- So a bunch of Redditors
on WallStreetBets found out that a hedge
fund was shorting GameStop. So they thought it'd be
fun to raise the price. In the process, they may have destroyed the financial markets as we know them. Then the hedge fund says that the Redditors are
manipulating the market. The Redditors say that the hedge fund is manipulating the market. And then Robinhood says
that no one can even trade and everyone loses a ton of money and everyone's gonna
end up suing each other. But Hans, Bobi, I'm your white knight. - I must have missed 60 minutes. - And I'm here to
explain what in the world is going on with GameStop,
Reddit, Robinhood and the entire stock market. And whether any of them this is legal. (upbeat music) Sponsored by Ting Mobile. Hey, LegalEagles, it's time to think like a securities' lawyer because trading on the stock
market is booming right now. According to online brokerages,
there's been a huge increase in trading activity during the pandemic. And in particular, a ton of
people have been hanging out on the subreddit forum WallStreetBets. Where they discuss stock tips information while also making fun
stock memes, basically. - Stonks - And part and parcel to that.
Many people have signed up with the trading app and
brokerage known as Robinhood which says it's on a mission
to democratize finance for all. Now, Robinhood is particularly interesting because unlike most
brokerages they encourage or at least allow a huge number of people to trade on margin or to
access options trading which as we'll talk about in a few minutes is sort of like giving
dynamite to children. Now, of course, that might
cause a huge amount of damage but it's definitely
going to be fun to watch. And speaking of which, there
are a lot of gamers on Reddit and they've taken an active interest in the retail video game
shop known as GameStop. There are still 5,000
GameStop stores around America but there's also some reason to think that GameStop is going to struggle in the near future. It faces challenges like
closing malls and competition from illegal downloads
and also legal downloads. Since a lot of people
are downloading games instead of purchasing the physical copies in brick and mortar stores, the company doesn't expect
to turn a profit until 2023. Some people think GameStop
may even disappear just like Blockbuster, but not everyone agrees that
GameStop is on their last legs. And the people of Reddithave
been talking about GameStop as a good company for a couple of years. Then some big time
investors announced that they had invested in GameStop, including the co-founder of
the online pet store Chewy. This made some investors take notice and Redditors realized that many investors had taken a short position on GameStop. The people of this subreddit
decided that if they acted in concert to drive up
the price of the stock they could actually make a
good profit by squeezing people who had shorted the GameStop stock, man, try saying that
a couple of times fast but just a few days ago, there were 1.9 million
members of WallStreetBets. Now it's up to four, maybe 5 million members of WallStreetBets. So if a substantial percentage of those people bought GameStop, then they really could have
an impact on the stock. And that is exactly what we saw happen. In January Redditors got to
work buying up GameStop stock. GameStop's stock price was trading at under $20 at the beginning of the year. But by January 27th,
it had soared to $350. Now the financial industry is up in arms. The SEC is watching, Redditors are pushing up the
price of several other stocks, including AMC, Elon Musk, and the Winklevoss twins
are cheering them on. And so there is a bit
of a David and Goliath framing in this whole war. Especially if you're reading Reddit. The Redditor investors are saying that they're doing just what regular folks When they invest in the markets trying to bet on stock prices on the rise. So although the traditional
investor community is somewhat to gas at all this activity, one could argue that
the little guys and gals were just trying to do
what the wealthier people have been doing for years, hoping to make money
from a company's growth. Though the giant hedge funds, many of whom drive the
short stock positions are pretty mad about this. And they are of course
the enemy of the people, or at least that's according to Reddit. But before we grand stand too much further down
the Victor Hugo track, keep in mind that there are
lots of institutional investors like these hedge funds like
pension funds, endowments and credit unions who may
suffer also huge losses because of what these Redditors
are doing with GameStop and the reverberations that are going through the entire stock market, which takes us to the crux
of what's going on here because you can't understand
the GameStop controversy without understanding the mechanics of the trades that are going on. The question is who is
getting hurt by traders trying to inflate the stock price. Well, it's the people who took
a short position on GameStop. And here's a quick explanation of what that means to short a stock. People obviously invest in
the stock market to make money and most small investors
trying to buy a stock that has not yet reached
its full potential. Making the bet that something will happen to increase the value of
