Robinhood, Other Brokerages Restrict Trading on GameStop, AMC

The rally in the shares fizzled Thursday: GameStop dropped 44%, and AMC lost 57%. Other popular stocks among individual investors including

BlackBerry Ltd.

,

Bed Bath & Beyond Inc.

and headphone-maker

Koss Corp.

lost 28% or more. All five are still up 89% or more year-to-date. Thursday’s losses came amid an otherwise upbeat day for markets, with the S&P 500 rising 1%.

In a week on Wall Street that has pitted individual investors against seasoned professionals, the trading restrictions were interpreted by many as the latest sign that financial markets are stacked against individuals. Gathering on social media platforms like Reddit, Discord,

Facebook

and Twitter, individual investors have piled into stocks like GameStop and AMC that were once left for dead and banded together to intensify losses among professional traders betting against the stocks.

At least three brokerages said the trading restrictions stemmed from mandates from their clearing firm, which process the securities on the back end after a user executes a trade with their brokerage. Webull Chief Executive Anthony Denier said his platform’s clearing firm, Apex Clearing Corp., notified him Thursday morning that Webull needed to shut off the ability to open new positions in certain stocks. Otherwise, Apex wouldn’t be able to settle the trades, he said.

The clash between short sellers and individual investors, frenzied trading in shares talked up on social media platforms and trading restrictions swiftly put in place left many financial professionals stunned.

“It’s a domino effect,” Mr. Denier said, adding the industry was likely reckoning with the question of whether “customers could pay for the stocks they had to buy to cover their short positions.”

“If [they] are not able to pay to cover their short positions, someone else is going to have to pay for that purchase,” he said. “And if their clearing firm fails and there’s not enough collateral in the account to cover the purchase, that trade fails and will cascade into multiple trades with multiple customers.”

Apex didn’t respond to a request for comment.

Webull later reopened trading in the three stocks it restricted: GameStop, AMC and Koss. Robinhood also said it would allow limited purchases starting Friday of the at least 13 stocks it restricted. The company said its initial decision to curtail trading in the stocks was based on its capital obligations and clearinghouse deposits, which fluctuate based on volatility in the markets. It added the decision wasn’t made on the direction of any market maker to which it routes orders, noting it was a “risk-management decision.”

An E*Trade spokeswoman said the company had imposed restrictions to “ensure that we could continue to serve our broader client base,” and that it expected to resume normal trading operations Friday.

Criticism of the restrictions was swift.

A group of individual investors filed a purported class action complaint against Robinhood on Thursday, alleging that the popular brokerage “deprived their customers of the ability to use their service” as well as potential gains from trading for “no legitimate reason.”

Among others rebuking the moves by the brokerages were Rep. Alexandria Ocasio-Cortez (D., N.Y.), Sen. Ted Cruz (R., Texas), billionaire

Mark Cuban

and

Dave Portnoy,

the founder of the popular digital media company Barstool Sports Inc. Mr. Portnoy was one of countless individual investors who dove into the markets this year, often streaming his trades to his followers on Twitter.

Ms. Ocasio-Cortez tweeted: “We now need to know more about @RobinhoodApp’s decision to block retail investors from purchasing stock while hedge funds are freely able to trade the stock as they see fit.”

She continued: “As a member of the Financial Services [Committee], I’d support a hearing if necessary.”

Mr. Denier at Webull said the restrictions originated Thursday morning when the Depository Trust & Clearing Corp. instructed his clearing firm, Apex, that it was increasing the collateral it needed to put up to help settle the trades for stocks like GameStop. In turn, Apex told Webull to restrict the ability to open new positions in order to prevent trades from failing, Mr. Denier said.

DTCC, which operates the clearinghouses for U.S. stock and bond trades, is a key part of the plumbing of financial markets. Usually drawing little notice, it facilitates the movement of stocks and bonds among buyers and sellers and provides data and analytics services.

In a statement, DTCC said the volatility in stocks like GameStop and AMC has “generated substantial risk exposures at firms that clear these trades” at its clearinghouse for stock trades. Those risks were especially pronounced for firms whose clients were ”predominantly on one side of the market,” a reference to brokers whose customers were heavily betting for stocks to rise or fall, rather than having a mix of positions.

The statement added that when volatility increases, it increases margin that DTCC collects from the banks and brokers that use its clearing services. “Margin requirements protect the entire industry against defaults and systemic risk in volatile markets,” it said.

Other brokerages including Ally Financial Inc. and Public Holdings Inc., which runs social investing network Public.com, also said Apex Clearing halted all opening transactions on GameStop, AMC and Koss.

“While we cannot speak to the specifics behind Apex’s decision, these types of restrictions are typically put in place due to increased volatility, when securities transactions introduce systemic risk to trading platforms, customers, and the market at-large,” a spokeswoman for Ally said.

Ultimately, trading in all three stocks was restored on Ally and Public.com as well.

Retail trading platforms, including Robinhood in particular, have been facing increased scrutiny from regulators. Massachusetts securities regulators filed a complaint against the company in December alleging it aggressively markets to inexperienced investors and failed to implement controls to protect them.

Robinhood has disputed those allegations and says it prides itself on “democratizing” the markets for investors, including for first-time traders. It reiterated that mission Thursday in a blog post, saying it is committed to helping customers navigate the current uncertainty in the market.

—Akane Otani and Alexander Osipovich contributed to this article.

Write to Caitlin McCabe at caitlin.mccabe@wsj.com