Class Action Claims Charles Schwab Short Sellers Harmed Financially by Online Account Malfunction

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A proposed class action claims a glitch with Charles Schwab & Co.’s online brokerage system caused certain trades to be processed in the opposite way instructed by the customer. 

The 19-page complaint alleges short sellers in particular were harmed by the malfunction given they were unable to close short positions as instructed, leaving the customers with incorrectly processed trades and shares of unwanted stock. 

Filed in San Francisco Superior Court, the lawsuit says Charles Schwab’s online brokerage account system allows customers to place a wide variety of investment orders online, including buying and selling stocks and mutual funds, and execute simple and sophisticated trades, including buying short positions. A short position, the suit relays, is a trading technique in which an investor sells a security with the intention to buy the same security back later on for profit, often with the belief that the price of the security will likely decrease in the near future: 

“In short selling, a position is opened by borrowing and then selling shares of a stock that the investor believes will decrease in value. Eventually, short sellers must return the shares they borrowed. The investor is betting the share price will decline, and new shares be purchased and given back to the stock lender at a lower price than originally borrowed.” 

The case adds that a short seller pays back a stock lender fees and interest while the short position is in place, or “open.” 

Investing in short positions can be especially profitable during times of significant stock market fluctuation, as seen during the coronavirus pandemic, the lawsuit says, noting that the price of a stock when closed must be lower than the price of the stock when the short position was purchased in order to turn a profit. Given the high risk/reward ratio, it is “critically important” that an investor be able to end a short position in a timely manner because if a stock price begins to rise instead of fall, the investor is exposed to “significant, theoretically unlimited risk of loss,” according to the complaint: 

“Ending the short position is known as ‘closing’ it. To close a short position, an investor buys the same number of shares back on the market—hopefully at a price less than the price the investor paid for it—and returns them to the lender or the broker. This is known as ‘buying to close’ the short position.”

As the lawsuit tells it, however, Charles Schwab’s online platform began to glitch for customers who attempted to close short positions taken on securities. According to the complaint, the malfunction caused Charles Schwab’s system to not “buy and close” short positions as instructed by a customer but rather add shares to their fictitious “long position,” a technique in which shares in a company are bought and held on to with the hope of their price going up.

“That is, rather than buy and close as instructed by Schwab customers, the system incorrectly processes the trade as a buy and not a close,” the plaintiff alleges, describing the financial consequences of the malfunction as “significant.”

“This results in the customer’s short position being kept open and shares of the unwanted stock being added to the customer’s account,” the suit says.

According to the case, Charles Schwab employees have admitted the company’s automated system is not working properly, and have acknowledged short trades are not being handled as instructed.

With regard to the plaintiff, the lawsuit says the man executed “thousands” of trades in the first quarter of 2020 alone. On April 20, 2020, the man submitted trade instructions through the defendant to close short positions on 6,300 shares of Royal Caribbean stock, the suit states. According to the lawsuit, however, the defendant’s automated trading system “acted contrary to Plaintiff’s instructions,” erroneously buying 6,300 shares long and keeping open the man’s short position. 

“This happened several times, and Schwab’s system malfunction eventually left Plaintiff owning 31,500 shares of a stock he instructed Schwab to sell in the first place,” the suit claims. “These 31,500 shares Plaintiff never desired were purchased on margin (i.e., on loaned funds) and were valued at over $1.1 million.”

The plaintiff’s losses exceeded $10,000, the lawsuit claims. 

The complaint looks to represent all Charles Schwab brokerage account clients who placed an order to close a short trading position that was not executed as made. 

Initially filed on June 23 in Los Angeles County Superior Court, the lawsuit has been removed to California’s Northern District. 

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