that stock or security. - Stonks. - But investors can also bet against the company's future potential. This is called shorting a stock. Shorting a stock enables an investor to actually make money
when the stock goes down. Because you can't make
money by buying a stock hoping it goes down. Because then the value of the thing that you have purchased has gone down. For an investor to short a stock they actually have to borrow
the stock from someone else. The investor does this by
opening a margin account, which lets them borrow the stock itself. The short seller wants to
see that the stock price will fall in the future, allowing the short seller to buy the stock back at an even lower price and pocketing the difference. But this is a riskier position than simply buying a stock with the hope that the value goes up. When you buy a stock, let's say $20. The most you can lose is
the amount you paid $20. And that will only happen if the stock you bought goes to zero. But shorting a stock is dangerous because at some point you must buy back
the stock that you borrowed. So if you're shorting the stock, you borrow the stock at, let's say $20, and it skyrockets to 500
you're in a world of hurt. If the value of the stock goes up there's no limit to how
much you might lose. The downside risk is literally infinite. You might have to buy
it back at a huge loss. In our example, the
short seller is squeezed. They need to pony up $500 on an initial investment of only $20. So you can do the math. - I'm in danger. - This appears to be what happened with at Redditday traders versus the institutional investors who took a short position on GameStop. A lot of the people on Reddit just simply like GameStop as a company. So they wanted to build up the price. And if they could destroy a
hedge fund at the same time, so much the better. And at some point Redditors
on WallStreetBets realized that more people were shorting the stock than actually owned it. In fact, 140% of the float. A lot of people think that
this is illegal, it's not, this is a relatively normal thing. And hedge fund Melvin Capital
was one of the hedge funds who was on the other end of the trade. We know by now that Melvin capital has closed out its short position which means that they
had to buy all the stock that they were shorting at
a much, much higher price. No one is been able to exactly
confirm how much they lost but we do know that Citadel and Point72 bigger hedge
funds have infused close to $3 billion to Melvin capital
to shore up its finances. And Melvin capital only had
roughly $12 billion to start. And this has fueled speculation that Melvin capital
might have gone bankrupt if not for the cash infusion but that's where things got even crazier. With the price of the GameStop
stock fluctuating wildly going up thousands of percent, in the middle of all of this, Robinhood, the preferred
brokerage and trading app of the people on WallStreetBets decided to stop all trading on
GameStop on January 28th. And some have reported
that as many as half of the people that use the
Robinhood app in general had some sort of position on GameStop. And some have reported that after Robinhood stopped
all trading on a GameStop they allowed some people
to exit their positions but not buy back in. And also some report that Robinhood was actually
closing their positions and selling other options or
stock in either GameStop or AMC causing fury among the people that were trying to hold
onto the stock forever. So with that admittedly
superficial explanation of the facts here. Now we get to the legal questions. Is any of this illegal? Is it illegal for a bunch
of people on the internet, if not to band together then at least express
what they're going to do in the hopes that they drive
prices in a certain direction. Does the SEC care about that? Is it illegal for
Robinhood to prevent people from trading in the way that they want? Is that something that can give rise to a class action lawsuit? And of course the initial action that gave rise to all of this, is it legal for the hedge funds to have a massive short position and
try and drive the market? And the answer as with
most things is, it depends. So let's first talk about
market manipulation. As you probably know,
securities fraud is illegal. Some common types of security fraud include manipulating stock
prices, lying on SEC filings and committing accounting fraud, but fraud also includes activity that manipulates the market. So what do we mean by market manipulation? And why does it matter? Market manipulation tends to distort the prices of stocks and securities, which damages the market's integrity because the conduct can lead
to other market participants to believe that the market
is rigged or unfair. And of course it actually changes the prices that people
pay for these things. - Because our economy is rigged. - And after the financial
meltdown of 2007, 2008, that belief was obviously
somewhat justified. And many people lost their
homes and life savings while giant financial
institutions got bailed out after going effectively bankrupt. Now, after the financial crisis, Congress passed the Commodity Exchange Act as a method of combating
fraud in financial markets. Congress added the CEA section 6(c) which prohibits manipulative
and deceptive devices and contrivances and adopted
