The Robinhood Markets Inc. user agreement is likely to protect the brokerage app from a flood of lawsuits filed by clients after it blocked a frantic commercial rally at companies like GameStop Corp that was fed on social media forums.
Internet platform owners where much of the discussion took place are also exempt from liability for user activity under a 25-year law known as Section 230.
At least a dozen proposed collective lawsuits accuse Robinhood of violating his contract with customers when he restricted trade on Thursday.
Robinhood users were at the center of this week’s wild high in a handful of shares that had been heavily shorted by hedge funds and defended by individual investors in online chat rooms, including Reddit’s WallStreetBets.
The lawsuits, filed in federal court, allege that the California-based Menlo Park company violated its contractual obligation as a regulated broker to execute orders quickly and effectively.
However, Robinhood is not legally obliged to carry out all negotiations and the lawsuits will not be successful without evidence that the company restricted trading for an undue reason, such as favoring certain investors, according to several legal experts.
The user agreement on the Robinhood website says that “you may, at any time, in its sole discretion and without notice to Me, prohibit or restrict my ability to trade securities.”
Adam Pritchard, a professor at the University of Michigan School of Law, said the lawsuits are unlikely to gain traction.
“The contract says they can do that,” said Pritchard of the company’s decision to restrict trade. “This appears to be a major obstacle to breaking the contract.”
Robinhood did not immediately respond to a request for comment.
The popular commission-free trading platform has become an app to empower retail investors to take on Wall Street and democratize finance, and trade restrictions have sparked a stir and reports of betrayal on social media.
Robinhood said the restrictions were necessary to comply with regulatory capital requirements and clearinghouse deposits, which, she said, fluctuate with volatility.
The lawsuits claim that the restrictions benefited large funds that would have been invested or Robinhood’s allies.
But clients are unlikely to overcome the preliminary court’s obstacles to the point where they can demand documents and testimony to investigate Robinhood’s actions, said Ann Lipton, a professor at Tulane University Law School.
She said attempts to prosecute brokers for improper manipulation of client accounts have generally been unsuccessful due to the limits that federal securities law imposes on filing class actions. For example, a federal judge in 2019 rejected a class action lawsuit against TD Ameritrade Holding Corp for allegedly mismanaging a fiscal feature of certain accounts.
The judge said TD Ameritrade’s customers did not demonstrate that the company broke promises or acted unfairly or in bad faith.
The lawsuits against Robinhood seek unspecified damages, including punitive damages, which represent another obstacle to the clients’ chances in court, according to experts.
It will be difficult to prove that users suffered from Robinhood’s measures because GameStop and other actions covered by the curb fell dramatically on Thursday after the restrictions were announced, said James Cox, a professor at Duke Law School.
“No harm, no fault,” said Cox.
Some of the lawsuits said investors were hurt because they failed to sell GameStop or speculate that the stock would fall.
But some investment firms suffered a major blow and the stock of the companies largely recovered after Robinhood and other online brokers said they planned to lift most restrictions on Friday.
Melvin Capital Management and Citron Capital had made big bets that GameStop would fall in price and suffered huge losses from the stock’s appreciation.
While Reddit users fueled the rally, the messaging platform is isolated from complaints from investment funds.
Social media companies are generally not responsible for user activity under a statute commonly known as Section 230, a 1996 law that was intended to encourage new forms of communication in the beginning of the online age.
In the early days of the Internet, there were several important cases where companies tried to suppress criticism by suing platform owners.
One involved a lawsuit against Stratton Oakmont’s first Prodigy online service, the brokerage house portrayed in Leonardo DiCaprio’s film “The Wolf on Wall Street.” The court held that Prodigy was responsible for allegedly defamatory comments from a user, as it was an editor who moderated the content of the service.
The growing Internet industry feared that such responsibility would make a range of new services impossible. Congress finally agreed and included Section 230 of the Communications Decency Act.
“The purpose of section 230 is to allow sites like Reddit to allow conversations to take place,” said Eric Goldman, a professor at the Santa Clara University School of Law.
“Knowing that some conversations will be anti-social and, in some cases, illegal, section 230 says that it is not the responsibility of the service that creates the location for those conversations.”
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