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Retail investors 'deserve the same opportunities that hedge funds and other pros have': Columbia Law Professor

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Joshua Mitts, Associate Professor of Law and Milton Handler Fellow at Columbia Law School, joins Yahoo Finance's Alexis Christoforous to break down the Robinhood backlash amid the short-squeeze chaos.

Video Transcript

ALEXIS CHRISTOFOROUS: All right, joining me now is Joshua Mitts. He is associate professor of law and Milton Handler fellow at Columbia Law School. Want to get a reaction from him as to what we just heard from Vlad. Good to have you on the show, Josh. You heard Robinhood CEO there defending his company in the face of a class action lawsuit now.

He said he is, "pretty confident that they can defend themselves against that lawsuit". He said that the company has lifted a lot of the trading restrictions. He said they've communicated with their customers and that other platforms have done similar things over the years. Does all of that sound like a plausible defense to you?

JOSHUA MITTS: Well, thanks for having me on. You know, I think that viewed in isolation, it's probably quite reasonable to say, well, we were caught off guard. But there's really a bigger narrative here and I think that's what Robinhood is sidestepping. The narrative is that retail investors are systematically disadvantaged in our financial markets.

This is but the latest iteration in a long string of frustrations that retail investors have encountered when they try to compete with the pros on Wall Street. I mean, this entire episode arose in part because retail investors had been systematically burned by short sighted hedge funds. My research has found to the tune of tens of billions of dollars. So, when Robinhood steps up and in effect restricts retail investors from doing the same thing that these short sighted hedge funds can do through their prime brokerage accounts, it does raise profound questions of equity. Are the markets actually fair for retail investors?

ALEXIS CHRISTOFOROUS: And do you think that, that class action lawsuit actually stands a chance? What might we see happen there based on your research?

JOSHUA MITTS: Well, the customer agreement that every Robinhood customer agrees to when they install the app does allow Robinhood to suspend trading and deny trading at any time, but Robinhood is subject to broader regulatory obligations. And here I think the SEC really needs to step up and scrutinize the level of risk taking and precautions that are in place when brokers offer apps like these to retail investors.

It is entirely predictable that retail investors excited about the opportunity to participate in the markets will in fact make these sort of risky bets. This isn't the first time it's happened. And Robinhood has a responsibility to make sure that these retail investors aren't worse off.

That's a responsibility that the SEC, as the regulatory agency responsible for policing the markets, needs to hold Robinhood accountable for their conduct. If in this case, they didn't have the appropriate capital levels in place prior to the events of yesterday, it's no defense to say that we fix things going forward. There's still thousands, tens of thousands, maybe even more, of retail investors who were worse off as a result of these lax capital and other regulatory compliance procedures that were in place.

ALEXIS CHRISTOFOROUS: When you think about some changes the SEC may make following this this debacle, this frenzied trading, could we see rules around margin calls change? May individual investor is perhaps not be able to buy on margin? Might they have to hold a stock for a certain period of time, which would squash sort of the day trader, if you will?

JOSHUA MITTS: Well see, I think it's just the reverse. I think the more we crack down on the ability of retail investors to enter and exit positions like professional hedge funds can, the more we're systematically disadvantaging those investors. So, I don't think it's a problem that retail investors want to speculate in this way. They deserve the same opportunities that hedge funds and other pros have.

The question is whether the infrastructure treats them fairly. Whether the rules of the road that apply to retail apply equally to hedge funds. It's really a question of discrimination, of treating retail investors differently.

And I think the SEC has an obligation to step in and to say, every broker must treat retail investors fairly. They must treat retail investors the same way that professional investors are treated, as opposed to this sort of paternalistic, we're going to keep you from the same kind of profits that we make available to professional clients. That's what's undermining retail confidence in companies like Robinhood.

ALEXIS CHRISTOFOROUS: The CEO, Vlad Tenev, just moments ago on our air was talking about-- in essence, he didn't use these words, but the idea was that they need to save investors from themselves, individual investors. I'm hearing from you, there are a lot of folks out there who are not that savvy, who are on these platforms and trading. Shouldn't they have these protocols and rules in place to protect them from themselves?

JOSHUA MITTS: Well, I agree completely that investor protection should be at the top of our regulatory agenda. The way to do that is to have a robust and rigorous enforcement regime. I think the real tragedy of this week is that the SEC was not actively intervening like they have, in theory, the capacity to do and cutting off this bubble before it blew up too far or at least under better understanding what was driving this trading. We don't know, for example, whether there might have been one, or two, or three hedge funds behind this GameStop bubble.

We don't know who might have been manipulating the market upwards. And I have no information to suggest one way or the other, but the fact that our regulators are often caught flat footed, that's the real problem here. And we see this systematically, as I said, investors have long been taken advantage of by short sellers.

That's what prompted this outcry. There needs to be policy reform in this area. The SEC, as Senator Warren has pointed out very recently, the SEC needs to start taking market manipulation far more seriously than it has thus far.

ALEXIS CHRISTOFOROUS: Do you think that people who have their money on the Robinhood platform right now would do best to take it off that platform? I mean, they did have to draw on their credit line and raise a whole bunch of cash.

JOSHUA MITTS: Well, I would. I think that's-- it's sort of like fool me once, shame on you. Fool me twice, shame on me. I mean, there's definitely a question, I think, a fair question about the financial prudence with which this company is managing its customers' cash.

They certainly made similar representations prior to yesterday that they made today. I mean, it wasn't as if folks were signing up having been told, well, we might actually run out of capital and we might actually have to restrict your trading. So, you know, one has to wonder whether you might be better off putting your money in a brokerage that does have better risk management practices.

And at the end of the day, you know, Fintech is an exciting new field full of tremendous innovation. But like financial innovation, you know, we saw this 12 years ago. Financial innovation without appropriate regulation, without safeguards that protect the system from excesses, can be a very dangerous thing. And I think we're seeing that here when it comes to consumer facing products.

We're seeing that at the intersection of social media and finance. We're seeing an overall lack of regulation when it comes to financial technology. And I think that's-- there's an urgent need, really, for the SEC to step up and start making more policy in this area.

ALEXIS CHRISTOFOROUS: Right. Joshua Mitts of Columbia Law School. Thank you. I'm sure we'll be seeing some precedent setting policies down the pike. Thanks for joining us and do