Robinhood is 'toast' after GameStop backlash: The Real Wolf of Wall Street Jordan Belfort

Jordan Belfort, Author of The Wolf of Wall Street, joined Yahoo Finance to discuss the GameStop phenomenon.

ADAM SHAPIRO: We want to invite into the stream Jordan Belfort. He's the author of "The Wolf of Wall Street." A lot of people know him for several reasons. I remember speaking to you when I worked at Fox Business many, many years ago. But we invited you in. And we don't want to glamorize you because of the past. But the past is in the past. But you have insight into Wall Street and what's going on with the GameStop phenomenon that could be useful to people. So what's the most important thing you want them to know, given what you've witnessed over the last 20 years?

JORDAN BELFORT: Well, listen, you know, it's amazing what these group of Robinhooders and Wall Street betters have been able to do. I mean, I used to battle with the shorts all the time. The shorts are usually right in the sense that they have the fundamental value, you know, pretty much worked out. But they have a way also sometimes of getting overly aggressive. So there's different types of short players. There are short-sellers that, you know, are healthy. They check the market. They bet against stocks. That works. It's good. It creates liquidity. It stops stocks from going up too fast.

Then there's other types of shorts that actually conspire to drive stocks down. They will create press releases, investigations. And they will try to short a stock out of business almost. They often are so short, they have the potential to create a short squeeze, meaning if buyers come together on the other side, they can create a rally and literally wipe the shorts out.

What the small investor has been able to do here is shocking. It deserves an applause, I think, by the way. I don't think it's illegal because most of them, by the way, if you actually go through the message boards, what they're saying, they're just like, they love the stock. They're just having fun, and they want to kind of stick it to the man more than anything. So it's a shocking thing, but they better be careful, because when it's over, it's going to be like catching a falling knife. And it's going to drop precipitously. So, I just want people to be really careful when they're playing in this space.

ADAM SHAPIRO: So let me just follow up with you because there are some people who are saying what we might be witnessing is some kind of either social media pump and dump-- and your history, you would know what a pump and dump looks like-- or maybe a big money silent person in a different form has gotten onto that Reddit channel and is manipulating people. What would you say?

JORDAN BELFORT: You know, listen. You know, you might-- the latter point, I mean, you would never really know. That's a good question. I guess you'll find out in the end. I doubt that. I think what you have here is a groundswell from the masses. People are locked up. They're bored. There's a convergence right now of technology. People can trade immediately now. There's access to information. There's ways to exchange ideas. It's like the perfect storm. And I think it represents a paradigm shift in how stocks trade, how they'll have to be not shorter or shorter, depending on not just on, do you think it's a bad company, can you get squeezed?

Now as far as, is there a crime going on, you know, listen, I wouldn't say it's a crime. When I first looked at it, I said, yeah, it's a modified pump and dump, right? Because in some respects, it is. You know, the stock is being pumped up. But here's the deal. Most of these people, like they know-- if you actually go through the messages, when I even said pump, they're like, no, we want to hold it. These people, like, they want to buy and hold. So, you know, I guess, you could argue that probably, you know, the stock's overvalued heavily. No one would deny that right now. It's massively overvalued.

But then, again, you know, on any given day, the stock is worth whatever the market says it's worth. So when you have these short squeezes going on, there are these blips where you're going to have wildly inflated prices. We see it now happening with the silver market again. Because it doesn't take that much, especially when you're buying options, which magnifies the buying effect.

So, again, the issue I have is that when these things unwind, they will unwind really fast on the downside. And typically, it's the last person on the deal team. For example, I had someone fixing my TV the other day. They said, oh, my mom, who's 83, was talking about GameStop. That's when it starts-- because, you know, when those people, the last group starts getting in, that's when it gets very dangerous.

SEANA SMITH: That is when you start to get very concerned. Jordan, I'm curious to get your thoughts just on the steps that Robinhood took last week and what they're doing today. They're still limiting trading on a lot of these heavily shorted names. It's a move that's been criticized by many out there. What do you think of it?

JORDAN BELFORT: Originally, I understood it because they do have liability for sure. But what they did by completely eliminating buying, that was a bit of a red flag to me that there might be some other more nefarious things involved, like getting pressure from the people who are short. I'll tell you why. They could have just as easily raised up the margin. That's a phrase meaning to make it more expensive to borrow money, to actually not allow people to borrow as much money to buy. That certainly could have slowed down the buying without them to stop it cold.

