Suing Robinhood - Again

What's down, you guys? It's Graham here, and this is not a video that I was planning to make today. In fact, I was never planning to make a video like this ever. But given the recent circumstances and allegations, I think this is worth diving into further so you understand exactly what's going on, why Robinhood and GameStop is now the center of controversy for market manipulation, and how this impacts you as an investor no matter what you're investing in.

Because I have a feeling for most of you watching, this story goes a lot deeper than you realize. It's so important to understand what's going on. By the way, if you want to help this video reach more people, go ahead and diamond hand that like button for the YouTube algorithm. That way, YouTube could recommend this video to an even bigger audience, which means this could potentially reach way more people who deserve to know the significance of what's going on and how this impacts them. So thank you so much for doing that.

And now let me quickly bring everyone up to speed because a lot has unraveled over these last 24 hours. And by the way, if you've already been following this extremely closely and you want to skip some of the background information, just go to this timestamp right here, and that way you get to go right to the current events. But for anyone who wants to be brought up to speed, here you go. This is basically the explain lincoln 5 tldr version of the entire story summed up in about a minute because this explains exactly how we got here.

GameStop, as I'm sure we're all aware, is a retail gaming shop that's been slowly declining in business as more and more people resorted to online downloads versus buying in-person games. Because of that, hedge funds and large institutional investors felt like the price of the company was overvalued and that eventually GameStop would take the same path as Toys R Us and Blockbuster, which declined in business and had to file for bankruptcy. So those big institutional investors shorted the company, essentially betting that the price of the stock would be going down.

However, out of nowhere, GameStop had a series of positive news that began driving up the price of the stock as investors believed that maybe things could turn around. This included a 519% jump in online sales, the billionaire co-founder of Chewy.com wanting to restructure management, and a multi-year strategic partnership with Microsoft. At that point, though, a user on Reddit's Wall Street Bets discovered that large institutional investors actually shorted more shares than exist on the market, meaning that there weren't possibly enough shares to buy in the event the stock price begins going up.

Of course, by now you're probably wondering how on earth are you able to short more stocks than even exist on the market? Well, here's where things start getting really good. Anytime you short a stock, you're actually borrowing it from person A and then immediately selling it to person C with the expectation of being able to buy it back from person C in the future at a cheaper price. So that way you could eventually give it back to person A while you pocket the difference in profit. But shares like this could actually be borrowed multiple times, and there's nothing stopping person C from loaning the stock to person D, who also wants to short the stock, by loaning it to person E, and this continues while the same stock is shorted multiple times, transferring from one person to another to another until eventually, more stocks are shorted than actually exist for sale.

Well, Reddit saw this, and they knew that the good news combined with an increased demand by the stock would cause a lot of these institutional short sellers to lose money. And when they're unable to find enough shares to buy so that they could return it to the person they borrowed it from, they would be forced to pay whatever price that you would want. However, institutional hedge funds caught on to this, and they saw the stock price rising up, so they literally doubled down, sunk billions of dollars into an even heavier position to stay afloat, and now it's become a full-on game of chicken to see who sells first: retail traders who could stand to make billions of dollars or hedge funds, which could go bankrupt.

Now, because of this unique situation, there's been a few rather serious implications for all of us as investors that we haven't really seen before. First, the trading of these meme stocks have been halted multiple times due to extreme volatility. This happens when stocks increase so much so quickly that it completely detaches from its fundamentals. And when that happens, the New York Stock Exchange reserves the right to temporarily suspend trading to give investors a small time to cool off.

Well, as it would turn out, trading in GameStop was halted for volatility nine times on Monday and five times on Tuesday because it went up and down too much in price too quickly. The Nasdaq CEO also said in response to this that they would halt trading in a stock if they link it to unusual social media chatter. But where do you draw the line between recognizing a market inefficiency in a public form for everyone to see and market manipulation?

Now, I'm certainly not a lawyer, and everything I'm talking about here is complete nonsense, so you should not even be listening to me. But how is Wall Street Bets publicly calling GameStop to potentially hit a thousand dollars a share any different than Kathy Woods talking about Tesla possibly hitting 7,000? Think about it. Large institutional investors do this all the time, and their message is circulated through tens of millions of people throughout the entire world in a matter of hours.

