Navigating the New Wave: Young Investors, Social Media, and the Arbitration Dilemma in Post-COVID Markets

Since the COVID-19 pandemic, there has been a surge in young adult and teen investors that the market has not seen before. Fifteen percent of investors in the U.S. stock market reported that they began investing in 2020.[1] Further, the number of custodial investment accounts at Charles Schwab jumped from 120,000 in 2019, to over 300,000 in 2023.[2] Other brokerages, including Vanguard and Fidelity, also reported similar surges.[3] 

The Shift in Investing During COVID-19

In the shadow of the COVID-19 pandemic, teenagers and young adults experienced increased uncertainty about their economic and career prospects.[4] A market downturn at the start of the pandemic lowered stock prices and made investing more accessible among traditionally underrepresented groups in the market.[5] Notably, the majority of these new investors were under 45 and hailed from lower income brackets.[6] Further, new investors were more likely to be ethnically or racially diverse.[7]

While decreased stock prices were a contributing factor, the rise of the latest social media platform, TikTok, led to an uptick in conversations about personal finance and investing among Gen Z. Rather than turning to the traditional investment resources that are common among Baby Boomers and Gen X, 60 percent of teens and young adults turned to financial influencers, dubbed “finfluencers,” for their investment advice.[8] With easy access to trading apps, like Robinhood, millions of Americans entered the market under the guidance of social media.[9] However, many young investors failed to do the proper due diligence and understand the risks of the stock market.[10] As lighthearted memes about GameStop flooded social media in 2021, users rushed to trading apps to join in the profits, ignoring the fine print.[11] When things took a bad turn and lawsuits were on the horizon, consumers were faced with a stark reality: they were bound by an arbitration clause.[12]

American Legal Position on Arbitration Clauses

Federal arbitration in the U.S. is principally governed by the Federal Arbitration Act (FAA).[13] Under the FAA, a written provision to settle controversies by arbitration is valid, irrevocable, and enforceable.[14] Thus, once a consumer agrees to the terms and conditions laid out by their financial service provider, the court is required to refer disputes arising out of the contract to arbitration.[15] The limited grounds for escaping a mandatory arbitration clause include generally applicable contract defenses such as fraud, duress, and unconscionability.[16]

After arbitration is complete, courts have minimal power under the FAA to review arbitral awards.[17] Under the statute, an award can only be set aside on four grounds: it was procured by fraud, the arbitrator was corrupt, the arbitrator refused to hear material evidence, or the arbitrator exceeded his or her power.[18]

 Arbitration has become increasingly common in the financial services industry as it offers a more timely, efficient, and affordable method of dispute resolution.[19] Financial Industry Regulatory Authority (FINRA) Dispute Resolution handles over 99 percent of securities-related arbitration in the U.S.  These proceedings are governed by the FINRA Code of Arbitration Procedure for Consumer Disputes.[20] While FINRA does not require members to use pre-dispute arbitration agreements for customer accounts, member firms are required to adhere to FINRA rules when using arbitration clauses.[21] Further, FINRA arbitration is required if a mandatory arbitration clause was included or if it is requested by a customer.[22]  

Arbitration Agreements Amid the GameStop-Robinhood Saga

In January 2021, the financial world was rocked by a high-profile showdown between retail investors and Wall Street hedge funds, centered around GameStop.[23] Retail investors, organized through online forums like Reddit's WallStreetBets, identified that stocks like AMC and GameStop were heavily shorted stock, meaning that hedge funds were betting on its price to fall.[24] In response, these retail investors began buying up shares of GameStop, driving its price to unprecedented heights until they achieved a “short squeeze” that inflicted heavy losses on the hedge funds.[25] A frenzy of viral memes on social media apps, primarily TikTok, called investors to cause this short squeeze, leading these stocks to be dubbed “meme stocks.”[26]

At the center of this frenzy was the trading platform Robinhood, which found itself caught in a whirlwind of controversy after restricting trading on GameStop and other volatile stocks.[27] This decision outraged users and drew scrutiny from lawmakers, who questioned whether Robinhood was unfairly favoring institutional investors over its retail user base.[28]

A few users decided to file claims alleging damages when Robinhood restricted trading on these “meme stocks” preventing traders from profiting off the short squeeze.[29] Due to Section 38 of Robinhood’s Consumer Agreement, all disputes between parties arising out of the agreement were required to be settled through arbitration before FINRA Dispute Resolution in the State of California.[30]

