Robinhood CEO Says It Stopped Trading to Meet Clearinghouse Deposit Requirements – but in Jeff Sonn’s Opinion, There Is a Lot More to This Story

Rather than file a class action, the Reddit wallstreetbets army can file a mass arbitration at FINRA. 

The following is my own opinion, based on news reports.

In a recent interview with Tesla CEO Elon Musk, Robinhood CEO Vlad Tenev purportedly said his brokerage firm had to stop trading Thursday, January 28, 2021, to give Robinhood Securities time to raise money to meet an increased deposit requirement from one of its clearing firms, National Securities Clearing Corp. Interestingly, he said in another interview that the halt in trading was also done to protect the customers. While I believe the first answer, I don’t believe the second.

Robinhood Securities is a registered broker dealer with the Financial Regulatory Authority (FINRA). Robinhood Securities’ clearing firm, National Securities Clearing Corporation earns fees on each transaction. From the buyer, the clearing firm receives cash, and from the seller, it receives securities or futures contracts. A clearing firm is an organization associated with a stock market exchange that handles the confirmation, settlement, and delivery of transactions for a broker dealer. Clearing firms have an obligation to clear trades in a prompt and efficient manner.

Importantly, clearing agreements typically require the introducing firm (Robinhood Securities, owned by Robinhood Markets) to deposit money (a clearing deposit) with the clearing firm (National Securities) to cover any obligations that may arise from the clearance of the introducing firm’s accounts (e.g., unsecured customer debit balances). 

Remember, when you place the trade, you haven’t paid for it yet. The trade occurs on day one, and usually, the transaction is “settled” within 3 business days (aka T+3). During the period between trade and settlement, the brokerage firm’s money is at risk because if the customer lacks the funds by day 3 or suffers losses in the interim, the customer may lack money by day 3 to pay for the trade, leaving Robinhood, and the clearing firm with the debt. The clearing deposit is posted to protect the clearing firm in the event that the broker dealer cannot pay.

It is not “market manipulation” when the wallstreetbets army was simply being opportunistic. Hedge funds are opportunistic everyday. Wall Street does not like Mainstreet operating on their turf. But the wallstreetbets army has shown that Mainstreet can play that game too.
– Jeff Sonn, securities fraud attorney

Now the question is, given the volatility in many stocks that were bought by reddit users, which I lovingly call the “wallstreetbets army,” is Robinhood liable for losses when they stopped trading? Maybe. Lawyers often say that, but that is my personal opinion. Buried in the contract that each customer signed with Robinhood is the clause that states in part, “I understand Robinhood may at any time, in its sole discretion and without prior notice to Me, prohibit or restrict My ability to trade securities.” If one were to read that by itself, then Robinhood would have the right to restrict trading, as it did on January 28, 2021. But that clause in Robinhood’s contract does not tell the whole story. Later in the contract it states,

All transactions in My Account will be subject to federal securities laws and regulations, the applicable laws and regulations of any state or jurisdiction in which Robinhood Financial is registered, the rules of any applicable self-regulatory organization of which Robinhood Financial is a member and the rules, regulations, customs and usages of the exchange or market, and its clearing house, if any, where the transactions are executed. In no event will Robinhood Financial be obligated to effect any transaction it believes would violate any federal or state law, rule or regulation or the rules or regulations of any regulatory or self-regulatory  organization.

Having practiced 32 years in securities litigation, my opinion is that this is where it gets interesting. You see, the rules of “any applicable self regulatory organization” includes the Financial Regulatory Authority (FINRA), and the reference to federal securities laws, opens the door to possible liability by Robinhood. Even if Robinhood was required to make a larger clearing firm deposit, one could argue that such a requirement was a “foreseeable” event. If so, then Robinhood was negligent in not having a credit line or other credit available on short notice, given the large volatility in the market, and that many of its users on Reddit were openly calling for the buying of mass quantities of certain stocks, including Gamestop and AMC.

If it was foreseeable, then Robinhood, in my opinion, violated one of the cardinal regulatory rules of FINRA: “Rule 2010. STANDARDS OF COMMERCIAL HONOR AND PRINCIPLES OF TRADE—A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”

Personally, my opinion is that Robinhood and the other brokerage firms that halted trading did not “observe high standards of commercial honor and just and equitable principles of trade.”

So, here is my idea. Rather than file a class action, the Reddit wallstreetbets army can file a mass arbitration with FINRA. We gather 3 million users, and file one case, since the case is all about the same issue. We can charge $1 per user to file the case, so long as we get at least 200,000 investors to agree to sue. Now THAT’S what I call a case. But there is a catch—some buyers may not have sold and realized a loss, or still have a profits on paper. Those who either “lost” principal because the sales price was less than they paid, or were sold out because of margin calls, have the best casers in my opinion. Lost profits cases can be challenging, so the wallstreetbets army should, in this author’s opinion, file cases where there are actual principal losses due to Thursday’s questionable shutdown by Robinhood and other broker dealers. Again, this is just my opinion, and other lawyers may believe differently.

In closing, the wallstreetbets army on reddit  has proven that social media is a powerful tool for Mainstreet to take on Wall Street. In my opinion, it is not “market manipulation” when the wallstreetbets army was simply being opportunistic. Hedge funds are opportunistic everyday. Wall Street does not like Mainstreet operating on their turf. But the wallstreetbets army has shown that Mainstreet can play that game too. So long as you don’t spread any lies, there is no case for market manipulation, and the wallstreetbets army should keep up the good fight!

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