a rule which prohibits any manipulative device,
scheme or artifice to defraud. Now market manipulation has been illegal for a very long time. I believe it was in place
in the original Securities and Exchange Act of 1934 under Rule 9. But I'm gonna focus on the CEA definition of market manipulation
because it's both more recent and seems to have a reasonably clear test. Now whether there is market manipulation under the CEA is decided
by a four-part test. That the accused had the ability
to influence market prices. Two that the accused
specifically intended to create or effect a price or price trend that does not reflect legitimate forces of supply and demand. Three that the artificial prices exists, and four that the accused
caused the artificial prices. So the first question, did Redditors have the ability
to influence market prices? Well, it seems clear
after a few days of this that the answer is obviously yes. They succeeded in dramatically
raising the price of stock. Now, did they intend to
inflate the GameStop stock in a way that was legitimate and did not reflect the
forces of supply and demand? Well, obviously you
can argue it both ways. Now on the one hand, this might be an example of
classic market manipulation known as a pump and dump scheme, but it doesn't really fit exactly in that mill you. The classic pump and dump
scheme fraudsters talk up stocks claiming that they have
insight information about something that will cause a stock's value to skyrocket. This insight information
is actually just nonsense. And the goal is to entice buyers to quickly buy a penny stocks. And after the buyers jump in, the fraudsters sell their own shares, making a big profit but causing the price
to drop dramatically. Of course, the new buyers
are left holding their hat and lose their money. This used to happen through cold calls, but in the modern era
chat rooms and forums have been fertile grounds for fraudsters illegally
giving false information in the hope of driving up a stock price so that they can sell for much less. Pump and dump schemes are clearly illegal under several laws, such as
the Securities Act of 1933, the Securities and Exchange Act of 1934 And 18 USC Section 371 at SEC. Now, if this activity
does fall under the rubric of market manipulation, it would qualify as what scholars call open market manipulation because this isn't happening
behind closed doors. This isn't happening
because of a cold call, it's happening in plain sight. It's happening on the internet And everyone effectively has
access to this information. And the SEC argues that
market manipulation can in fact happen through social media, "One way fraudsters may
explore social media is to engage in market manipulation, such as spreading false
and misleading information About a company to affect
that stock share price. Wrongdoers may perpetrate
stock rumors on social media as well as on online bulletin boards and internet chat rooms. The false or misleading rumors
may be positive or negative." And the subreddit
WallStreetBets really seem to be exploiting social media to spur interest in lifting
the GameStop stock price in order to manipulate the market. Four months ago a post
appeared on WallStreetBets with a subject, Bankrupting
Institutional Investors for Dummies featuring GameStop. There's been a perception
that the traders of Reddit are just internet trolls
out for a joy ride. And the title of the post certainly reinforces that perception. You also interpret this post as evidence that the Redditors wanted
to manipulate the market for GameStop stock, and in an illegal way
to hurt big investors who shorted the stock. On the other hand,
there's not much evidence that the posters who used WallStreetBets We're lying about GameStop
or creating false rumors designed to pump up the stock's value so that they could induce
people to buy the stock. WallStreetBets also has a counter-argument that there's evidence that
Redditors were being thoughtful about their position not
intending to screw people over. The post isn't just about
bankrupting short sellers that lays out many
rules reasons to believe that GameStop will make
it as a going concern, "Well it turns out their
books are rock solid. So they offered their
creditors a new set of terms to push back debt for two
years, 50% of them took it. They have eliminated all
excess goodwill impairments. There are 300 billion net cash position with significantly reduced inventory which explains the sharp
reductions in Q1/2 sales and massively cut SG&A by 28% in preparation for the console cycle." And of course, many
things can be true at once especially when you're dealing with a group of potentially
thousands of people who all have different motivations
for what they're doing. Some traders shared apparently
legitimate information about GameStop and talked about it. Their arguments appeared to be convincing to lots of other traders. They have a free speech, right? To make these statements. So was that market manipulation? Well, we have to talk about intent because the SEC and other
enforcement agencies argue that even legitimate
transactions are manipulative. If the trader intends to
manipulate the market. The government's position
is that an investor's intent is enough to turn a legitimate transaction into illegal market manipulation. And anyone who's watched
