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By: Kirsten Patzer
In the wake of GameStop Corp. (GME) stock spiking as high as 800% over the last several weeks, broker dealers are stepping in to stop the madness. The lead up to Robinhood, Interactive Brokers, and other trading platforms halting the purchase of high-flying stocks GameStop, AMC Entertainment Holdings Inc. (AMC), and other low-value shorted securities, was a dizzying roller coaster ride fueled by users of the popular online message board, Reddit.
The strategy implemented by the Reddit members was simple: target low priced stocks held in large positions by hedge funds who were “shorting” the position; purchase those stocks in quantities large enough to move the market; watch as the hedge funds are forced to purchase the stock to offset losses held by their shorted positions; sell the stock at an outsized profit. The situation only became problematic for Robinhood and other broker dealers when new investors, not part of the initial purchases leading to the surge in prices, began buying the stocks at the inflated price hoping the rise in value would continue. The initial investors will likely see a positive return on their investments. The new investors, however, stand to lose nearly all the money they invested once the stocks lose their inflated value.
Robinhood had to step in to protect those new investors. If they had not done so, the potential for customer harm could be catastrophic, leading to litigation and regulatory scrutiny. The ill-advised class action suits filed in the Southern District of New York and the Northern District of Illinois fail to understand the regulatory landscape surrounding the financial services industry. Broker dealers have no obligation to unconditionally accept orders to buy or sell stocks or any other security. In fact, given the newly implemented Regulation Best Interest, and here in Massachusetts where a fiduciary standard applies to broker dealers, Robinhood arguably was required to shut down any further purchase of the stocks. Robinhood is already the subject of the Commonwealth’s first Enforcement Action under the new fiduciary standard (See In the Matter of: Robinhood Financial LLC Docket No. E-2020-0047).
Broker dealers have historically restricted the purchase and sale of securities they deem too risky for retail customers. In the aftermath of the 2008 financial crisis many financial advisors advised their clients to invest in triple and quadruple inverse leveraged securities, betting the rise of the markets that started in March 2009 could not possibly be maintained. Once the markets “corrected” they would receive the spoils for shorting the market. That prediction did not come to pass, and many broker dealers removed these investments from their trading platforms to stop the bleeding. These decisions are made to protect investors, not harm them.
Sometimes Wallstreet does the right thing.
For more information, please contact Kirsten Patzer at [email protected].