The Robinhood Markets Inc. User Agreement the brokerage app likely protects against a barrage of lawsuits filed by clients after it blocked a frenzied trading rally in companies like GameStop Corp that was sparked on social media forums.
The owners of internet platforms where much of the discussion took place are also protected from liability for user activities under a 25 year old law known as section 230.
At least a dozen proposed class action lawsuits accuse Robinhood of breaching its contract with clients when it restricted trading on Thursday.
Robinhood’s users were at the center of this week’s wild rally in a handful of stocks heavily shorted by hedge funds and defended by individual investors in online chat rooms, including Reddit’s WallStreetBets.
The lawsuits, which have been filed in federal court, allege that the Menlo Park, California-based company has violated its contractual obligation as a regulated broker to execute orders promptly and effectively.
However, Robinhood is not required by law to execute every transaction and the lawsuits will not succeed without evidence that the company has restricted trading for an improper reason, such as favoring certain investors, several legal experts said.
The user agreement on Robinhood’s website says it “may prohibit or restrict My ability to trade in securities at any time, in its sole discretion and without notice to Me.”
Adam Pritchard, a professor at the University of Michigan Law School, said the lawsuits are unlikely to gain traction.
“The contract says they can,” Pritchard said of the company’s decision to restrict trade. “That appears to be a major stumbling block to the breach of contract claim.”
Robinhood did not immediately respond to a request for comment.
The popular commission-free trading platform had branded itself an app to enable retail investors to take up Wall Street and democratize finances, and the trade restrictions sparked uproar and claims of treason on social media.
Robinhood said the restrictions were necessary to meet regulatory capital requirements and clearinghouse deposits, which it said fluctuate with volatility.
The lawsuits allege the restrictions benefited large funds allegedly invested in or associated with Robinhood.
But the clients are unlikely to take hurdles in court to get to the point where they can demand documents and statements to investigate Robinhood’s actions, said Ann Lipton, a professor at Tulane University Law School.
She said attempts to sue brokers for mishandling client accounts have generally been unsuccessful because of the federal securities law’s restrictions on filing class actions. For example, in 2019, a federal judge dismissed a proposed class action against TD Ameritrade Holding Corp for allegedly mismanaging a tax feature of certain accounts.
The judge said TD Ameritrade customers could not prove that the company had broken promises or was acting unfairly or in bad faith.
The lawsuits against Robinhood are seeking unspecified damages, including punitive damages, which, experts say, represents a new hurdle to the clients’ chances in court.
It will be difficult to prove that users suffered from Robinhood’s measures, as GameStop and other curbside stocks fell sharply on Thursday after the restrictions were announced, said James Cox, a professor at Duke Law School.
“No harm, no foul,” Cox said.
Some of the lawsuits said investors were harmed for not being able to short GameStop, or speculate that the stock would fall.
But some investment firms did take a major blow, and stocks in 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 placed big bets that GameStop would drop in price and suffer massive losses while the stock recovered.
While Reddit users sparked the rally, the messaging platform has been isolated from claims made by the investment funds.
Social media companies are generally not liable for user activities under a statute commonly known as Section 230, a 1996 law that aimed to encourage new forms of communication at the dawn of the online age.
In the early days of the Internet, there were several high profile cases where companies tried to quell criticism by suing platform owners.
One involved a lawsuit against the early online service Prodigy by Stratton Oakmont, the brokerage firm portrayed in the Leonardo DiCaprio movie “The Wolf of Wall Street”. The court ruled that Prodigy was liable for allegedly defamatory comments made by a user because it was a publisher who moderated the content of the service.
The emerging internet industry was concerned that such liability would make a range of new services impossible. Congress eventually agreed to include Section 230 in the Communications Decency Act.
“The whole point of Section 230 is to allow sites like Reddit to allow conversations to take place,” said Eric Goldman, a professor at Santa Clara University School of Law.
“Knowing that some conversations are anti-social and in some cases illegal, Section 230 says this is not the responsibility of the agency creating the location of those conversations.”
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