this channel before at all, knows that the same actual
conduct can become illegal based on the mens rea the mental state that you have when you
conduct that action. And of course the traders of Reddit seemed to have a mix motive, and there are lots of different people acting for many different reasons. On the other hand, there's
almost no argument. This isn't a really weird
and interesting case in part because you generally
don't have the telltale signs of securities fraud. This is not the classic case where someone is talking up a stock, getting other people to buy so that they can sell at
a higher price themselves, really, well, there're exceptions to this it seems that most of the things that people are talking
about on Reddit are true. They are not false. They are talking about
real things in the world, as well as what they intend to do. They're trying to get the entire
internet to buy the stock, hold it, drive up the price, screw over the hedge
funds who are shorting it and potentially save a company that a lot of people
have fond memories over. Though granted fraud is not
required for market manipulation under the SEC's definition. So just because people have good motives doesn't mean that their
intend doesn't qualify as illegal market manipulation. And at the same time, anytime you have a whole
bunch of people coordinating to change the price of something you have to ask he question,
is that an antitrust violation. Because the Sherman
Antitrust Act Section 1, deals with setting market prices and that applies to even individuals. It doesn't just require
the monopolies and cartels are the ones that can't set market prices. When you engage in a
conspiracy to set a price, you might be engaged in something illegal under the Sherman Antitrust Act. But let's talk about who's
manipulating whom here because one reason there's so much fury over this situation is that
people feel like markets are nothing but a fake game anyway. And there's certainly a
kernel of truth to this. Since everyone that
participates in the market changes prices by their very participation in the market itself. And that changes the prices of stocks and securities
to some small degree. But of course the market is regulated. And in other words, there are
laws that constrain traders from crossing certain lines and the Reddit investors claimed that the hedge fund get to
do whatever they want to manipulate the markets
crossing every line that retail investors don't get to cross and are getting punished because of trying to use the same tools that the hedge funds have been using for years. And a lot of people would
absolutely argue that this is a question of under enforcement of the SEC's rules rather
than over enforcement. That there's nothing that
would exempt the hedge funds from the exact same
rules as everybody else. It's just a question
of the SEC's resources. The SEC has been classically underfunded and there's no doubt that
the actual definition is codified in the law
of market manipulation is incredibly broad. It's another question entirely whether all of the activity that falls under that definition should
be considered illegal or not but there's nothing that
would exempt the hedge funds from being punished
under those same rules. If the SEC decided to
make that a priority. But that being said, there is no validity to the idea that short-selling
alone is an illegal practice. Even if someone you
don't like is doing it. Short selling has existed
for hundreds of years basically as long as there
has been stock markets. Short squeezes have existed, gamma traps have existed. All of these are just tools
and in and of themselves don't qualify as market manipulation. But that being said, since we're talking about the hedge funds, let's talk about the
allegations of collusion between Robinhood and the
hedge funds themselves. Many have speculated some
with more evidence than others that Robinhood agreed to stop
trading on the GameStop stock specifically as a
concession to hedge funds that it does business with
in one way or another. And these allegations seem
like more conspiracy theories, than they are based in real life. That being said, it is also possible, if not more probable that these actions are related to legitimate
business concerns rather than a conspiracy to
defraud Robinhood customers. For example, most people
are trading on margin, which means that they're
not actually purchasing individual stocks so much as
getting the rights to purchase the stocks from Robinhood and the market makers that
Robinhood interacts with. And because of that, a lot of these transactions
don't clear for many days after they're put in place these are incredibly
complicated transactions that involve a number
of different companies. And in this instance, Robinhood number one,
was probably was worried about its own liquidity, given the incredible volatility going on it would be able to fulfill these orders. Number two, it was probably worried about the counterparty
risk of the companies that it was dealing
with to make the markets and fulfill these orders. And number three was probably worried about the actual ability of its customers who are trading on extreme margins to place these orders, to actually fulfill the things that they were putting in place. So it's entirely possible that Robinhood had legitimate business justifications for limiting the trading
