• Free-stock trading pioneer Robinhood and Interactive Brokers took steps to curb the wild trading activity in heavily shorted names like GameStop.
  • In some cases, investors would only be able to sell their positions and not open new ones.
  • The brokers also raised margin requirements for certain securities.

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Retail brokerages restricted trading on Thursday in GameStop and other stocks caught in a frenzy that has captivated Wall Street and caused big losses for hedge funds.

Free-stock trading pioneer Robinhood and Interactive Brokers said that in some cases, investors would be able to sell only their positions and not open new ones. Both brokerages raised margin requirements on certain securities.

Robinhood told clients in a blog post that it would close out some positions automatically if the client was at risk of not having the necessary collateral. The Menlo-Park, CA based said it plans to allow limited buys of these securities on Friday.

After the announcement, shares of GameStop initially reversed their gains, sliding quickly into negative territory. The stock, which traded above $500 at one point in premarket trading, closed down 44% on Thursday.

In addition to GameStop, the wild trading affected other heavily shorted stocks, including AMC Entertainment, BlackBerry and Koss.

"We continuously monitor the markets and make changes where necessary. In light of recent volatility, we are restricting transactions for certain securities to position closing only, including $AAL, $AMC, $BB, $BBBY, $CTRM, $EXPR, $GME, $KOSS, $NAKD, $NOK, $SNDL, $TR and $TRVG. We also raised margin requirements for certain securities," Robinhood said in a statement.

Raising margin requirements increases how much money an investor using leverage and derivatives must have in their brokerage account after a stock purchase.

"As a brokerage firm, we have many financial requirements, including SEC net capital obligations and clearinghouse deposits. Some of these requirements fluctuate based on volatility in the markets and can be substantial in the current environment. These requirements exist to protect investors and the markets," Robinhhood said in a blog post.

Interactive Brokers said: "As of midday yesterday, Interactive Brokers has put AMC, BB, EXPR, GME, and KOSS option trading into liquidation only due to the extraordinary volatility in the markets. In addition, long stock positions will require 100% margin and short stock positions will require 300% margin until further notice. We do not believe this situation will subside until the exchanges and regulators halt or put certain symbols into liquidation only. We will continue to monitor market conditions and may add or remove symbols as may be warranted."

Interactive Brokers chairman Thomas Peterffy told CNBC Thursday the broker's decision was to protect the market and the clearing house, the body responsible for the trusted transfer of securities and funds between the buyer and seller. Robinhood, however, has its own clearing system.

"We are concerned about the ability of the market and the clearing systems, through the onslaught of orders, to continue to provide liquidity. And we are concerned about the financial viability of intermediaries and the clearing houses," Peterffy said.

Shares of GameStop ballooned nearly 200% this week and nearly 930% this year thanks to emboldened retail investors in Reddit chat rooms trying to stick it to Wall Street pros. The rookies are piling into names heavily shorted by hedge funds, squeezing the stocks higher as the institutions rushed to cover their losses. Shares of AMC Entertainment are up nearly 150% this week.

The steps by Robinhood and Interactive Brokers taken Thursday were more drastic than what brokerages did earlier in the week. TD Ameritrade and Charles Schwab raised margin requirements on Wednesday.

Robinhood customers took to Twitter to express their outrage surrounding the decision. Robinhood has made a name for itself through its mission to democratize investing for everyone. The Silicon-Valley start-up with more than 13 million users pioneered free trading, forcing the entire brokerage industry to drop commissions in late 2019.

"Either #Robinhood allows people to trade freely in the market or they will lose millions of users #ToTheMoon #GME #AMC #NAKD," one twitter user wrote.

"Robinhood canceled stock orders on #gme #amc #NOK  etc.... There should be a class action lawsuit. I thought we had a free market. So Wall Street is OK with me losing hundreds of dollars, so that rich investors can't be called out on their risks.... #wallstreetbets," another user said.

Atom Finance told CNBC that 10.96% of its clients on Robinhood traded GameStop's stock on Monday when the gyrations took off. The research firm said 11% of Interactive Broker clients trade GameStop.

Pushback against Wall Street

The Reddit crew is banding together to rally certain stocks in what some say is pushback against the Wall Street establishment.

Hedge fund Melvin Capital closed out its short position in GameStop on Tuesday after taking huge losses as a target of the army of retail investors. Citadel and Point72 have infused close to $3 billion into Gabe Plotkin's hedge fund to shore up its finances. 

"This is a big problem of the e-brokers' own making as they are so beholden to their payment for order flow overlords and shows the real fragility of the zero commission business model," said Timothy Welsh, founder and CEO of wealth management consulting firm Nexus Strategy.

Taking payments for order flow from Wall Street firms is a controversial, but legal practice done by most electronic brokers. For Robinhood, it's the biggest revenue source.

There was some speculation about brokers receiving pressure from other entities to halt trading in certain stocks.

"Citadel Securities has not instructed or otherwise caused any brokerage firm to stop, suspend, or limit trading or otherwise refuse to do business.  Citadel Securities remains focused on continuously providing liquidity to our clients across all market conditions," the company told CNBC.

Peterffy also confirmed there was no compulsion from market makers.

"The high-frequency traders and hedge funds that could predictably trade against the 'dumb' money from Robinhood traders and pay Robinhood for that information are now realizing that the order flow they are buying is no longer predictable or safe for them. In fact, it now includes thermonuclear bombs in the form of GameStop and AMC," Welsh said.

Rep. Alexandria Ocasio-Cortez weighed in on Twitter, calling Robinhood's new parameters "unacceptable."

"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 tweeted.

Republican Senator Ted Cruz tweeted "fully agree" in response to Ocasio-Cortez.

Amid twitter threats about a class action lawsuit against Robinhood, law firm ChapmanAlbin LLC announced Thursday it is "investigating claims on behalf of Robinhood users that were affected and suffered losses as a result of investing in Gamestop or AMC through the Robinhood brokerage platform."

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