How Can Robinhood Restrict Trading on Some Stocks?

Robinhood users were up in arms recently when the company made the unpopular decision to restrict trading on several stocks, including GameStop (GME 1.20%), AMC Entertainment Holdings (AMC 2.05%), Express (EXPR), Naked Brand Group (NAKD), and Nokia (NOK -1.22%). The move came as the result of rising capital requirements from the Depository Trust & Clearing Corporation, which provides clearing and settlement services for stock trades.

On this clip from Motley Fool Live recorded on Jan. 28, "The Wrap" host Jason Hall and Fool.com contributors Danny Vena and Dan Caplinger explained how Robinhood is allowed to make such a move.

Jason Hall: Great. All right. The first question, the most popular one here, Dan Caplinger, capital growth and it makes sense to kick us anew. Jason McKenna. What a great name, Jason. What a great, great name. "Please explain how it's legal for Robinhood to freeze some accounts from buying a stock while allowing others to freely close their positions to minimize their losses while preventing the other from profiting?"

Of course, it's not just Robinhood. This is something that I think [Morgan Stanley's (MS 1.09%)] E*Trade, Interactive Brokers (IBKR 0.47%), definitely multiple brokers did this today with the whole GameStop saga that's going on. Dan Caplinger, talk to us about this, please.

Dan Caplinger: Well, I was curious. I took a look at things. I'm a lawyer by training, not giving in any legal advice. Danny posted just something just the other minute that was talking about class action lawsuit that maybe you could post to the chat.

Jason Hall: I just dropped it.

Dan Caplinger: Awesome. Whether there's any basis in fact for that, I'm not a 100% sure. But the first thing that I always think of when I have something happen with a business relationship is I look to the foundation of business relationship. That's in the customer agreement.

These days when you sign up for stuff, often there's a 1,500-page document that hardly anybody ever even pays any attention to. You just run through the bottom and click where it says, "I accept." You never think about it again.

But in that agreement, there's a whole bunch of stuff that you agreed to in exchange for using whenever service it is and Robinhood has that customer agreement.

I take a look and on page 6 of that 33-page customer agreement in Section 5, subparagraph F, talking about customer representations and responsibilities. It says, "I understand that Robinhood may, at any time, in its sole discretion and without any prior notice to me, prohibit or restrict my ability to trade securities."

Basically, in exchange for using Robinhood services, you have agreed that if Robinhood wants to tell you, "No, we're not going to let you buy that stock. We're not going to let you just short that stock. We're not going to let you cover your position," it has the right to do that.

Now, how many people read that in the agreement? Probably zero. I didn't read it until now when I was looking for it. I would venture that pretty much every brokerage agreement you've got, not just Robinhood, probably every broker out there, has something very similar there that gives the broker discretion to do these things.

The question Jason McKenna raises about, "Well, how is it fair to do it for some people and not for others?" That, I wonder about. There are some legal prohibitions against discrimination, but the question is whether you're a protected class. Certainly, mainstream investor vs. Wall Street investor is not a court-recognized protected class.

I'd be surprised this class action goes any further than all the class actions you have filed against every single stock on the stock market. Anytime something goes wrong or right against somebody who is betting it, it was going to go right or wrong respectively.

It's frustrating. But it is the leverage that the businesses that you do business with have over you. It's something that you need to get used to because just about all of those agreements, whether it's on the mobile device you use, the internet services that you have, they all have this language there to protect them and give them a lot of discretion and do things that they don't usually do. When they do, everybody's surprised. But it's right there in the agreement that says they can do it.

Jason Hall: The Overton window shifted so much because every time you download an app, anytime you install something on your connected TV, all of those things, you do it every time you do one of those transactions -- every single time. You create an account on a new website. Every time, it's the same thing, and we all do the same thing. We race to the bottom, check off the boxes we have to and then click, "I agree." The fact that none of us read it doesn't absolve us from that contract being in force. Here we are. It's not a very satisfying answer, Dan. Come on. You got to do it better than that next time.

Dan Caplinger: I'm sorry.

Jason Hall: Truth hurts sometimes.

Dan Caplinger: There are situations where you are required to adhere to a contract that is unenforceable because it's a contract of adherence. But voluntarily opening into a brokerage relationship with somebody who gives you stock trading for free, come on, there's a price that you pay for things. If it is free in one way, then there's something you're paying somewhere else.

I'm skeptical of everything and that sometimes makes me have a negative attitude when I should have a positive attitude. But in this case, it's totally consistent with the way things are going. In page six of the customer agreement at the bottom, it's a big F, Purchases under Section 5. Jason, if somebody was asking where that is. That's where it is.