So that knee-jerk reaction to stop it cold is a bit troubling. And, you know, at first, I understood it, but now as I look more deeply, it is very strange that we're just not raise the margin up because that would have accomplished the same thing without shutting it down. And meanwhile, the bigger problem I think for Robinhood, is that now they're going to be getting sued by everybody. And whatever side you're on, you'll say, I lost money because of the decision Robinhood made. And it's going to be very, very hard for them to stay in business, I believe.

ADAM SHAPIRO: Well, they raising quite a bit of money from their investors. But how do you view that-- desperation or something else?

JORDAN BELFORT: They're raising money right now probably for the purposes of margin. And you have to have certain amounts of money on reserve with your clearing brokers. Remember that when all these small investors are trading, when the stock drops precipitously, the likelihood is that there will be losses in the accounts that exceed the amount the people had on reserve for margin. There actually will be net losses in these people's accounts.

So now you have all these small accounts that might have losses in there that Robinhood would have to make good on. That's why they're being forced to pledge more money. That's why I said the better move would have been to raise up the margin to eliminate that possibility versus to stop trading altogether. So they raise money because they probably had to raise money because they were almost out of ratio.

I don't think that has anything to do with what's going to happen when so many lawsuits are pouring in. That's the bigger issue, I believe. Because, you know, we live in a world where people sue. They form classes to sue. So I think that is the biggest danger of all, the lawsuits that followed this-- what's right now a massive upswing and eventually will, of course, be a downswing as well.

SEANA SMITH: Jordan, we're getting some breaking news. There's reports that Robinhood CEO is going to be testifying in front of the House Financial Services Committee later on this month. I'm curious just when we talk about potential regulation, because that, of course, is another aspect of this conversation. The SEC has said that they're monitoring this extreme volatility. But what do you think is going to happen on the regulation side as a result of this?

JORDAN BELFORT: The SEC is great at doing stuff after the horse is already out of the barn. Then they're going to close the barn door. The market itself will be far swifter in closing what you could call either a loophole or an inefficiency in the market right now. So what you basically have right now is an inefficiency where people are able to get involved with certain stocks or commodities.

And if they get behind them, and it's on a message board, and they all love a stock and they start talking about it, then this sort of loose group of-- it's not really collusion. I don't know what to really call it, but you have this group of people that-- and it spreads like wildfire because things go viral. And they get together and drive up these stocks that had large short interests and are just probably more thinly traded.

Wall Street will close that efficiency very quickly. In other words, you're starting to see already insiders selling at the higher price. I believe AMC, some funds blew out of all of their stock on Friday. You're going to start to see short-sellers become much more conservative with allowing themselves to get that short.

So I believe that eventually, the SEC will do some things to try to stop this behavior. But before they even get around to it, I think Wall Street itself will have closed most of these gaps and loopholes and make it more difficult for people to find the right deals to do this with. They'll always find some people, smart on the other side. So I think Wall Street will close the gap.

ADAM SHAPIRO: Jordan, the business model for Robinhood, we talk about order flow and selling that. And we had a discussion two years ago with Vlad Tenev about potential frontrunning. But I want to ask you very simply, is Robinhood toast? Are they going to be forced out of business, do you think?

JORDAN BELFORT: Toast, I think. But that's just my opinion. I think there's a couple of things. Number one, obviously, there's this PR debacle they're in right now. They were actually selling those democratizing investing, and actually, they're selling order flow to the big guys, were using that to try to gather intelligence on what the market's going to do next. Bad, bad PR-- not illegal.

I really believe the lawsuits are going to be very problematic, and we've seen this in the past with other brokerage firms when, you know, they get sued. It gets to a certain point. They might not go out of business. They'll have to sell to someone else, and they'll have to sort of separate out the legal entity that got sued from the assets of the company.

Something is going to have to happen here I believe, because I can only imagine. Think about it. There's all these small investors. On one day, they were not allowed to buy anymore, which theoretically it could be said, well, they were manipulating the stock down with Robinhood. And they had their reasons why, I'm sure.

But maybe there's also some emails-- and I bet there are-- where the shorts are complaining to Robinhood, like this is not right. What do you-- like, any one of these emails will come out in discovery and be a so-called smoking gun. And wow, I mean, just imagine the number of lawsuits and what that will do to the ability of Robinhood to stay in business because of just that capital reserves. Forget public perception. Just simply their balance sheet will be a disaster. So that's my opinion.

ADAM SHAPIRO: Jordan Belfort is the author of "The Wolf of Wall Street." Thank you for joining us here.