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Will GameStop Get Another Boost From the Robinhood Lawsuit?

By Rhian Hunt – Updated Sep 30, 2021 at 4:27PM

Key Points

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Revelations of alleged internal Robinhood communications add another layer of complication to the picture.

The retail investors from the Wall Street Bets Reddit forum, known among themselves as "apes," are likely feeling vindicated about their meme stock choice of GameStop (GME -4.83%) this week. Robinhood (HOOD -1.38%), the online brokerage handling much of the GameStop "short squeeze" trading early in 2021, is the target of a lawsuit alleging damages from its trading limitations during the GameStop frenzy. But will this drama and legalistic uproar have any concrete effect on GameStop itself? Under the right circumstances, they might actually be to GameStop's benefit.

What's going on with the lawsuit

Robinhood, the retail stock trading platform that has hosted at least seven explosively successful IPOs in recent days, was also in the thick of the action during the world-famous GameStop short squeeze in 2021's first weeks. An army of retail investors, using the Reddit subforum r/WallStreetBets to discuss the situation, bought into GameStop and the share price soared. As a result, Robinhood eventually imposed trading restrictions on January 28. The restrictions blocked new purchases of GameStop shares, allowing traders only to sell their stock in the company. This led to share prices crashing from a peak of around $483 to a February low near $40.

A businessperson stopping the fall of dominos.

Image source: Getty Images.

The lawsuit brought against Robinhood and Citadel Securities on behalf of investors claims those investors collectively suffered $10 billion in financial harm from the GameStop trading restrictions, and it alleges significant collusion between Robinhood and Citadel Securities . Robinhood, other brokerages, and hedge funds painted their actions at the time as intended to protect small investors, with one managing director stating publicly, "Brokers were forced to take action because they would be in the firing line if an unsophisticated investor loses money." However, the plaintiffs in the suit allege Robinhood and Citadel Securities "entered an anticompetitive agreement" and that as a result of that agreement, Citadel Securities opened fresh short positions when GameStop shares were at their highest price. Robinhood, the plaintiffs allege, then imposed its trading restrictions in collusion with Citadel Securities to "artificially depress" GameStop's price. This, they claim, caused a collapse in share prices and enabled Citadel Securities to profit from its newly acquired short positions.

New revelations this week include news of documents allegedly presenting evidence of Robinhood's executives directly contradicting their own public statements in their private communications. On Friday, September 24, these emails and memos emerged as part of legal discovery. CNBC reported that while Robinhood CEO Vlad Tenev stated publicly on January 29 the company had "no liquidity problem," simultaneously, internal messages conversely described a "major liquidity crisis." The filings also allege that on "January 27, 2021, the day before the restrictions were implemented, high level employees of Citadel Securities and Robinhood had numerous communications with each other that indicate that Citadel applied pressure on Robinhood." They also state that top executives at both firms were in regular communication prior to and during the short squeeze and trading halt.

Will the lawsuit actually benefit GameStop?

While it is impossible to guess at the lawsuit's outcome and its possible consequences for the defendants, the latest documents seem likely to rekindle Wall Street Bets' retail investors' ire. Even if the evidence fails to win the litigation for the plaintiffs, this new apparent confirmation of the "apes'" suspicions will reinforce their certainty about the corruption of the entire trading process surrounding GameStop and other meme stocks, buttressing faith in the possibility of another short squeeze.

Indeed, on Monday, Sept. 27, the first trading day after the new documents were revealed through discovery, GameStop's stock was up 2.3% at market close. It rose another 0.8% in post-market trading. With no other significant GameStop news at the time, the gains were very likely driven by retail investor sentiment following the release of the alleged new evidence.

How, then, will all this affect GameStop? Just as short-selling doesn't actually reduce the shorted company's cash balance -- despite the apparent belief among many Reddit retail investors that it does -- GameStop's share price rising again won't put more money into the game retailer's pocket. The exception to this will be if GameStop issues new shares, diluting its stock but benefiting from stock prices driven upward by retail investors' bullish positions.

A judge's gavel rests on a wooden stand.

Image source: Getty Images.

The company already did this once, when it sold 5 million shares of stock in June, obtaining gross proceeds of $1.1 billion. This move left GameStop with a practically debt-free balance sheet and $1.78 billion in cash and cash equivalents at the end of the second quarter.

GameStop has plenty of cash, but it desperately needs to transform its business model to something capable of generating a profit under current video game market conditions. At this point, it doesn't seem to have come up with any revolutionary new strategies to give itself a fresh long-term lease on life as an ongoing business. However, if its executives do devise a plan to reforge it into a successful enterprise with a new, profitable direction, the current renewal of retail investor interest could help it repeat its stock-selling cash windfall, if it finds itself in need of even more money to remake itself into a winner among video game stocks

Rhian Hunt has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Stocks Mentioned

GameStop Stock Quote
GameStop
GME
$22.26 (-4.83%) $-1.13
Robinhood Markets Stock Quote
Robinhood Markets
HOOD
$9.26 (-1.38%) $0.13

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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