in the way that it did. Though, just because Robinhood might have had some
legitimate business reasons for undertaking these practices. You can absolutely understand why users of Robinhood were furious, that Robinhood prevented them from buying more shares of GameStop, while only allowing people to sell their positions in GameStop, which apparently resulted in the price of GameStop plummeting. And at the same time, there
were even isolated reports of individual users
who said that Robinhood literally sold the stock that they had purchased in GameStop. Though, I have to believe that
in those particular cases, those users were trading on margin and were probably facing a margin call where in order to meet
the reserve requirements for their margin account the brokerage sells stock to
meet that reserve requirement. That's fairly common when
people are trading on margin and I'd be surprised if
Robinhood sold people's positions who weren't subject to a margin call. But the bottom line is that users of Robinhood are absolutely furious often for a perfectly legitimate reason. And so, because this is America, they did what Americans do and they almost
immediately sued Robinhood. The first lawsuit filed by
Robinhood user Brendan Nelson, in the Southern District
of New York the SDNY, alleges that Robinhood engaged in unlawful market manipulation by removing GameStop
stock from its platform. And Nelson seeks to make
his suit a class action. And there's another lawsuit filed in the Northern District of Illinois by Robinhood user Richard Joseph Gatz, and says that Robinhood protected
institutional investments at the expense of its retail customers, the traders, the WallStreetBets traders. Gatz alleges that this
sudden halts resulted in major losses because
prices were decreasing and Gatz couldn't make any moves. So Gatz has represented himself. And it seems like immediately after Robinhood started doing
this people started clamoring for a class action lawsuit. And many people asked, "Can
Robinhood be allowed to screw over its user base in this way?" Well, I hate to be the bearer of bad news, but it's very likely that these lawsuits are going to be dead on arrival for a couple of different reasons. Number one, when you sign
up for a Robinhood account you are forced to sign up for
their terms and conditions. To trade on Robinhood, you have to sign their customer agreement, regardless of whether you don't read it. This is generally an enforceable contract. So the first question is what
did all of the users agree to? And one of the very first
things that you'll see which is very, very bad news for someone trying to file
a class action lawsuit, is that everyone under section
38 of the user agreement, agreed to arbitration and agreed to forgo a class action suit. Arbitration as you probably know is a form of alternative
dispute resolution for resolving disputes out of court. Now, arbitration is often seen as a boogeyman within legal circles. People think that arbitration
just means a plaintiff will never get anything
and that's simply not true. It just means that things
will be adjudicated in front of an arbitrator
instead of a court But an arbitrator has the ability to fashion almost any remedy. So theoretically you can
get exactly the same remedy that you can get in a courtroom. In an arbitration they
have the power to do so. And the big issue here is that the arbitration clause
includes a class action waiver which means that you're
not going to be able to have a class action represent all of the users of Robinhood, even if you were able to
meet all of the requirements for a class action under rule 23 which I am very, very skeptical
that a plaintiff's lawyer would be able to meet the
requirements that you need to have a class action in the first place. Though at the same time, that can be both a sword and a shield. We've seen many times where a company has included a class action waiver, thinking that by breaking up
every individual plaintiff into their own arbitration case, that's actually in their favor except that when thousands of
individuals take them up on that and have the company
pay for the arbitration, that's going on, the company can get really screwed because they'll end up
paying a huge amount of money just to go forward in arbitration. So sometimes arbitrations
are sometimes they're bad. They're just a tool, but in this particular case it's going to result almost
certainly in the dismissal of the class action suit that
was filed against Robinhood. But then we get to the even
more fundamental issue here which is what the user agreement
allows Robinhood to do. Even if plaintiffs could get
around the arbitration clause their arguments would probably be doomed by the other provisions of the contract that all of the users signed. For example, the
agreement allows Robinhood to take into account market
volatility, section 13 market volatility, market orders, limited orders and queued orders. I understand that during periods of high volume illiquidity, fast movement or volatility
in the marketplace, the execution price received may differ from the quote provided
on entry of an order. I may receive partial
executions of an order at different prices. Of course, Robinhood reserves
