Online brokerages are facing an immense wave of class-action lawsuits involving the recent meme-stocks short squeeze — even if they did not directly restrict trading.
New complaints alleging conspiracy and unfair trade have flooded into courts over the past week, and jurisdictions have been scrambling to consolidate them. Robinhood, Charles Schwab, Morgan Stanley, ETrade, Interactive Brokers and more than a dozen other free or low-cost brokerages are named in the suits. Law firms are also targeting hedge funds and clearinghouses.
Lawyers observing the trend say that the cases will have a monumental challenge overcoming motions to dismiss. But the brokerages named in the suits will have to pour resources into defending against the claims, and some have found themselves in an unwanted spotlight.
Regardless of the outcomes, the claims are some indication the financial services industry could be changing in several important ways, bringing new participants to the world of online trading.
“These are going to be really hard cases to win,” said Andrew Stoltmann, founder of Stoltmann Law Offices and past president of the Public Investors Arbitration Bar Association. “It’s a great theory, and they’re probably right, but proving it is going to be really, really hard.”
The defendants and their counsels are “uber sophisticated” and have “compliance that covers the bases,” he said.
The firms named in the suits all but certainly have the option to restrict trading spelled out in the fine print of their customer agreements, said Tom Gorman, partner at Dorsey & Whitney.
“The restrictions really are the brokerage firms protecting themselves,” Gorman said, citing capital requirements. “And they can do this because they don’t really have any choice.”
The bigger firms defending themselves in court are used to litigation, but for smaller brokerages “this will be a new experience for them, but it’s part of the business,” he said. Nonetheless, in defending against lawsuits, “It’s time. It’s effort. It’s money. It’s angst. That side of it is bad for the industry.”
Some firms, like Schwab, have issued statements specifically to tell customers that they did not prevent the buying or selling of individual stocks or options.
One defendant, Ally, said in a statement that its “inclusion among the more than 30 defendants in this case is without merit and look forward to vigorously defending ourselves.”
Some firms declined to comment or could not be reached.
There have been more than 20 separate cases filed across U.S. district courts bringing claims against Robinhood and numerous other online brokerages, as well as clearinghouses and several hedge funds caught up in the short squeeze involving GameStop and other stocks.
Judges “will do everything humanly possible to consolidate, to lessen the burden on the various courts. Lead council will be appointed,” Stoltmann said. “It’s a good practice.”
Plaintiffs’ law firms allege that the brokerages, hedge funds and clearinghouses conspired to restrict public trading after stock prices for heavily shorted companies such as GameStop, AMC Entertainment, Bed Bath & Beyond, BlackBerry Ltd., Nokia, Koss, Tootsie Roll and American Airlines skyrocketed. The wild price increases were reportedly fueled by amateur day traders who piled onto the short squeeze that was publicized on the WallStreetBets subreddit.
“The fund defendants, clearinghouse defendants and unnamed co-conspirators predicted [their shorts] incorrectly. The relevant securities grew in value, exposing the defendant funds and clearing houses to billions of dollars in losses,” according to the complaint of one suit brought by a law firm vying to represent a proposed class that could result from about a dozen cases consolidating. “Rather than facing the consequences of their risky bets … [they] entered into an agreement and conspiracy to prevent the market from operating, to prevent decrease in prices … to avoid their own financial losses and to cause financial losses to plaintiffs and the members of the class.”
That case names many of brokerages, as well as Citadel Enterprise Americas, Melvin Capital, Sequoia Capital Operations, Apex Clearing Corporation and The Depository Trust & Clearing Corporation.
MOUNTAIN OF LITIGATION
The individual lawsuits in the new mountain of litigation vary in their claims and which firms they are targeting. While some of the cases cast a big net, a few only name Robinhood as the defendant and do not allege a widespread conspiracy.
One case filed in Florida against Robinhood, for example, claims breach of contract, breach of faith, negligence, unjust enrichment and breach of fiduciary duty.
Robinhood “could be the weak link in the legal daisy chain,” if the company has paid the amount of attention to supervision and compliance as it has to customer service, Stoltmann said.
“Some really salacious allegations have been made,” he said. However, “Nobody outside of the [defendant] firms knows what really happened. If the plaintiffs’ lawyers get over motions to dismiss, then you’ll get into discovery. These class actions can die a lot of different deaths.”
Though the cases will likely get dismissed, it is potentially just be beginning of social-media-fueled short squeezes, Gorman said. “This is the first time that anybody ever really fought back,” he said. Hedge funds will probably keep that in mind for some time, he noted.
“That changes the dynamic about what happens with some of these [public] companies that are in difficult financial positions,” he said. “I think you’re going to see this again and again.”
For better or worse, more people will likely be trading stocks as a result of this, he said. “This is the beginning of a new segment in the market, if you will.”
As our second lead editor, Cindy Hamilton covers health, fitness and other wellness topics. She is also instrumental in making sure the content on the site is clear and accurate for our readers. Cindy received a BA and an MA from NYU.