‘Bad Bets’: Antitrust Class Action Alleges Major Brokerages, Hedge Funds, Clearinghouses Conspired Against Ordinary Investors

A bevy of stock brokerages, hedge funds and clearinghouses worked together to strip non-professional individual investors of their right to control their investments amid last week’s social media-driven price increases, a proposed class action alleges.

The 53-page antitrust complaint filed Monday alleges the following defendants, through a “large, overarching conspiracy,” aimed to prevent the market from operating freely and stop the hemorrhaging of any more money after their highly speculative short-selling strategies for certain stocks were hijacked by amateur investors:

The plaintiffs, non-professional investors in California, allege the companies listed above have violated federal antitrust laws, in particular Section 1 of the Sherman Act and Section 16 of the Clayton Act, in addition to state antitrust and consumer protection statutes.

Rather than use their financial acumen to compete and invest in good opportunities in the market to recoup the loss in their short positions the growth in the Relevant Securities’ prices represented, or paying the price for their highly speculative bad bets, Defendants instead hatched an anticompetitive scheme to limit trading in the Relevant Securities.”

The suit relays that the extent and scope of the defendants’ alleged conspiracy is yet unknown and may be ongoing, even in the face of increased regulatory and customer scrutiny.

Tell me more about the lawsuit.

First, some background.

Per the suit, many retail investors share information on market observations on Reddit, Facebook and TikTok, aiming to help “like-minded peers” benefit from what they’ve learned. As retail investors and other non-professionals continued to buy up shares of certain stocks last week—namely GameStop, AMC Theaters, American Airlines, Bed Bath & Beyond, Blackberry, Express, Koss, Naked Brand Group, Nokia, Sundial Growers, Tootsie Roll Industries and Trivago—the defendants found themselves caught in a classic “short squeeze,” the lawsuit, filed in California’s Northern District, says.

According to the complaint, a short squeeze occurs when a stock or some other asset rises sharply in value, straining what are called “short positions,” which essentially amount to bets that certain shares will sink in value. In a short squeeze, short sellers stare down “increased and theoretically limitless loss,” and eventually must decide whether to buy back the stock, which would increase its value, to mitigate losing money, the suit relays. In the event short sellers buy back certain stocks, known as “exiting” their short positions, the re-purchasing of the stock continues to increase its price, the case states.

As the lawsuit tells it, the defendants, after the close of the stock market on January 27 and before the market’s open the following day, “coordinated and planned” increased short volumes (that is, the number of shares that have been borrowed to open short positions) in anticipation of short calls on January 28.

To accomplish this, the brokerage defendants—companies like Robinhood, E*Trade and TD Ameritrade, who operate trading websites and mobile apps—disabled all buy features on their platforms, which left retail investors no options other than to sell or hold onto their “rapidly dwindling” stocks, the case says. Per the suit, this was done by the brokerage defendants to ensure that stock prices for the dozen stocks listed above went down.

According to the suit, some of the brokerage defendants displayed loading graphics on the landing pages for the stocks to prevent users from buying any more shares. Faced with an imminent drop in the price of their positions in the stocks due to their inability to buy more shares, the plaintiffs and proposed class members were “induced” to sell their shares at “a lower price than they otherwise would have,” the lawsuit alleges.

Consequently, the defendants intentionally placed retail investors between a rock and a hard place, while at the same time artificially reducing the value of certain stocks, in an effort to stop their own financial bleeding, the suit relays. From the complaint:

By doing so, the Defendants and their co-conspirators forced Retail Investors to choose between selling the Relevant Securities at a lower price or holding their rapidly declining positions in the Relevant Securities. Defendants did so to drive the price of the Relevant Securities down.”

It all started with GameStop

As of early 2019, the value of GameStop stock was as low as $3 per share. Retail investors deduced correctly that GameStop, a brick-and-mortar store that had been regularly paying off its debts and now facing the release of the next generation of gaming consoles, was being undervalued as a result of large financial institutions taking sizeable short positions, or essentially betting on GameStop’s failure.

“Due to GameStop’s low stock price, the Retailer Investors correctly determined GameStop represented a good investment opportunity,” the case says.

Soon thereafter, the stock of companies like Nokia drew the attention of retail investors with regard to share valuation and anticipated performance, the suit goes on. Appropriately, non-professional investors bought “long” positions, which are generally held onto with the expectation that their price will rise, in the companies, including stocks, option contracts and other securities, the lawsuit reads.

At the other end of the spectrum, the institutional investors, such as the hedge fund defendants, acquired massive “short” positions on certain stocks, betting that the shares would plummet in price, the suit states. A short position holder profits by way of the difference between the sell price and the buy price.

For example, a short seller borrows a share of Company X (for a fee) from a broker which is presently valued at $10. The short seller immediately sells the share and waits for the value of the share to drop. The share price then falls to $4. The short seller then purchases the share at the reduced value of $4 and returns it to the lender and earns the difference of $6.”

Defendant Melvin Capital was one such short seller who bet big on the failure of GameStop stock, shorting approximately 140 percent of the company’s total shares, the lawsuit says. A hiccup in the Citadel Securities subsidiary’s plan, however, was that retail investors, driven by Reddit’s r/wallstreetbets, bought long positions in GameStop, creating a “short squeeze,” according to the case.

The lawsuit summarizes what came next:

The tremendous growth in the Relevant Securities’ stock price resulted in significant and potentially disastrous exposure of institutional investors, and hedge funds, including the Fund Defendants and their co-conspirators holding short positions in the Relevant Securities.

Defendant Citadel Investments, for example, holds a significant interest in Defendant Melvin Capital (who had the illegal naked 140% short position) and was forced to inject around $3 billion along with another fund, Point72, to bailout Melvin Capital from its distressed short position.

In essence, small Retail Investors concluded that institutional investors had severely undervalued the Relevant Securities by shorting them, presenting a good investment opportunity. By investing in the undervalued Relevant Securities, the Retail Investors were outfoxing Wall Street at its own game.”

Who’s covered by the lawsuit?

The case looks to cover all persons or entities in the United States who directly bought securities in GameStop Corp. (GME); AMC Entertainment Holdings Inc. (AMC); American Airlines Group Inc. (AAL); Bed Bath & Beyond Inc. (BBBY); BlackBerry Ltd (BB); Express, Inc. (EXPR); Koss Corporation (KOSS); Naked Brand Group Ltd. (NAKD); Nokia Corp. (NOK); Sundial Growers Inc. (SNDL); Tootsie Roll Industries, Inc. (TR); or Trivago N.V. (TRVG) from one or more of the companies listed above between January 1, 2021 through and until the alleged anticompetitive effects of the defendants’ unlawful conduct cease.

Can I join the lawsuit?

There’s really nothing you need to do to join or be considered a part of most class action lawsuits. Cases like these almost always take a while to work their way through the legal system, usually toward either a settlement or dismissal. This means it might take a bit before the time comes for those who are covered by a lawsuit—called “class members”—to submit claims for whatever compensation the court deems appropriate.

It’s generally only if and when a proposed class action settles that you’d need to take action, unless you’re interested in serving as a lead plaintiff.

How do I stay in the loop?

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The complaint can be found below.