What happened

Shares of Virgin Galactic Holdings (SPCE -1.52%) traded up as much as 7.4% on Thursday before abruptly changing course and heading back down toward earth. The government is stepping in to investigate Virgin Galactic's historic flight that sent founder Richard Branson into space, and has grounded the company until the probe is complete. The shares fell as much as 7% in afternoon trading before recovering slightly.

So what

Virgin Galactic is a volatile ticker on even the quietest of days, twice so far in 2021 doubling for the year before giving back all of those gains each time. The initial rise on Thursday appears to just track a risk-on day for the markets -- fellow space stock Rocket Lab USA was up as much as 20% at one point. But the decline had a clear explanation.

Richard Branson and the crew pose in front of the Unity spacecraft.

Image source: Virgin Galactic.

The Federal Aviation Administration in a statement emailed to news organizations said it had launched a review into why Virgin Galactic's SpaceShipTwo flew outside of the area for which it was cleared during a July 11 flight. The flight was a major milestone for Virgin Galactic, as Branson became the first of hopefully many space tourists to take advantage of the company's services.

The FAA said it will not permit Virgin Galactic to fly while the review is ongoing.

"Virgin Galactic may not return the SpaceShipTwo vehicle to flight until the FAA approves the final mishap investigation report or determines the issues related to the mishap do not affect public safety," the FAA wrote in a statement to CNBC.

The grounding follows a New Yorker article that was critical of Virgin Galactic's safety culture. Virgin Galactic in response told CNBC it disputes what it calls "the misleading characterizations and conclusions" in the article.

Now what

The deviation was relatively minor, and the FAA's job is to take every little issue seriously, so there is no reason to believe this will be a long-term setback for Virgin Galactic. That said, the reputational risk is huge.

Going into space, even for a brief few minutes, is inherently dangerous, and few are going to be willing to pay the six-figure price to reach weightlessness via Virgin Galactic if they aren't absolutely convinced the rocket is safe.

The Branson flight was meant to demonstrate how reliable the service was, but instead it is turning into an eyesore for Virgin Galactic. It's too soon to know what the long-term impact will be on its reputation, but investors are moving to the sidelines on Thursday based on that new risk.