatory partners … to ensure that regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing.” “We will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws.”

It’s not looking good for Robinhood either. Whether or not their founders will face criminal charges, it’s clear that their 7 year ride towards an IPO has been destroyed, after angering millions of investors across the world. In just several hours, they’ve received over 100,000 one-star reviews on the Google Play Store, and users are leaving the platform in the masses.

So… Is This It?

Absolutely not! There have been reports that Citadel have in fact reloaded their shorts before telling Robinhood to halt trading of GameStop stock. In that case, there would be clear evidence that Robinhood has indeed participated in market manipulation, meaning the Citadel and Robinhood founders could be looking at potential jail time.

As Justin Kan, Co-Founder of Twitch put it, the SEC should investigate the following:

1. Did Citadel’s hedge funds (Citadel Global Equities and Citadel Wellington) hold any short positions in stocks heavily owned by Robinhood users? And did they increase them in the past few days?

2. Subpoena all emails and phone calls between Citadel Securities and Robinhood

3. Subpoena all emails and phone calls between the Wall Street banks and Robinhood (Robinhood gives its shares to Wall Street banks to lend out to hedge fund clients to short through prime brokerage).

4. Did the Wall Street banks communicate with Robinhood to stop trading GME otherwise they’d cut them off from their short borrow revenues?

5. Subpoena all emails and communications between the hedge funds who were taking huge losses who are investors in Robinhood (example: D1 Capital. D1 was down $4bn on its shorts and only has $200mn investment in Robinhood.

What stands out about this historic event is that many of the retail investors and supporters involved know little to nothing about the stock market and investing, but simply want to see justice being served. They’re willing to put their money towards a movement that’s fighting against the corruption that takes place in Wall Street everyday, to save their fellow investors who might’ve been just looking to pay off their student loans or pay for their parents’ medical bills.

That’s why giving these hedge funds a slap on the wrist isn’t enough, a $10, $50, even $100 million fine wouldn’t be enough, if the maneuver that Robinhood pulled with Citadel in fact saved them billions of dollars. The people want justice being served, and the beauty is that they’re putting their money where their mouths are—contrary to what Robinhood was capable of.