Platform Faces Scrutiny For Trading Freeze
Last week, we shared an article about the potential exposure that some investors may have in the GameStop saga as investigations into whether an illegal “pump-and-dump” had occurred were in the news. This week, we look at another side of the coin: whether Robinhood, an app and trading platform, faces any potential exposure for its decision to prevent users from trading GameStop and several other stocks (other than to close out their position) for several hours.
Robinhood CEO Claims Stock Freeze Was Due To Regulatory Requirements
Various motivations for Robinhood’s decision have been speculated about in the media, ranging from explanations that Robinhood’s hands were tied to conspiratorial accusations that Robinhood was influenced by institutional investors. Robinhood CEO Vlad Tenev told Yahoo! Finance that “[o]ur decision to temporarily restrict customers from buying certain securities had nothing to do with a market maker or a market participant or anyone like that putting pressure on us or asking us to do that. It was entirely about market dynamics and clearinghouse deposit requirements as per regulations.”
The Yahoo! Finance article compares Robinhood’s statement with WeBull, another low-cost platform that suspended trading on the basis that its third-party clearinghouse was barred by various regulations from allowing additional trading until it could secure additional capital to back the trades. However, Robinhood does not use a third-party clearinghouse. Instead, Robinhood has a captive clearinghouse, Clearing by Robinhood, that enables Robinhood to substantially increase its own revenue. This is not abnormal, as Charles Schwab and TD Ameritrade also have captive clearinghouses, but notably, Schwab never suspended trading on any of the most volatile stocks last week.
Was Robinhood’s Clearing System Undercapitalized?
Robinhood ultimately raised $1 billion before reopening trading. While there are several possible questions, the simplest is this: was Robinhood’s clearing system undercapitalized? If so, could Robinhood face regulatory consequences for its effective refusal to provide market access to investors? Could Robinhood face liability to consumers in a civil suit?
The answer to this question will likely be known to the public in the near future. The Securities and Exchange Commission announced on January 29, 2021 that it was monitoring the situation, stating “[t]he Commission is working closely with our regulatory partners, both across the government and at FINRA and other self-regulatory organizations, including the stock exchanges, to ensure that regulated entities uphold their obligations to protect investors and to identify and pursue potential wrongdoing. The Commission will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.”
While Robinhood is barely one month removed from a $65 million SEC settlement after the SEC alleged that Robinhood deceived its users as to how it made money, an investigation here would be focused on Clearing by Robinhood. If Clearing by Robinhood violated any aspect of its heavily regulated duties as a clearinghouse, it may certainly find itself in the unpleasant position of being a defendant in action brought by the SEC.
Robinhood’s Terms Of Service Will Factor Into Lawsuits
Moreover, Robinhood has been named as a defendant in at least 33 actions in ten different states alleging a variety of legal theories, including breach of contract, breach of securities laws, and violations of consumer protection statutes. Robinhood’s initial defenses will likely point to the terms of service that its customers agreed to at the outset of the relationship. Reporting indicates that the terms allow Robinhood to prohibit or restrict the user’s ability to trade securities in its sole discretion and without notice to the user.
Further, Robinhood’s terms contain a mandatory arbitration clause that prohibits bringing actions in federal courts. Unilateral, one-sided contracts that unfairly favor the party with disproportionately greater bargaining power are known as contracts of adhesion. A contract of adhesion may be so unfair to one party that a court will find it unconscionable. In Pennsylvania, a contract or term is unconscionable and thus unenforceable where there is both (1) a lack of meaningful choice in the acceptance of the challenged provision, i.e. it is procedurally unconscionable, and (2) the provision unreasonably favors the party asserting it, i.e. it is substantively unconscionable.” Salley v. Option One Mortgage Corp., 592 Pa. 323, 925 A.2d 115 (Pa. 2007) (holding that most mandatory arbitration clauses are enforceable).
Basically, this means that the weaker party to the contract had no choice but to sign the contract and that the contract is so unfair to that party that the court could not in good conscience enforce it. In Robinhood’s case, as to procedural unconscionability, Robinhood will point out that its users have plenty of other options and could have signed with a different platform. In other words, no one forces a Robinhood user to use Robinhood alone.
As to substantive unconscionability, Robinhood will likely assert that it must have the ability to restrict trading to protect it from regulatory violations or to prevent fraud. This does not mean that a customer’s case can never be winnable, even if the case were brought before FINRA, but it does appear that a breach of contract case against Robinhood could be difficult for many customers. Furthermore, at least in Pennsylvania, the Unfair Trade Practices and Consumer Protection Law (UTPCPL) likely does not provide an avenue of relief for users absent an indicator that Robinhood engaged in deceptive conduct with its users.
The GameStop and Robinhood saga will almost certainly take additional twists and turns over the next few weeks. If the SEC does open a formal investigation, new facts could be brought to light that completely change this analysis, especially if rumors of institutional investors pressuring Robinhood are shown to be true. We will continue to monitor the situation and post updates as appropriate. In the meantime, we will continue to provide representation in areas such as securities fraud, UTPCPL violations, and breach of contract.
Pittsburgh Litigation Attorneys
David C. Weber handles a variety of litigation matters, including antitrust and securities fraud,breach of contract, construction, insurance bad faith litigation, and employment disputes. He can be reached at (724) 776-8000 or firstname.lastname@example.org.