The Securities Litigation Expert Blog

GameStop Litigation - Part 2

Posted by Jack Duval

Jan 29, 2021 3:46:12 PM

This is the second post in my series on potential litigation arising from the trading restrictions imposed by Robinhood and other firms on GameStop and other securities involved in the recent short squeezes. The first post can be found here.

Broker-Dealer Risks

Broker-Dealers (“BDs”) can get burned by margin clients blowing up. But that’s not what happened to Robinhood or any other BD yesterday.

As of 10am Thursday morning, every owner of Robinhood stock and call options (what the Redditors were buying) was profitable because the stock was at an all-time high.

The risk to a BD is that their margin customers take large losses in excess of the equity in their accounts. In these instances, the BD has to make up the difference to their clearing firm, if that amount is greater than the firm’s equity, it is bankrupt.

The way BDs manage this risk is to change client margin requirements to increase their client's account equity and/or to sell out client positions if their equity falls below a certain level.

Robinhood did increase the margin requirements on GameStop and the other names that were part of the ongoing short squeeze on Wednesday, January 27th.[1]

Clearing Firm Margin Requirements

BDs, like their clients, are subject to their own margin requirements from their clearing firms. Also just like their clients, BD margin requirements change, typically under a formula that includes volatility as an input. As volatility increases, so does the margin requirement of the BD.

When a BD's margin requirement increases, it must post more collateral with its clearing firm.

Robinhood CEO Vlad Tenev said in a CNBC interview this morning that the firm tapped its bank credit lines proactively, meaning that it did so before it received margin calls from the Robinhood’s clearing firms.[2] Further, Tenev stated that Robinhood had “no liquidity problem, and that: 

By drawing on our credit lines, which we do all the time, as part of normal day-to-day operation, we get more capital that we can deposit with the clearinghouses. And that will allow us to enable ideally more investment with fewer restrictions.[3]

If there was no liquidity problem and Robinhood drew on its credit lines to bolster its capital position with its clearing brokers, there should have been no reason to restrict trading in GameStop and the other short squeeze names.

GameStop Volatility

There is no doubt that GameStop volatility has been rising, but it had already risen significantly by Wednesday, January 27, and trading had not been stopped. Again, if Robinhood had bolstered its capital position on January 27th and 28th, why restrict trading yesterday?

Chart 1: GameStop 10, 30, 90, and 120 Day Historical Volatility

accelerant jack duval GME historical volatility chart

 Furthermore, overall market volatility, measured by the VIX Index fell from 37.21 on Wednesday to 30.21 on Thursday, a decline of 18.8 percent.[4]

This is important, because Robinhood clients hold many more securities that GameStop and the other short squeeze names. Thus on an aggregate basis, it is possible that the volatility on the combined Robinhood securities declined on January 28th.

In short, it would appear that Robinhood's proactive trade restrictions were implemented not because the firm had run out of money, but because the firm was worried about running out of money.

However, Robinhood was fully capitalized Robinhood and acted on these worries by preventing its clients from purchasing GameStop and other short squeeze names and only allowing closing transactions.

While it is certainly prudent for Robinhood to act proactively to protect its business it cannot be reckless or negligent in how it does so.

As can be seen in Chart 1, above, the volatilities of GameStop had been rising starting on January 13th, when the 10 day volatility spiked from 100 to 258.

On January 26th, the 10-day volatility spiked again from 308 to 394. Ultimately, the 10-day volatility peaked out at 688, nearly a 10x increase from the January low of 77.

However, Robinhood had lived through other 10x increases in single stock volatility.

Chart 2: Tesla 10, 30, 90, and 120 Day Historical Volatility

accelerant jack duval tesla historical volatility chart

 

Chart 2, above, shows the 10-day Tesla stock volatility increasing from 18 to 210 in the three months leading to the climax of the COVID selloff in March 2020. Furthermore, this was a time when all equity volatilities were spiking to extreme levels.

In order to protect the firm, prudent risk management would dictate that Robinhood:

  • Raise the margin requirements on its clients in the short squeeze names;
  • Bolster the firm's capital position by drawing on bank lines; and,
  • Raise additional capital from its backers (which have included some bold-faced venture capital names that surely had cash available on short notice).

Robinhood did all three, but not before it helped manipulate a catastrophic decline in the GameStop stock price.

