Legal liability around the GME short squeeze
The events around the GameStop short squeeze have resulted in a number of legal consequences for some of the major players. This squeeze has been unprecedented, what happens next will be useful to know in the future for anyone involving themselves in the stock market.
Financial Services Hearing
On Thursday February 18th 2021 the House Committee on Financial Services held a hearing to investigate January’s short squeeze[1]. Witnesses included the CEOs Steve Huffman (Reddit), Gabriel Plotkin (Melvin Capital Management LP), Vladimir Tenev (Robinhood Markets Inc), Kenneth C. Griffin (Citadel LLC), and amateur investor Keith Gill (known online as Roaring Kitty or DeepF***ingValue).
In their memorandum, the Committee outlined the key points of the investigation. Largely they were concerned with the potential for market manipulation, the relationship between Citadel, Melvin Capital, and Robinhood, and to a lesser degree the legality of naked shorts (noting that in some circumstances naked shorts are not illegal)[2].
Keith Gill appearing at the virtual hearing Feb 18th
The potential for market manipulation was low. Mr Gill emphasised that he only had access to the same public information as anyone else and that all he could do was discuss his opinions of stocks[1]. Nonetheless, concerns were raised about social media’s impact on market stability. Representative David Scott is quoted as saying “something has gone terribly wrong” when Robinhood CEO Tenev informed him that they take no measures to monitor how social media affects the use of their trading platform[1].
Citadel’s connection to both Robinhood and Melvin Capital was a cause for concern. Robinhood routes orders to Citadel for execution. Melvin Capital ended the month with $8 billion in assets despite 53% losses, in part due to investment from Citadel. Naturally, when Robinhood prevented users from buying stocks such as GME and AMC suspicions were raised that they may have been instructed to do so by Citadel[2]. Mr Tenev denied such notions with a prepared statement that was also published to his blog[3]. However, it was pointed out that his explanation regarding a lack of liquidity to pay trading fees was not the same explanation he gave on the day his app prevented trading. Instead, his initial statements on the matter mentioned protecting users from volatility[4].
Little was said regarding the fact GME stock was 140% short, with Melvin Capital CEO assuring representatives that they adhere to all the rules[1]. This hearing is part of an ongoing investigation looking into the possible necessity of further regulation on the markets. A second hearing is scheduled for March 17th 2021[5].
Robinhood
As mentioned above, Robinhood was under scrutiny for preventing users from buying stock. This scrutiny has resulted in at least six class action complaints against the company[6][7][8][9][10][11].
The causes of action are numerous and varied, including breach of contract, negligence, breach of fiduciary duty, conspiracy, deceptive trade practices, and even fraud. Predominantly they relate to Robinhood failing to do business fairly and potentially even conspiring with Citadel to protect the interests of hedge funds.
Robinhood's homepage
This is far from the first time Robinhood has had legal trouble relating to limiting trading. In March 2020 they were sued for outages of their app during a stock market peak.[12] Furthermore, while in no way legally binding, in 2019 Robinhood lost in arbitration against a claim that they had locked a customer’s account and reversed his trades.[13] Robinhood may not have lost had they responded to the claim.
Additionally, in 2020 the Securities Exchange Commission charged Robinhood with “misleading customers about revenue sources” and did not “satisfy a duty of best execution”. In short, by not seeking the best prices for executing trades but assuring customers of their quality, they were losing investors millions of dollars. As penalty, Robinhood was required to pay $65 million.
The company has been criticised for its practices before, and the current lawsuits against them now may not be their last.
Keith Gill
Finally, Mr Gill was sued in Massachusetts court by Christian Iovin for securities fraud.[14] Iovin, a short seller, alleges that Mr Gill misrepresented himself as an amateur investor to create a narrative of defeating evil hedge funds in order to manipulate the market. This class action suit has not yet been heard in court.
Summary
In conclusion, as we move deeper into the 21st century new legal questions around the stock market and how it interacts with other technology continue to emerge. With these questions will likely come more regulation rather than less.
This poses significant legal risk for those prominent in online trading. It must be remembered that the cost of legal battles is not limited to potential damages paid, but also attorney's fees and court filings, and potentially even reputational damage.
While the average amateur trader isn’t likely to run into issues, those rising to prominence (whether they intend to or not) should familiarise themselves with the law and be prepared.
References
[1] House Committee On Financial Services, GameStopped Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, 18/02/2021
[2] House Committee On Financial Services, Memorandum: GameStopped Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide, 18/02/2021 https://financialservices.house.gov/uploadedfiles/hhrg-117-ba00-20210218-sd002.pdf
[3] Robinhood, A Note From Our CEO, 18/2/2021 https://blog.robinhood.com/news/2021/2/18/a-note-from-our-ceo
[4] Robinhood, Keeping Customers Informed Through Market Volatility, 28/1/2021 https://blog.robinhood.com/news/2021/1/28/keeping-customers-informed-through-market-volatility
[5] House Committee On Financial Services, GameStopped Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide Part II https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=406268
[6] Dalton v Robinhood Securities LLC (2021) WL 355003 (N.D.Cal.) (Trial Pleading)
[7] Fresa v Robinhood Financial LLC (2021) WL 354990 (D.Conn.) (Trial Pleading)
[8] Juncadella v Robinhood Financial LLC (2021) WL 325698 (S.D.Fla.) (Trial Pleading)
[9] Lavin v Robinhood Financial LLC (2021) WL 354996 (E.D.Va.) (Trial Pleading)
[10] Ng v Robinhood Markets Inc (2021) WL 355011 (S.D.Tex.) (Trial Pleading)
[11] Perri v Robinhood Markets Inc (2021) WL 359895 (M.D.Fla.) (Trial Pleading)
[12] Taafe v Robinhood Markets Inc (2020) United States District Court, M.D. Florida,
Tampa Division. 2020 WL 1531127
[13] Vasani v Robinhood Financial LLC, (2019) WL 2161345 (FINRA)
[14] Iovin v Gill (2021) United States District Court, District of Massachusetts, Case 3:21-cv-10264-MGM
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