On 26 January 2022, U.S. District Judge Cecilia Altonaga of the Southern District of Florida dismissed the state law claims related to the “GameStop short squeeze” brought against Robinhood entities. The dismissal follows Judge Altonaga’s previous dismissals of state law claims brought against other brokerage defendants and related antitrust claims. The GameStop short squeeze, which took place in January 2021, caused significant financial losses for short sellers, including several prominent hedge funds. Robinhood (and other online brokerages that placed restrictions on certain stocks) faced multiple class action lawsuits and investigations by state attorneys general, the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the U.S. Department of Justice.

Individual investors purchased “meme stocks” on Robinhood. In January 2021, hordes of retail investors, urged by social media and the popular subreddit r/WallStreetBets, purchased stocks of GameStop, Blackberry, Nokia, AMC and other securities on Robinhood and other online brokerages. The mad rush in buying stocks dramatically increased the stock price and created a “short squeeze” on GameStop and the other securities, forcing institutional investors that had bet against the companies to repurchase shares to prevent even greater losses. By 28 January 2021, GameStop’s intraday stock price had increased to $483.00, nearly 30 times the $17.25 valuation at the beginning of the month. Major short sellers, including Citron Capital and Melvin Capital, closed their GameStop positions at a significant loss. The U.S. Securities and Exchange Commission has since defined “meme stocks” as stocks that “experienced a dramatic increase in their share price in January 2021 as bullish sentiments of individual investors filled social media.”

Several retail trading platforms, including Robinhood, restricted the buying of GameStop and other securities. On 28 January 2021, Robinhood restricted transactions involving GameStop, Blackberry, Nokia, AMC, and other volatile securities, stating that the restrictions were necessary to facilitate compliance with increased clearinghouse deposit requirements. Robinhood’s “position closing only” restriction permitted customers to close out their positions on the restricted stocks by selling their holdings but prohibited them from purchasing new shares. This decision was met with widespread criticism from retail investors and politicians across the political spectrum, including Ted Cruz and Alexandria Ocasio-Cortez. As a result of the restrictions, the stock prices of GameStop and other “meme stocks” fell dramatically, leading to a highly volatile securities trading market. By 2 February 2021, the stock price for GameStop had lost more than 80% of its value from its intraday peak price of $483.00. On 5 February 2021, Robinhood lifted all purchasing restrictions.

Various class actions were filed across the country. Several class action lawsuits, starting with Cheng v. Ally Financial Inc., were filed against Robinhood and other online brokerages for the restrictions they placed on the purchases of a variety of “meme stocks.” In April 2021, the various class action lawsuits were consolidated as January 2021 Short Squeeze Trading Litigation in the U.S. District Court for the Southern District of Florida. The litigation was split into four separate “tranches” of claims:

1. antitrust claims (the “Antitrust Tranche”),
2. state law claims against Robinhood entities (the “Robinhood Tranche”),
3. state law claims against the other broker-dealer defendants (the “Other Broker Tranche”), and
4. federal security law claims.

In November 2021, Judge Altonaga dismissed the Antitrust Tranche claims. In their consolidated class action, the plaintiffs argued that defendants Robinhood, E*Trade Securities. Interactive Brokers, Citadel Securities, Apex Clearing Corp, Electronic Transaction Clearing, and PEAK6 Investments conspired to “artificially constrict the price appreciation of the relevant securities” in violation of the Sherman Act, pointing to regular communication between high-level executives at Citadel and the brokerages during and after the restrictions imposed on 28 January 2021. Judge Altonaga dismissed the plaintiffs’ claim, finding that the communication was vague and that the plaintiffs fell short in showing allegations “explicitly manifesting the existence of the agreement in question.” The Plaintiffs filed an amended complaint on 20 January 2022, so these claims are still in the case.

On 10 January 2022, Judge Altonaga dismissed the Other Broker Tranche claims. This complaint asserted claims for negligence, breach of fiduciary duty and tortious interference with a business relationship against Apex Clearing Corporation. However, Judge Altonaga found that the plaintiffs’ claims were not properly consolidated, and the court therefore lacked subject matter jurisdiction over Apex. The complaint was dismissed.

On 26 January 2022, Judge Altonaga dismissed the Robinhood Tranche claims. The plaintiffs’ tort law claims included negligence and gross negligence, breach of fiduciary duties, tortious interference, and civil conspiracy. The defendants, Robinhood and Citadel, argued that their duties to the plaintiffs are defined by certain Customer Agreements, which stipulate 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.” Judge Altonaga dismissed the plaintiffs’ claims with no leave to amend, agreeing with Robinhood and Citadel that the plaintiffs should be held to the terms of the Customer Agreements. Judge Altonaga noted that contract law, rather than tort law, is a superior mechanism for allocating financial risk and responsibility, stating that “expanding tort law at contract law’s expense may cause uncertainty…[which] can discourage behaviour that benefits society.”

Financial institutions may take comfort in Judge Altonaga’s approach. Judge Altonaga’s approach in the January 2021 Short Squeeze Trading Litigation signals that U.S. federal courts will be unwilling to alter the careful balance between contract and tort law, even when faced with a technologically-evolving and increasingly-accessible financial system which is exposing more ordinary people to financial losses. Accordingly, financial institutions, such as trading platforms, should ensure that their customer agreements contain the necessary safeguards and provisions that will allow them to mount a viable contractual defense when forced to take necessary but unpopular actions, as in the case here.

Brenda DiLuigi, Partner, New York

Elizabeth Raulston, Senior U.S. Associate, New York

Stephanie Sebastian, U.S. Associate, New York