On June 30, 2021, the Financial Industry Regulatory Authority (“FINRA”) entered into a settlement1 with Robinhood Financial LLC (“Robinhood”) and announced it has fined Robinhood $57 million and ordered that approximately $12.6 million (plus interest) be paid as restitution to customers. You can find the settlement here.
Robinhood is a financial technology company that is an online broker with mobile stock trading apps that have attracted many young retail investors. It does not charge its customers commissions. Instead Robinhood earns a majority of its revenue by routing its customers’ stock, options and cryptocurrency orders to market makers and other entities who pay Robinhood for routing of the customer orders to them. This is known as payment for order flow.
The FINRA settlement ended an investigation that included extensive assertions, including that Robinhood:
• provided false and misleading information to its customers;
• failed to manage its own technology leading to outages and system failures; and
• did not perform appropriate due diligence on customers prior to approving option accounts for those customers.
FINRA noted that the approximately $70 million penalty was the largest financial penalty it has ever levied.
FINRA’s allegations refer, most recently, to Robinhood’s March 2020 system outages when its website and mobile apps shut down, not allowing Robinhood’s customers to access their accounts. The claim that it had failed to exercise due diligence before approving customers to trade options, dates back to December 2017 when Robinhood began offering options trading. Accusations of a “wide array” of false and misleading information provided to its customers date back to September 2016. Five instances were detailed by FINRA, including displaying to many customers negative cash balances twice as large as they actually were.
Robinhood’s Corrective Actions.
Robinhood, as part of the settlement, must retain and cooperate with a third-party compliance consultant who will conduct a comprehensive review of the adequacy of Robinhood’s compliance with all of the areas identified in the AWC. It must also, within 60 days of FINRA’s issuance of its notice of acceptance of the AWC (June 30, 2021), submit a signed certification that the firm has ceased making the false or misleading statements detailed in the AWC.
Other Regulatory Issues
Robinhood recently settled other investigations.
These other settlements include:
• Settlement with the New York State Department of Financial Services (“NYDFS”). In its recently filed S-1 registration statement in anticipation of its IPO, Robinhood reported that its cryptocurrency firm, Robinhood Crypto LLC reached “a settlement in principle” with the NYSDFS over allegations related to its handling of cybersecurity and anti-money laundering issues. The fine is estimated to be $15 million and the settlement includes the appointment of an independent consultant.
• A December 2020 settlement with the SEC and fine of $65 million for what was claimed to be repeated failures to disclose the firm’s receipt of payment for order flow and related failure to seek the best execution terms for its customers.
• A December 2019 settlement with FINRA for best execution violations. Robinhood agreed to pay $1.25 million. As part of the settlement, Robinhood also agreed to retain an independent consultant to conduct a comprehensive review of the firm’s systems and procedures related to best execution.
There remain current outstanding regulatory issues, most notably the Massachusetts enforcement action against Robinhood.
The Massachusetts Matter
In December 2020, the Massachusetts Security Division (“MSD”) filed a regulatory complaint seeking improved compliance, restitution, fines, etc. for use of “aggressive” sales tactics, “gamification” to encourage customers to trade, failure to correctly approve options trading and failure to comply with Massachusetts fiduciary standard.2 Originally the MSD did not seek termination of registration of Robinhood as a broker and dealer in Massachusetts. Robinhood then filed a state suit in an attempt to stop the enforcement action claiming that the Massachusetts fiduciary rule is invalid. In rejecting this suit, the judge stated that , even if the fiduciary rule is invalid (and Robinhood can continue to make that claim), all the other claims against Robinhood must still be sorted out. MSD then revised its regulatory complaint to seek to revoke Robinhood’s state securities license, citing a “continued a pattern of aggressively inducing and enticing trading among its customers.”
Robinhood’s recent settlements, and related remedial actions it must undertake, will likely improve its compliance and risk controls and foster protection of its retail customers. The Massachusetts regulatory complaint is being followed closely as it puts to the test the Massachusetts fiduciary rule (including what constitutes a recommendation) and its outcome will affect approximately 500,000 Massachusetts residents and Robinhood customers and, perhaps, Robinhood’s ability to do act as a broker in the state.