Following a volatile trading week, Robinhood now faces a class action after it restricted users from trading a handful of stocks—including those for GameStop. The lawsuit, filed in the Southern District of New York on January 28, 2021, alleges Robinhood “deprived their customers of the ability to use their service,” in an effort “to manipulate the market for the benefit of people and financial intuitions.” Just one day after filing, over 26,000 people had joined the proposed class.
GameStop’s Business Outlook
GameStop, a Fortune 500 brick-and-mortar video game retail chain, has faced a grim business outlook as consumers increasingly buy and download games digitally. Though the tides seemed to be turning in GameStop’s favor in August 2020 as Chewy founder Ryan Cohen revealed a substantial investment in the company. GameStop shares soared 179% in 2020 and analysts began to predict the company may avoid bankruptcy. But despite this upswing for the company, large institutional investors continued to short the stock—essentially betting on a downward stock trend.
But the real change came in mid-January 2021, when GameStop announced new board members with serious e-commerce industry chops, including Cohen.
Soon after the new board member announcement, amateur traders’ interest in GameStop stock took off. Large online trading communities—particularly Reddit’s WallStreetBets—drove investments through brokerage apps, most notably, Robinhood. Headquartered in Menlo Park, California, the class action defendant-Robinhood proclaims it is on a “mission to democratize finance for all.”
Meanwhile, institutional investors who shorted the stock saw massive losses. During the week of January 24, 2021, GameStop shares soared 400%, reaching more than $500 per share in pre-trading on Thursday, January 28.
Robinhood Pumps the Brakes
On that same day, Robinhood announced it had restricted GameStop trading and raised margin requirements for several stocks, including GameStop. Customers became enraged at the self-proclaimed “democratizing force” in the world of finance for shutting them down in the middle of a trading whirlwind. Following Robinhood’s announcement, GameStop’s stock was down 44% when markets closed on Thursday.
A second Robinhood announcement after Thursday’s closing said it would allow limited trading of GameStop. On Friday, GameStop stock recovered to $325 at market close. According to individuals involved in the negotiations, this second announcement hinged on Robinhood’s success in raising $1 billion from investors overnight to comply with federal capital requirements. The class action, however, was filed the day before Robinhood reinstated limited trading.
The Lawsuit Allegations
Plaintiff Brendon Nelson claims that Robinhood “has completely blocked retailer investors from purchasing GameStop stock (GME) for no legitimate reason, thereby depriving retailer investors of the benefits of Robinhood’s services.” The complaint states that on Thursday, January 28, 2021, Nelson could no longer find GME via Robinhood, causing him and many others to lose out on earning opportunities.
Nelson is suing Robinhood on behalf of the class for breach of contract and implied covenant of good faith and fair dealing. The complaint also lists negligence and breach of fiduciary duty causes of action.
Class Action Chances
This will be a class action to watch. Legal scholars have cast doubt on the success of this class action, pointing out that the Robinhood user agreement allows the company to block, cancel and restrict transactions—even delete user accounts. Further, the 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.” Though other experts say the user agreement doesn’t necessarily apply to Robinhood’s actions here, citing a successful 2020 class action against Chime Bank involving a service outage for bank customers.
Robinhood Under Scrutiny
The Robinhood debacle has caught the attention of the nation, including Congress and official market watchers. It seems likely there will soon be federal inquiries into what happened during this wild week for Wall Street and how Robinhood may have contributed to the losses. Representative Ro Khanna of California, who sits on the House Oversight Committee, told Market Watch this “episode reveals deep flaws in the U.S. financial services industry that require investigations by Congress, regulatory action and potentially new legislation.”
Many see this as a David and Goliath story where small investors influenced by social media drove stock prices up, hurting the Wall Street titans who normally make money by betting companies will fail. Another opinion is that this sudden scrutiny will reveal that professional investors played a role in pumping up the value of GameStop and other stocks with heavy trading on Thursday, January 28, 2021. Yet another prediction is that the young, amateur investors who jumped on the social media-fueled bandwagon may face greater scrutiny and potentially more official oversight. This may prompt even more lawsuits as the smoke clears.