the right to restrict trading or prohibited altogether. Section 16 restrictions on trading. I understand that Robinhood
may in its discretion prohibit or restrict the trading of securities or the substitution of
securities in any of my accounts. I understand that
Robinhood may at any time, at its sole discretion and without prior notice to me: one prohibit or restrict
my access to use the app or the website or related services, and my ability to trade, two, refuse to accept
any of my transactions, three, refuse to execute
any of my transactions or four, terminate my account. Now that says nothing about whether this was a good business decision or not. People are rightfully upset. People are furious with the decisions that Robinhood has made, regardless of whether
Robinson had to do it, whether it's colluding with
the hedge funds or not, people are probably going
to leave Robinhood on us because they hate the way
that they have been treated. This is only to say
that the user agreement that Robinhood wrote and made
all of its customer sign, appears to give them a lot of leeway. And I would not be surprised
if these lawsuits fail simply because the customers
agreed to it in advance. But if you don't like it, you can do business with somebody else. And maybe that's a good
idea as Matt Levine who is absolutely the best
financial writer writing today, put it, "Also, I have to
say that if Robinhood stops letting people gamble on meme stocks, that is going to hurt its
ability to attract customers who want to gamble on meme stocks." I simply couldn't have
said it better myself, just because it's legal doesn't
mean you have to like it. But if you want to gamble on meme stonks, you gonna need a cell
phone to mess with the app. And the best cell provider is Ting Mobile. I personally switched to Ting Mobile. Why, because of this. Yes, this is an actual
bill that I actually got and I switched. And it's great because Ting Mobile has three brand new plans to make sure that never happens to you. You can get talking texts
for just $10 a month and pay for the data you use get five gigabytes for $25 a month and even unlimited for just $45 per month. And switching plans is
actually really, really easy because you can keep
your same phone number and use pretty much any phone. And the service is great too because Ting partners with
several massive networks very possibly the exact same network that you're using right
now, but at a huge discount. Now, contractually, I can't tell you which
ones they partner with because I always respect contracts, but I'll give you a hint. My
service hasn't changed at all. Now I've been on the phone with my last provider for hours on just the simplest things but you can transfer services Ting by ordering a Ting SIM card
popping it in and setting it up. No phone call to your old
legacy carrier at all required. It's like magic. And if you're around WiFi all the time, like you're working from home, Ting still gives you their flex plan which gives you the option
to just pay for what you use. It is a smarter, cheaper version of the same plan that they've always had. Now they're just adding
unlimited versions as well. So if you want unlimited data go crazy. If you go to LegalEagle.Ting.com or click on the link in the description you can use your last bill to compare just how much you would save. And LegalEagles will
get a $25 service credit that could cover months of service. So just click on the
link in the description to give it a try, plus clicking on that link
really helps out this channel. So do you agree with my analysis, leave your objections in the comments and check out this playlist over here with all my other real law reviews, where I talk about all the crazy stuff that's happening in the legal world today. So click on this playlist
and I'll see you in court.
The thumbnail is art
Super interesting video. And for once something I know a bit about.
I am not a lawyer but terms and conditions really apply to financial services, those t&c are pretty solid because they need to obey SEC rules and, like with the IRS, you don’t want to be on the wrong side of the SEC (fu filings for every single thing!). I feel a bit vindicated there.
What I didn’t know (because mmm I wouldn’t day trade unless it’s my day job, it’s an expensive hobby) is that RH was letting clients trade on margin, on freaking credit, no wonder they had to stop trades, does anyone remember 1929?
The market moves on volume, that’s just math. Now Reddit has realized that they can create enough volume to move prices which is interesting and probably keeps some SEC officers awake at night. I wonder if WSB could create their own hedge fund to troll further the market, that would be hilarious.
Ah Die Hard,the movie who taught me how to swear in German...
So one thing I thought was weird was he said shorting 140% of the float was "a relatively normal thing"? I'm not sure how he's coming to that reasoning, as far as I could find the second most heavily shorted stock after GME is "ligand pharmaceuticals inc" at ~64% less than half that of GME. By the time you get out of the top 10 heaviest shortest stock its down to ~46%.
I was really disappointed that apparently it’s so legal for a news network to spread completely false propaganda to benefit the market makers that it’s not even part of the conversation.