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Why Robinhood is blocking the little guy from the GameStop showdown

REUTERS/Shannon Stapleton
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By Roya Wolverson
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In some corners of social media, the epic short squeeze on GameStop, the beleaguered video game company, is a David and Goliath battle between retail investors and hedge funds. As legions of day traders drove up GameStop’s share price more than than 1,700% this month, institutional investors who had bet against it have stomached massive losses, scrambling to cover their positions by buying the stock back.

But the fallout extends far beyond rich hedge funders. ”If there are a bunch of retail investors who are invested in this stock and a bubble bursts, investors get hurt,” says Jill Fisch, a business law professor at the University of Pennsylvania.

So retail brokerages and trading platforms are stepping in. A slew of retail firms this week slapped trading restrictions on GameStop, AMC Entertainment Holdings, and other companies targeted in the tussle.

These include Charles Schwab and TD Ameritrade, which have tightened margin requirements on some stocks, including GameStop; Interactive Brokers Group, which put option trading into liquidation only for stocks including GameStop, BlackBerry Limited, and retailer Express Ltd (meaning investors can unwind their positions but not cash in); and Robinhood, which has taken similar measures.

Brokerages catering to “buy and hold” investors view dramatic market swings as destabilizing, since extreme volatility tends to drag on market returns and can undermine long-term bets for people investing for retirement. TD Ameritrade told Quartz it’s looking out for the “investing experience for our clients” and that the trading frenzy has sparked “risk that appears to be divorced from what most would view as traditional market fundamentals.” In a blog post, Robinhood vowed to “continuously monitor the markets and make changes where necessary” and encouraged customers to make use of its “educational resources.”

Retail firms “don’t want to be instruments for manipulating stock prices,” says Fisch, even though defining what amounts to stock manipulation here isn’t easy. Shortly after imposing restrictions, Robinhood was slapped with a class-action lawsuit for allegedly depriving “retail investors of the ability to invest in the open-market and manipulating the open-market.”

For firms like Robinhood bent on democratizing investing, stepping in comes with an uncomfortable twist. “They are damned if they do and damned if they don’t,” says James Angel, a professor at Georgetown University. “The brokerage firms aren’t dumb. They’ve seen this playbook before. GameStop is a classic crowded trade.”

Later today, after users revolted, Robinhood reversed its decision, saying it would resume limited trading of the restricted securities on Friday. It added to its blog that the reason for the restrictions had been to meet SEC capital requirements.

“It’s a special kind of irony when an app called “Robin Hood” prevents the poor from taking from the rich,” one commenter quipped on Robinhood’s Twitter page. “LET THE PEOPLE TRADE,” demanded another.

“Typically this would be the kind of thing that would be handled at the exchange level,” says Fisch, who notes that Nasdaq and the New York Stock Exchange have the power to suspend trading if there’s too much manipulation or too much volatility. “That way all investors are on equal footing.” At least one state regulator is calling for the NYSE to halt trading of GameStop shares for a 30-day period.

National regulators are already on high alert about the prospect of a market crash. But they too face uncomfortable tradeoffs in the GameStop era: In the face of a fragile economic recovery, the consequences of letting markets run hot are just as daunting as forcing bubbles to burst.

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