But the free trading app’s breakneck growth hurt the same small-time investors it sought to empower.
That’s the accusation leveled by Wall Street’s self-funded watchdog, which extracted almost $70 million from the brokerage in a record settlement Wednesday, including a $57 million fine and about $12.6 million in payments to aggrieved customers. It follows Robinhood’s meteoric rise against the backdrop of the Covid-19 pandemic and the frenzy over hot stocks such as
Robinhood’s settlement with the Financial Industry Regulatory Authority also comes at a crucial moment, as the brokerage prepares a public offering this year, a move that will require the trust of small-time investors and mainstream financial institutions alike. Though Robinhood long stood out as one of Silicon Valley’s biggest threats to Wall Street’s status quo, Finra signaled its impatience with the “move fast and break things” approach embedded in the tech industry’s DNA.
Complying with rules governing brokerages “is not optional and cannot be sacrificed for the sake of innovation or a willingness to ‘break things’ and fix them later,”
The agency accused Robinhood of misleading customers, having weak technology oversight and allowing thousands of users to trade options even though they may not have been suitable candidates, among other infractions.
Robinhood, which didn’t admit or deny the allegations, published a blog post Wednesday saying it made improvements, including more than tripling customer-support personnel since March 2020 to about 2,700 people. The firm also changed how it manages technology and options trading.
“Robinhood has invested heavily in improving platform stability, enhancing our educational resources and building out our customer support and legal and compliance teams,” spokeswoman
The settlement encompasses a variety of lingering controversies, some of which drew fresh scrutiny after the January run-up of meme stocks such as GameStop. Robinhood, with more than 31 million users, had 18 million funded accounts at the end of March, according to the settlement. That demonstrates the firm’s explosive growth since 2015, when it had fewer than 500,000 users.
Regulators, lawmakers and investor advocates have questioned whether Robinhood is responsibly handling that expansion and exposing novice traders to investment products they don’t understand.
One area of particular concern for Finra was Robinhood’s options-trading platform.
Options, which convey the right to buy or sell shares at a certain price in the future, can magnify gains or losses. Robinhood lapsed in its due diligence when approving customers for such trading, Finra said in its settlement order. The brokerage used computer algorithms known as “option account approval bots,” with limited human oversight, when deciding whether to allow customers to trade the derivatives, according to the regulator.
Finra also alleged that Robinhood failed to disclose to 818,000 customers who had been approved for options trading that their activity could involve the use of margin lending, potentially resulting in losses significantly greater than the money invested. The lack of disclosure contributed to confusion, the watchdog said.
A 20-year-old killed himself last year after mistakenly thinking he had lost more than $730,000 while using the app to bet on options. The client left behind a note questioning how he could have used margin because he didn’t believe he had enabled it on his account, according to Finra. Others who incurred major losses complained to Robinhood, expressing exasperation because they also didn’t think that they had agreed to trade using leverage.
“I DO NOT have margin trading enabled on my account,” one of the people said in an email to Robinhood, according to Finra. “I specifically selected to not trade on margin to limit my losses only to what I personally have in my account.”
The platform also displayed inaccurate cash balances for customers from December 2019 through June 2020. For customers who had selected margin to be “off” on the app, Robinhood displayed negative cash balances that were double the amount of the actual deficits.
In the roughly three years through March, the firm cost 630 customers more than $5.7 million with “misrepresentations and omissions of material fact about options spread transactions,” Finra said in the order.
A series of service disruptions in March 2020 proved to be another pain point for Robinhood, just as panic over the pandemic roiled stocks. Its platform failed repeatedly, including one outage that prevented users from trading for more than a day.
Although Finra issued two warnings that the firm wasn’t properly managing its technology, the outages persisted, the regulator said. Moreover, the plan that Robinhood had in place to keep its business running in the event of a disruption applied only to a physical disturbance -- not a technological one -- and was therefore inadequate.
The firm’s handling of the outages sparked a rash of complaints, Bloomberg reported in August. The Securities and Exchange Commission and Finra have continued to focus on other aspects of the booming market that are widely associated with Robinhood, including “gamification” -- video-game like features that have helped attract legions of new retail traders.
While Finra’s order didn’t mention gamification, that issue was a sticking point for House Democrats who questioned Chief Executive Officer
During a May congressional hearing, SEC Chair
“In making it easier, we’ve lost that human in the middle saying, ‘Wait, wait is this appropriate?” Gensler said at the time.
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Peter Eichenbaum, Alan Goldstein
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