Now, I've been saying this for quite some time, but this is going to be extremely difficult to regulate because it becomes impossible to figure out where to draw the line and at which point you're liable for what you say online. Is it based on the size of their audience? Is it based on their influence? Who's to say what that is and when that mark is crossed? If everyone collectively agrees on a certain sentiment, who's to blame? Is it the person who started it, or do you go after the entire group, or maybe the website the group is hosted on is now responsible? Then once you go beyond that, how do you actually prove damages or intentional wrongdoing? What if you just happen to like the stock and have diamond hands?

Honestly, all of this is just open to interpretation, and while I always think it's a good idea to be completely honest with full disclosure, it's probably going to be a very lengthy battle if they try to regulate what someone can and cannot say in a public forum about their investments, and most likely it's something that is never going to be easily regulated.

Second, I realize this is what everyone wants me to talk about, and that would be Robinhood and the alleged price manipulation on the morning of Thursday, January 28th. Robinhood, along with several other brokerages, disabled their users from being able to buy certain stocks like AMC, GameStop, Blackberry, Nokia, and a few others, only allowing them to sell their positions, thereby inadvertently causing the price of those stocks to drop substantially. That completely eliminates the natural price discovery of the stock market, where people are free to buy and sell a stock for whatever they feel it's worth.

Because of that, users are alleging that Robinhood is guilty of price manipulation as defined by the SEC: one, intentionally controlling or artificially affecting the price of securities; two, intentional interference with the free forces of supply and demand; and three, could be designed to drive the stock's price up or down. And even the SEC says that this affects the integrity of the entire stock market. It undermines fair and honest orders, and investors are going to be less likely to participate if they feel like the market is rigged against them.

Whereas instead, the price of the stock should really be set by the collective judgment of both the buyers and the sellers. That's why now there's a big push for a class-action lawsuit against Robinhood, claiming that Robinhood has been pulling stocks from its platform in order to slow growth and help benefit Robinhood's large institutional investors and partners, not its customers, to whom it should owe a fiduciary duty.

Robinhood did respond to this after the market closed, saying that this was done as a financial requirement to meet SEC net capital obligations and clearinghouse deposits. And they ended it by saying, “To be clear, this decision was not made on the direction of any market maker we route to or other market participants.”

But there's also certainly another theory that's floating around out there on the interwebs. Now, I want to make a very important note here that none of this is a fact; this is all just a theory and my uninformed opinion that you should definitely not listen to. But some people think that it might have to do with exactly who routes Robinhood's order flows, and that would be Citadel.

Here's how that works: when you place a trade on Robinhood, Robinhood is not the one who executes that trade. Instead, they instantly outsource it to another company that pays Robinhood for the right to execute your trade, and in this case, that company is Citadel. But that same company, Citadel, recently lent 2.8 billion dollars to Melvin Capital, who was on the brink of bankruptcy because they had shorted GameStop and lost 13 billion dollars, and the stock wasn't going down. So this is now potentially, in theory, allegedly where some of this starts piecing together according to other people who think this is true.

So many people argue that this is a conflict of interest and blatant price manipulation to protect Citadel, who loaned money to Melvin, who is losing money because of GameStop. And Robinhood, now to be fair to Robinhood, this did happen to other brokerages as well who happened to use Apex Clearing to process their trades, or maybe it has less to do with the brokerages and more to do with the companies that route all of that order flow.

Well, many people seem to think that these companies would rather face a class-action lawsuit and pay a fine than potentially risk billions of dollars and go bankrupt. Today, I'm really trying to do my best to be as neutral as possible when it comes to this because I don't think it's fair just to point our fingers at Robinhood when most likely this is a lot deeper than I'm sure a lot of us realize, and it's certainly going to require a lot more research to get down to what's really going on.

But I hate to say it, guys, as interesting as it is to think about Robinhood trying to protect Citadel trying to protect Melvin Capital by disabling the buy button, the actual reason could possibly be a little less exciting than you think. Remember, the buy button of GameStop was temporarily disabled across multiple brokerages, extending way beyond just Robinhood. Even the CEO of Webull went on record yesterday to explain that their clearing house Apex was dealing with a behind-the-scenes issue and had to disable trading against their wishes.

