Robinhood Financial LLC has agreed to pay nearly $70m to resolve sweeping regulatory allegations that the brokerage misled customers, approved ineligible traders for risky strategies and didn’t supervise technology that failed and locked millions out of trading.
The enforcement action is a blow to the fast-growing online brokerage, which was launched in 2014 and has won over users with commission-free trades and its sleek mobile app. The company took on millions of new customers and attracted more scrutiny this year as many investors accessed Robinhood to speculate on so-called meme stocks such as GameStop Corp. and AMC Entertainment Holdings Inc. Its forthcoming initial public offering is one of the most anticipated of the year.
Robinhood’s growth has continued, with its biggest source of revenue, stemming from customer trading, more than tripling in the first quarter, even as many customers complained about its technology snafus and limited customer service. It enraged clients earlier this year when it restricted trading in some popular stocks that had become so volatile that Robinhood’s clearinghouse told the brokerage to post billions of dollars in additional collateral.
The Financial Industry Regulatory Authority, the front-line inspector of broker-dealers, unveiled the settlement on 30 June. Robinhood neither admitted nor denied the claims.
“We’re fine with innovation, but innovation can’t be at the cost of creating compliance and supervision systems,” Finra enforcement chief Jessica Hopper said in an interview. Finra, which is privately funded by the brokerage industry, is overseen by the Securities and Exchange Commission.
Robinhood spokeswoman Jacqueline Ortiz Ramsay said that the company was pleased to resolve the investigation and would focus on its mission of making investing more accessible. “Robinhood has invested heavily in improving platform stability, enhancing our educational resources, and building out our customer support and legal and compliance teams,” she said.
Robinhood now has 31 million customers, 18 million of whom have funded accounts, according to a settlement document made public Wednesday.
Finra alleged a series of failings by Robinhood, which agreed to a $57m fine and $12.6m in compensation for harmed investors. Many allegations involved problems with technology that automated the opening of new accounts or trading strategies and updated clients about their balances or borrowed funds.
The company opened 90,000 new accounts from 2016 to 2018 despite red flags signalling possible identity theft or other fraud, Finra said. Robinhood qualified thousands of other accounts to trade options even though the clients didn’t meet eligibility criteria, according to Finra.
One example cited by Finra: A new customer, who was 20-years old, was rejected for options trading after noting that he had little investing experience and a low risk tolerance. Three minutes later, the customer changed his risk appetite to “medium” and said he had three years of investing experience. Within seconds, Robinhood approved him for options, according to Finra’s settlement document.
In another example that turned into tragedy, a 20-year-old Robinhood customer, identified as Customer A, took his own life in June 2020 after seeing an account notice that he had a negative balance of $720,000. The customer was rattled by the notice because he thought he had turned off his ability to borrow funds from the brokerage to trade, according to the settlement document.
Robinhood also misinformed the customer about the value of his position; it was actually negative $365,530, or half what Robinhood’s system showed, the settlement states.
The description of Customer A matches that of Alex Kearns, whose family sued Robinhood in 2021 in California state court, asserting claims for wrongful death, negligent infliction of emotional distress and unfair business practices.
Attorneys for the Kearns family notified the court in May that it reached a settlement with Robinhood for an undisclosed amount.
“We were devastated by Alex Kearns’ death,” a Robinhood spokesman said in an email at the time. “We remain committed to making Robinhood a place to learn and invest responsibly.”
Robinhood misled other traders who similarly believed they couldn’t use borrowed money, or margin, if they turned off that feature, Finra said. Clients who disabled margin could still wind up using borrowed money if they made certain types of options trades, the regulator said.
Finra’s investigation also faulted Robinhood for technology outages that disrupted its service in early March 2020 and prevented 12.5 million account holders from trading. Users of its app couldn’t communicate with Robinhood about the outages because the company’s customer-service channels also experienced disruptions, Finra said.
Later that month, Robinhood experienced another outage that stemmed from an untested update to how it communicated with a trading venue that executed client orders. Robinhood didn’t adequately supervise such systems, even though senior executives were aware that disruptions threatened the company’s reputation and growth, according to the regulator.
The $57m fine is the biggest ever levied by Finra, which employs about 3,700 people and handles inspections of most broker-dealers for the SEC. Finra, then known as the National Association of Securities Dealers, fined Credit Suisse First Boston Corp $50m in 2002 over allegedly inflated commissions for hot initial public offerings.
The investment bank, now known as Credit Suisse, settled the matter without admitting or denying the allegations. John Mack, the head of CSFB at the time, said the bank was pleased to resolve the investigation.
The self-regulatory organisation has sometimes been criticised for assessing fines that lack teeth. In recent months, it has stressed that it would dig into the ways that more tech-savvy retail investors trade, including brokerage platforms that use enticing graphics and other behavioural cues to reward and encourage trading.
The terms of the settlement also call for Robinhood to hire a consultant to review the brokerage company’s compliance systems within six months. Robinhood would then have another three months to implement any recommendations made by the consultant.
Also on Wednesday, Finra said it would launch a $30m campaign to educate new investors who use apps like Robinhood’s to trade a variety of risky assets. Finra said it would seek public and industry comment about how to carry out the effort.
Robinhood still faces scrutiny from the SEC and New York state regulators related to options trading, according to a regulatory disclosure filed by Robinhood in February. The SEC’s examinations division, which is separate from its enforcement staff, is looking into its practices related to options, the disclosure said.
The settlement follows two earlier enforcement investigations that Robinhood settled with Finra and the SEC.
In 2019, the broker paid $1.5 m to resolve Finra’s claims that it didn’t take adequate steps to ensure it got the best prices for customer orders. In December, Robinhood agreed to pay $65m to the SEC to settle claims related to its disclosures of payment for order flow, or accepting revenue from high-speed trading companies that pay for the right to execute retail investors’ orders.
Robinhood said after reaching the SEC settlement that the problems found through that investigation “do not reflect Robinhood today.”
US securities laws allow payment for order flow, as long as the brokerage company’s relationships and any conflicts of interest are disclosed accurately.
Peter Rudegeair contributed to this article.
This article was published by The Wall Street Journal.