Impact of Broker-Dealer Trading Restrictions

Robinhood implemented its closing-position only trading restrictions at 10am yesterday, January 28th, 2020.

During the day, the SEC halted trading in GameStop 19 times.

These two factors appear to have panicked investors into selling (which is, of course, the only option they had at many BDs yesterday).

Chart 3: January 28, 2021 GameStop Intraday Price Chart

accelerant jack duval GameStop Intraday Chart

Yesterday from 10am to 11:24am, GameStop stock declined by nearly 77 percent.

What's more instructive is that the price was effectively "limit down" multiple times from 10am after almost every trading halt through 11:24am.

This means it was very difficult to sell the stock. It essentially went like this:[5]

  • 10am, Robinhood told clients they could only close out positions (i.e. sell stock or long call options, or buy back short positions), this caused the stock to decline;
  • 10:03am the SEC implemented the first trading halt in GameStop;
  • 10:08am the trading halt was lifted;
  • 10:16am the stock had declined by over eight percent;
  • 10:17am the SEC implemented the second trading halt in GameStop;
  • 10:22am the trading halt was lifted;
  • 10:39am the stock declined by roughly 11 percent; and,
  • 10:40am the SEC implements the third trading halt.

 This cycle repeated seven more times until 11:24am, when the stock has an intraday peak to trough decline of almost 77 percent.

Client Losses

It is not clear how much money was lost during the one hour and 24 minutes that encompassed the 77 percent decline.

However, it is certain that some investors experienced large losses, especially those that had purchased call options over the past few days.

Liability

There have already been two class-action cases filed against Robinhood, including Nelson v. Robinhoood Financial et al in the Southern District of New York.

There are many issues involved. On Thursday, Robinhood management pointed to their own margin calls from clearing firms, but this morning said there was no liquidity crunch. If the firm implemented the trading restrictions when it did not need to, under the perception that it might face a cash crunch at some later date, that is problematic.

Instead of restricting trading due to a potential problem, Robinhood should have bolstered its capital and/or undertaken other measures in advance of those potential needs. The firm had plenty of notice as the short squeezed stock appreciation gathered pace over the past month.

Finally, Robinhood claims to have raised an additional $1 billion from its existing backers (in addition to the reported $200 million in bank line draws). If that’s true, why is the firm only allowing the purchase of one additional GameStop share as of 3:15pm today.[6] Something doesn’t add up there.

For attorneys contemplating bringing a complaint, it is good to keep in mind that Robinhood has plans to IPO this year at a price that would value the firm at around $20 billion. The firm has already had regulatory issues and had to pay an SEC fine of $65 million on December 17, 2020 for violations of FINRA's Best Execution rule.

Robinhood will not want to IPO under a cloud of litigation uncertainty and may be more willing to settle cases because of that.

Conspiracy!

What would the Redditor/Robinhood story be without a good conspiracy? This one is brought to you by Congressman Paul Gosar, D.D.S.:

Melvin Capital Management is owned by the parent company “Citadel, LLC” which, according to a Bloomberg Report, gave Robinhood roughly 40% of their revenue (through payment for order flow). Knowing the involvement Citadel has with Robinhood, it is clear that the actions taken today were motivated by anti-competitive reasons not for concerns of volatility claimed by Robinhood. Because of this blatant conflict of interest and obvious monopolistic activity, I am calling on an immediate investigation by the U.S. Department of Justice into Robinhood and the hedge fund of Citadel, LLC.[7]

 Let the investigations begin.

__________

Notes:

[1]      Robinhood ramps up margin requirements on zooming GameStop, AMC; Matt Egan; CNN Business; January 27, 2021. Available at: https://www.cnn.com/business/live-news/stock-market-news-012721/h_f037344e14a037160cc724607ff72da0#:~:text=Robinhood%2C%20the%20free%20trading%20app,initial%20margin%20requirement%20and%20maintenance; Accessed January 29, 2021.

[2]      Robinhood CEO: Tapping Credit lines proactive, not a sign of cash crunch in GameStop frenzy; Kevin Stankiewicz; CNBC; January 29, 2021. Available at: https://www.cnbc.com/2021/01/29/robinhood-ceo-vlad-tenev-tapping-credit-lines-proactive-to-help-lift-gamestop-trading-limits.html; Accessed January 29, 2021.

[3]      Id.

[4]      Source: Bloomberg.