Joe Batista, an aggrieved Robinhood user, notably secured the first arbitration award arising out of the company’s decision to restrict trading in January 2021.[31] Batista was awarded approximately $30,000, including compensatory damages, interest, and forum fees to RobinHood, through arbitration before FINRA Dispute Resolution.[32] While this was a monumental step in holding Robinhood accountable and awarding an individual investor, the pre-dispute arbitration clause in Robinhood’s Consumer Agreement bars consumers from resolving the dispute through a class action.[33] Under Rule 12204 of the FINRA Code of Arbitration Procedure for Consumer Disputes, arbitration of class actions under the code is prohibited.[34]

However, Robinhood’s arbitration clause did not stop more than 50 lawsuits from being filed in federal court.[35] The actions from 14 jurisdictions were consolidated before the U.S. District Court for the Southern District of Florida.[36] Despite attempts to certify a class, Chief Judge Cecilia M. Altonaga agreed with Robinhood that Plaintiff failed to establish class-wide reliance in relation to the meme stock phenomena.[37] On appeal, the 11th Circuit Court of Appeals opined that while Robinhood took a “sizable…hit in the court of public opinion,” the case should be dismissed.[38]

Resources for Young Investors

The Robinhood-GameStop saga serves as a stark reminder of the power of individual investors in the digital age, while also exposing the complexities and risks inherent in the democratization of financial markets. Young investors must use caution when obtaining their investment advice from social media. In response to these post-COVID investment trends, the North American Securities Administrators Association issued an Informed Investor Advisory in 2022, advising investors to use caution when relying on advice from finfluencers.[39]

Young investors today have access to a plethora of resources aimed at empowering them to navigate the complexities of the financial markets with confidence and knowledge. Investor.gov, operated by the U.S. Securities and Exchange Commission (SEC), offers a wealth of educational materials tailored specifically for novice investors.[40] From basic primers on investing and understanding different types of securities to interactive tools for calculating compound interest and assessing risk tolerance, Investor.gov equips young investors with essential tools to make informed decisions.[41] Further, the Chair of the Securities and Exchange Commission, Gary Gensler, recently emphasized the importance of giving small investors “much-needed legal assistance” at the 2024 Investor Advocacy Clinic Summit.[42] Investor advocacy clinics, like Fordham’s Securities Litigation and Arbitration Clinic, provide legal representation to small investors who have limited resources to battle large brokerage firms.[43]

Additionally, FINRA provides valuable resources through its website, offering educational modules, articles, and guides designed to enhance financial literacy and promote responsible investing practices.[44] Through these platforms, young investors can gain a solid foundation in financial principles, learn about regulatory safeguards, and develop the skills necessary to build a successful investment portfolio for their future.

For those adamant about following the advice of finfluencers, FINRA recommends considering the following questions:

-      Are they a registered financial professional?

-      Do they have a verifiable financial degree or employment experience?

-      What might they have to gain by promoting a particular product?

-      Does their investing philosophy match your own? [45]

As technology continuously transforms the investment landscape, young investors need to evaluate their information sources and utilize reputable educational resources to safeguard their financial futures.

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[1] Krishan Arora, The Rise of the Retail Investor, Forbes (Nov. 4, 2022, 7:30 AM), https://www.forbes.com/sites/forbesagencycouncil/2022/11/04/the-rise-of-the-retail-investor/?sh=71ece3e41755.

[2] Hannah Miao and Gunjan Banerji, These Teenagers Know More About Investing Than You Do, The Wall Street Journal (Feb. 18, 2024, 5:30 AM), https://www.wsj.com/personal-finance/url-teens-stock-trading-apps-e839f82a.

[3] Id.

[4] Angelita Williams and Eric Young, New Research: Global Pandemic Brings Surge of New and Experienced Retail Investors Into the Stock Market, FINRA (Feb. 2, 2021), https://www.finra.org/media-center/newsreleases/2021/new-research-global-pandemic-brings-surge-new-and-experienced-retail.

[5] Id.

[6] Id.

[7] Id.

[8] Serena Espeute and Rhodri Preece, The Finfluencer Appeal: Investing in the Age

of Social Media, CFA Institute (Jan. 25, 2024), https://rpc.cfainstitute.org/en/research/reports/2024/finfluencer-appeal.

[9] Id.

[10] Allan M. Malz, The Game Stop Episode: What Happened and What Does it Mean, 41 Cato J. 529, 530 (2021).

[11] Id.

[12] Id.

[13] 9 U.S.C. § 2 (2024).

[14] Id.

[15] Id.

[16] Id.

[17] Michael A. Stover, The Federal Arbitration Act, Wright, Constable, & Skeen (Oct. 24, 2023), https://www.wcslaw.com/accolades/the-federal-arbitration-act/.

[18] 9 U.S.C. § 10 (2024).

