Robinhood and the Merry Men of Reddit

 /  Feb. 18, 2021, 9:58 a.m.

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Gamestop, a video game retailer reminiscent of a different era, was gently fading into the past with its steadily declining share prices dropping as low as $3.09 in April 2020. It was almost certain that the company was headed towards a graceful demise, as it had all but disappeared from the vocabulary of gaming enthusiasts. Then, on January 28, 2021, the GameStop Corporation stock (GME) hit a daily high price of $483.00, flummoxing institutional investors who had placed large sums of money in short positions on the stock, and lost so much on the position that financial giants Citadel and Point72 were forced to infuse $3 billion to keep the fund afloat. Short positions involve borrowing stock and selling it in the hopes that prices will fall and it can be bought back for cheaper and returned to the lender, allowing the investor to make the difference in share price as a profit. If the prices rise instead, the borrowing investor must pay the lender the difference in prices out of pocket when the stock is returned, which is what happened on a magnified scale for many hedge funds. 

The surprising source of the sudden rise was soon traced back to the depths of a foul-mouthed subreddit group called WallStreetBets, a chatpage home for amateur investors. The self-described group of if “4chan found a Bloomberg terminal” is filled with memes, catchy trading lingo, and a particular focus on highly-volatile companies. The past year has served as a perfect storm for the rise of the subreddit’s popularity, as the pandemic impacted the market in unforeseen ways and people staying in quarantine had the time for a new hobby. Buzzing interest in the chat about investing heavily in unexpected yesteryear companies like GameStop and AMC was translated into action as casual traders took advantage of user-friendly platforms like Robinhood. The stock grew so popular on the app that at one point, over half of all Robinhood users owned some GameStop stock. 

Investing has long been a contentious topic, with most of the wild newsworthy profit margins benefitting elite hedge fund managers and staid Wall Street firms. Robinhood, a popular free-trading app that eliminates brokerage fees and removes the information barrier, has made huge strides in bringing finance into homes across the nation. However, institutional investors still make up as much as 80 percent of market capitalization. When GameStop prices skyrocketed due to high volumes of trading activity, such investors who were holding a short position were “squeezed” as they scrambled to hedge their bets by investing long in GameStop and thus driving prices up further. 

Robinhood and a couple of peer brokerages instituted restrictions on trading of the more volatile stocks like GameStop in the immediate aftermath. Users were temporarily prevented from selling GME, AMC, BlackBerry (BB), and several other stocks made popular on Reddit. This drew ire from many individual traders who felt that their profits were being capped by a system rigged to be in favor of old hedge funds. Due to the backlash, the company reversed the policy and issued an explanatory letter indicating that the limitations were placed due to Robinhood being unable to meet rising capital deposit requirements for the clearinghouses processing the risky trades. Though these concerns were addressed quickly and the soaring GME prices plummeted back down to $50.75 by February 12, it opened the conversation on the potential for retail traders to impact the financial markets. 

Political Ramifications 

While the story has been largely co-opted and marketed to the public as a tale of everyday Americans—friendly neighbors and kind coworkers—striking gold, the motivations behind the subreddit thread have brought into question the legality of the phenomenon. The Securities and Exchange Commission (SEC), the government agency responsible for monitoring and maintaining efficient markets, has reportedly been investigating the extent to which the Reddit frenzy was a “pump and dump” scheme—a scenario in which misinformation is used to elevate a stock and then initial investors sell and turn a tremendous profit off of new investors duped by the sudden action. 

Daniel Hawke, a partner at Arnold & Porter Kaye Scholer LLP, said regarding the matter, “If they are all egging each other on using a social-media platform, they are effectively engaged in a crowdsourced pump-and-dump scheme.” This is a form of market manipulation, an illegal activity that is difficult to prove in court, particularly when there are as many defendants as there would be in a trial targeting the Reddit users. Rules regarding the discussion of stocks are relaxed for individual investors in comparison to larger institutions, but it is still illegal to explicitly coordinate an effort to force one share to rise, as the goal is always to have a financial market that closely resembles the true valuations of companies.

Furthermore, many frustrated investors have joined together to file a suit against Robinhood for the losses they suffered from the trading restrictions placed on them by the app. Legal scholars have indicated that the class-action lawsuit does not have strong grounds, as the user agreement clearly states that the company “may at any time, in its sole discretion and without prior notice to Me, prohibit or restrict My ability to trade securities.” The lawsuits will thus have to embark on the difficult task of proving that Robinhood’s intentions in restricting the trades were against the interests of the customers and a direct result of some agreement with parties that benefited. 

The issue was brought to the forefront of political debate when bipartisan support was issued in favor of the small-time traders. Representative Alexandria Ocasio-Cortez (D - NY), who has long been vocal about her support of dismantling the power of traditional Wall Street institutions, tweeted shortly after the Robinhood freeze, “This is unacceptable. We now need to know more about @RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit.” Senator Ted Cruz (R- TX), who falls on the opposite end of the political spectrum and has clashed repeatedly with Ocasio-Cortez, tweeted a response of support. In an era of growing political divisions and extremes, this agreement has been seen as a unifying event. 

The House Financial Services Committee has called for a hearing set for February 18 about the sudden GME stock rally. The committee is planning to address the issue from the standpoint of regulators and legislation as well as from the perspective of the investors and businesses involved. Robinhood CEO Vlad Tenev has been called to testify, along with Reddit executives and representatives of financial institutions. Tenev has expressed regret over the way the communications were handled during the frenzy, saying, “No doubt we could have communicated this a little bit better to customers,” though he maintains that the company did not act incorrectly given the unprecedented circumstances. 

The GameStop saga has wound down, with the unfortunate result of many average people losing large sums by waiting too long to sell. However, the questions still remain of the legality of the matter and whether Wall Street can be hoodwinked again. After years of complex algorithms and newfangled financial derivatives putting institutional investors far ahead of average investors in the market, the Reddit rally was seen as a sort of comeuppance for hedge fund managers. Whether the common people can and should unify again to influence particular stocks remains to be seen, but it is certain that the keen investors of r/wallstreetbets have no intention of letting Wall Street giants continue to control the market.

The image featured in this article is licensed for reuse under the Creative Commons Attribution-Share Alike 4.0 International license. No changes were made to the original image which can be found here.

Niharika Iyer


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