[5]      Bloomberg News reported the Robinhood trading restrictions at 9:43am on January 28, 2021, however the New York Times reported on after-hours trading restrictions the night before at 6pm. See, Trading platforms are limiting trades of GameStop and other companies; Gillian Friedman and Tara Siegel Bernard; The New York Times; January 27, 2021. Available at: https://www.nytimes.com/2021/01/27/business/gamestop-td-ameritrade-robinhood.html?partner=bloomberg; Accessed January 29, 2021. SEC Trading Halts obtained from NasdaqTrader.com. Available at: http://nasdaqtrader.com/trader.aspx?id=TradingHaltHistory; Accessed January 29,2021.

[6]      Robinhood raises $1bn from investors and taps banks at end of wild week; Michael Mackenzie, Eric Platt, James Fontanella-Khan, and Philip Stafford; Financial Times; January 28, 2021. Available at: https://www.ft.com/content/9a1b24e6-0433-462a-a860-c2504ea565e4; Accessed January 29, 2021.

[7]      Letter of Paul A. Gosar, D.D.S. to Activing Attorney General Monty Wilkinson; January 28, 2021. Available at: https://twitter.com/PJ_Matlock/status/1354974631619395591/photo/1; Accessed January 29, 2021.

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Topics: FINRA, securities litigation, Bantam Inc., GameStop, Trading Restrictions, Trading Halt, Reddit, Robinhood

GameStop Litigation

Posted by Jack Duval

Jan 28, 2021 11:51:17 AM

Yesterday and this morning, TD Ameritrade, Robinhood, and other firms restricted trading in GameStop, AMC, and other heavily shorted stocks that have been undergoing tremendous short squeezes over the past few weeks.

GameStop Chart

Jack Duval Accelerant GameStop litigation image

Source: Bloomberg

Regulatory Halts v. Trading Restrictions

For clarification there is a difference between a Regulatory Halt, which can be issued by FINRA or the SEC, and a broker-dealer ("BD") restricting trading in a security.  The former is common and happens every day, usually due to a large move (up or down) in a stock.  The regulator typically contacts the issuer to see if there is news that needs be be disclosed and will remove the halt after their questions have been answered.  (Frequently, there is no news from the company.)

A BD-initiated trading restriction is much less common.  When they do happen, they are usually for clients a firm wants to fire.  They ask the client to leave and tell them they will only accept closing orders, i.e. sales of securities held long, or purchases of securities held short.

This morning, Robinhood announced it would accept only closing orders for GameStop, AMC, and other securities.  They had already raised the margin requirements for these securities.

Robinhood Customer Agreement

The Robinhood Customer Agreement explicitly allows for the firm to "prohibit or restrict" trading in securities, without notice.

Robinhood Customer Agreement Extract

robinhood account agreement

Litigation Implications

While Robinhood, and most likely all BDs, have the ability to restrict client trading in securities, doing so raises a host of issues.  Some of those include:

  • Was the implementation of the trading restriction commercially reasonable?
  • If the BD allowed the clients to buy the security and then only allowed sales of the same security, are they engineering a decline in the security?  That is, if owners can only sell a security and no one can buy, there is only one way for the security to trade - down.
  • If all BDs implement closing-only restrictions, they themselves are engaging in market manipulation, guaranteeing a price decline and losses for investors.
  • If a client has an open options position, is the BD preventing the client from hedging their position via an opening transaction in the underlying or another option?
  • It is likely that FINRA has been in consultation with the BDs about these restrictions, which would seemingly raise the same liability issues for the regulator.
  • Are these restrictions being applied to institutional investors as well as retail investors?  For instance, are the options market makers able to trade in these names freely?  What about hedge funds and other institutions?
  • If the restrictions have not been implemented uniformly, it raises serious self-dealing issues.  FINRA's members are BDs and are heavily connected to institutional investors such as hedge funds.  If the regulator coordinated a member-wide closing trade only restriction for retail investors, it would benefit the hedge funds (who have been short) at the expense of the retail investors.

As I was writing this, it would appear that the trading restrictions have negatively affected the GameStop stock price.  It has declined by 67 percent from the peak today (from roughly $450 to about $126).

GameStop Intraday Chart

gamestop intraday chart

Source: Bloomberg

I'll have more on this as developments continue.

__________

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Topics: FINRA, securities litigation, Bantam Inc., GameStop, Trading Restrictions, Trading Halt

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