[19] Kim L. Kern, FINRA Mediation & Arbitration: Why ADR Is The Right Choice (March 30, 2021), https://kimlkirnlaw.com/finra-mediation-arbitration-why-adr-is-the-right-choice/.

[20] FINRA, Rule 12200 (2024).

[21] FINRA Reminds Members About Requirements When Using Predispute Arbitration Agreements for Customer Accounts, FINRA (April 21, 2021), https://www.finra.org/rules-guidance/notices/21-16.

[22] Id.

[23] Sarah Cabral and Amy LaCombe, Robinhood, Reddit, and GameStop: What Happened and What Should Happen Next, Santa Clara Univ. Markkula Ctr. for Applied Ethics, https://www.scu.edu/ethics/focus-areas/business-ethics/resources/robinhood-reddit-and-gamestop-what-happened-and-what-should-happen-next/ (last visited on Mar. 13, 2024).

[24] Jim Osman, Why You’re Almost Guaranteed To Lose Money Trading GameStop, AMC & Other Meme Stocks, Forbes (Aug. 26, 2023, 12:47 PM), https://www.forbes.com/sites/jimosman/2023/08/26/why-youre-almost-guaranteed-to-lose-money-trading-gamestop-amc--other-meme-stocks/amp/.

[25] Id.

[26] Eric Levitz, How Redditors Beat Hedge Funds at Their Own Game(Stop), N.Y. Mag. (Jan. 27, 2021), https://nymag.com/intelligencer/2021/01/reddit-gamestop-share-price-explained-wallstreetbets-melvin-capital.html.

[27] Malz, supra note 10.

[28] Tara S. Bernard and Gillian Friedman, Robinhood Says It Will Reopen GameStop Trading, Wall St. J. (Feb. 12, 2021), https://www.nytimes.com/live/2021/01/28/business/us-economy-coronavirus.

[29] Id.

[30] Robinhood Customer Agreement, Robinhood (Jan. 18, 2024), https://cdn.robinhood.com/assets/robinhood/legal/Robinhood-Customer-Agreement.pdf [hereinafter the “Robinhood Customer Agreement”].

[31] Iorio Altamirano LLP Wins First Arbitration Award in the Nation Over January 2021 Trading Restrictions, Holds Robinhood Accountable, Businesswire (Jan. 7, 2022, 10:00 AM), https://www.businesswire.com/news/home/20220107005121/en/Iorio-Altamirano-LLP-Wins-First-Arbitration-Award-in-the-Nation-Over-January-2021-Trading-Restrictions-Holds-Robinhood-Accountable.

[32] Id.

[33] Robinhood Customer Agreement, supra note 28.

[34] FINRA, Rule 12204 (2024).

[35] Matthew Goldstein, Robinhood is Facing Nearly 50 Lawsuits Over GameStop Frenzy, N.Y. Times (Feb. 26, 2021), https://www.nytimes.com/2021/02/26/business/robinhood-gamestop.html.

[36] Robinhood Defeats Certification of Proposed Class Asserting Securities Claims In Sprawling Meme Stock Litigation, Cravath, Swaine & Moore LLP (Nov. 15, 2023), https://www.cravath.com/news/robinhood-defeats-certification-of-proposed-class-asserting-securities-claims-in-sprawling-meme-stock-litigation.html.

[37] Id.

[38] Juncadella v. Robinhood Fin. LLC (In re January 2021 Short Squeeze Trading Litig.), 76 F.4th 1335, 1355 (11th Cir. 2023).

[39] NASAA Cautions Investors on the Rise of the Finfluencer, NASAA (Aug. 9, 2022), https://www.nasaa.org/65026/nasaa-cautions-investors-on-the-rise-of-the-finfluencer/.

[40] Investor.gov, Sec. & Exch. Comm’n, https://www.investor.gov (last visited Mar. 13, 2024).  

[41] Id.

[42] Prepared Remarks Before the 2024 SEC Investor Advocacy Clinic Summit, Gary Gensler, Chair, Sec. & Exch. Comm’n (March 1, 2024, 11:15 AM), https://www.sec.gov/news/upcoming-events/2024-investor-advocacy-clinic-summit.

[43] Securities Litigation and Arbitration, Fordham L. Sch., https://www.fordham.edu/school-of-law/experiential-education/clinics/securities-litigation-and-arbitration/.

[44] For Investors, FINRA, https://www.finra.org/investors#/ (last visited Mar. 13, 2024).

[45] Following the Crowd: Investing and Social Media, FINRA (March 13, 2023), https://www.finra.org/investors/insights/following-crowd-investing-and-social-media.