See, when you buy or sell a stock, that money does not immediately change hands even though it'll show up instantly for you in your account. Instead, the money goes through a clearing process where all of those transactions are recorded and settled about two days later. But what happens if the person you bought your stock from goes bankrupt before the clearinghouse is able to settle the transaction? Then all of a sudden, the broker can't deliver your shares.

So they go to the clearinghouse, but they can't deliver your shares because the person they were getting it from went bankrupt. So they now have to pay out of pocket. But when the price of the stock skyrockets to unbelievable numbers, the clearinghouse simply doesn't have that much in reserves, and that could cause them to go under as well. Essentially, there weren't enough shares of GameStop available to buy. They couldn't margin call the short sellers fast enough to provide liquidity; they couldn't guarantee that those stocks would be available when you bought them, and they didn't want to be on the hook for the next two days if they couldn't provide you with the stock that you bought to the price that you bought it for.

Then apparently, the Depository Trust Company, who clears transactions, saw this happening and told their clearinghouse that starting immediately, they will need 100 percent collateral on hand in order to cover the price of the stock being bought. But clearinghouses didn't have that type of capital on hand with a moment's notice, and brokerages didn't want to be on the hook for delivering shares that might not exist. So the only option was to refuse to clear GameStop purchases, which in turn caused brokerages unable to offer those shares for sale.

Unfortunately, the Robinhood CEO did a really bad job explaining this, but the CEO of Webull was very upfront about the situation, and this probably makes more sense. Plus, Webull's gonna be offering you four free stocks when you deposit a hundred dollars on the platform using the link down below in the description, and that could be worth all the way up to one thousand six hundred dollars.

Now, anyways, what they said 100 percent confirmed to be the case? Maybe, maybe not. Is it possible that the clearinghouses are all in on it and trying to crash the stock as well? Who knows? I know it’s fun to band together and try to pick an enemy, and Robinhood is definitely the easy target. But at least I'm going to be giving you all the information, and then you can make a decision for yourself.

As far as where we go from here, we have two sides to the coin. One, we have the SEC, who wants to monitor market volatility and communications around stocks like this, alongside regulation around communities like Wall Street Bets. And two, we have hundreds of others who want to monitor the stock trading platforms to ensure that stocks are readily open for buying and selling without restriction.

One side argues that Reddit artificially drove up the demand in the price of GameStop, while the other side says that they just took advantage of greedy Wall Street funds who exploited the system by overly shorting the stock and trying to drive down the price. To me, Robinhood disabling the buy button is just like pouring gasoline on the fire. But the way I see it, this event is most likely almost guaranteed to cause further regulation to prevent something like this from happening again in the future.

Most likely the SEC is going to find a way to prevent more than 100% of the shares from being shorted all at once. That way there’s not going to be this cataclysmic slingshot of value in the event that the price starts going up, and that would definitely soften the blow for something like this happening again. And even though I'm 100% sure they're going to start to pay very close attention to communities like Wall Street Bets, that's going to be very difficult to ever enforce, especially if a lot of people just like the stock.

And it’s going to be difficult to calculate how much market perception influences the price that someone is willing to pay for whatever stock they want to buy or how much value is attributed to hype versus someone's real conviction about buying a stock that they believe is undervalued. But I think one thing is for sure: disabling the buy button was not the right way to do it.

And I was upset that this was seen as the best solution to what I think is a much greater problem. If you agree with me on this, just make sure to subscribe and smash the like button for the YouTube algorithm. And with that said, you guys, thank you so much for watching. I really appreciate it.

As always, make sure to also follow me on Instagram. I post it pretty much daily, so if you want to be a part of it there, feel free to add me there. As my second channel, The Graham Stephan Show, I post there every single day I'm not posting here. So if you want to see a brand new video from me every single day, make sure to add yourself to that.

And lastly, if you guys want four free stocks, use the link down below in the description, and Webull is going to be giving you four free stocks when you deposit 100 on the platform, with those stocks potentially worth all the way up to 1,600 dollars. So if you want four free stocks, enjoy it. It's pretty much like free money down below in the description. Let me know which stocks you get. Thank you so much for watching, and until next time!