Securities Litigation

During the height of the GameStop (NYSE: GME) mania, Slate author Jordan Weissman explained that

“[A]t a moment that the markets are being overrun, for better or worse, by posters who’ve basically dedicated themselves to shredding the idea that markets are efficient, rational mechanisms for allocating capital and discovering value, tweeting about stonks seems far more appropriate than discussing something as reasonable and comprehensible as stocks. It’s an emotional onomatopoeia for talking about people throwing their money at the market when, lol, nothing matters.”

“What We Talk About When We Talk About Stonks,”  Slate (Jan. 28, 2021), here.

In that week when GME swung wildly from $76 to $347 per share, regulators issued several investor alerts warning about the risks of short-term trading in volatile assets.  The SEC warned of “the significant risks of short-term investing based on social media, especially in volatile markets” – and particularly in small-cap stocks and/or with leveraged by margin or options.  The Alert reminded investors that “broker-dealers may reserve the ability to reject or limit customer transactions.  This may be done for legal, compliance, or risk management reasons, and is typically discussed in the customer account agreement.  In certain circumstances, broker-dealers may determine not to accept orders where a transaction presents certain associated compliance or legal risks.” The SEC Investor Alert (SEC Jan. 29, 2021) is here.

FINRA issued its Investor Alert cautioning against emotional trading not aligned with long-term financial means and goals, among others.  “Following the Crowd: Investing and Social Media,”  (FINRA Jan. 29, 2021) is here.

The United Kingdom’s Financial Conduct Authority issued a statement:

Buying shares in volatile markets is risky and you may quickly lose money. These losses are unlikely to be covered by the Financial Services Compensation Scheme.

Broking firms are not obliged to offer trading facilities to clients.  They may withdraw their services, in line with customer terms and conditions if, for instance, they consider it necessary or prudent to do so. Firms are exposed to greater risk and therefore more likely to need to take such action during periods of abnormally high transaction volumes and price volatility.

The Statement (FCA Jan. 29, 2021) is here. In little more than a week from its January 28 high of $483/share, GME has declined about 87%, now trading at $47/share on February 9.

A market study released by FINRA on February 2, 2021, reveals that the COVID pandemic “witnessed a surge in retail investors who entered the markets … via online brokers.”  Of them, 38% were “New Investors” who never before had opened a taxable, non-retirement investment account.  The study found that

“New Investors were younger, had lower incomes, and were more racially diverse than Experienced Entrants and Holdover Account Owners. New Investors held smaller balances in their taxable accounts when compared with investors in the other two categories.”

Importantly, “[i]nvestment knowledge was lowest among New Investors (both self-assessed and objectively measured).”  The FINRA study is here.

Gamification Suits

Even before the crowd-sourced short squeeze of GME, Massachusetts’ securities enforcers filed suit against Robinhood Financial, alleging:

“1) aggressive tactics to attract new, often inexperienced, investors; 2) failure to implement policies and procedures reasonably designed to prevent and respond to outages and disruptions on its trading platform; 3) use of strategies such as gamification to encourage and entice continuous and repetitive use of its trading applications; 4) failure to follow its own written supervisory procedures regarding the approval of options trading; and 5) breach of the fiduciary conduct standard….”

The December 16, 2020 Complaint is here.

Thus far, over 40 class-action suits have been filed against trading app broker-dealers in the wake of the GameStop mania.  Among the latest is a wrongful death suit by the family of a young trader, alleging that Robinhood’s “misleading communications” and “virtually nonexistent” customer service lead to his death.  The Complaint begins:

“How was a 20-year-old with no income able to get assigned almost $1 million worth of leverage?” These were the last known written words of 20-year-old Alex Kearns before he rode his bicycle to a railroad crossing and ran in front of an oncoming train.”

Complaint at 1.  Kearns allegedly opened his account when he was a high-school senior and after only a year, was allowed to trade options as a college freshman.  The family says Kearns had executed a complicated options trade -- a put option spread, simultaneously buying and selling put options on the same underlying security.  Late at night, Kearns received a margin call email, demanding the deposit of $178,000, while his app showed an apparent loss of $780,000.  The suit alleges that after Kearns emailed customer service three times about the situation and received only automated responses, he committed suicide.  The company did not then have telephone customer service hotlines.  The Complaint alleges that Kearns in fact had more than enough value in the other leg of the spread trade to cover the account deficiencies.

The Complaint in Kearns v. Robinhood Financial, LLC, No. 21CV375872 (Superior Court, Santa Clara County, CA filed Feb. 8, 2021) is here.

The Wall St. Journal coverage is here.

Removing barriers to entry and increasing consumer access to financial markets is a good thing.  But explicitly catering to new and inexperienced investors carries a concomitant – and arguably higher – obligation to disclose and inform.  Newer, more “gamified,” customer interfaces still must comply with existing regulatory requirements.  See Robinhood’s Long Way Out of Sherwood Forest, here. That’s not to say that everything about markets needs to be dull, gray, and somber.  But without adequate information and safeguards, day-trading stonks is all fun and games, until it’s not.