Robinhood, apparently always beset by controversy, is now in jeopardy of losing the ability to serve customers in Massachusetts. Amping up a legal attack on the trading app, Massachusetts securities regulators asked state officials yesterday to revoke Robinhood’s registration as a broker-dealer.
The move came at a particularly sensitive time for the company as it prepares for an IPO later this year. The new complaint also hit the docket while the app struggled with a widespread crypto trading outage — amid a massive surge in Dogecoin — that led to numerous users trashing the app online. Service was reportedly restored by midday Eastern time on Thursday, according to Bloomberg.
Founded by 34-year-old Bulgarian-American Vlad Tenev, Menlo Park, California-based Robinhood is no stranger to regulatory scuffles. It was previously fined $65 million by the U.S. Securities and Exchange Commission for failing to disclose its revenue sources. It also paid $1.25 million to the Financial Industry Regulatory Authority to end a probe into whether it failed to get the best prices for its customers, and it has faced Congressional probing into its role in the sudden skyrocketing of GameStop’s stock price, driven by amateur traders on Reddit group WallStreetBets.
The company has maintained that its goal is to “democratize” markets by making it easier for beginners with limited capital to invest than at typical brokerages. It offers commission-free trades and fractional shares. In a blog post, the company called the latest move by securities regulators in Massachusetts “elitist and against everything we stand for.”
Robinhood was the most downloaded app in Apple’s app store this week, notching just ahead of Coinbase, the cryptocurrency exchange that went public Wednesday, according to CNBC. Thinknum data shows that app store ratings jumped from 2.43 million on January 29 to a 3.3 million on Wednesday.
“The complaint reflects the old way of thinking: That new, younger, and more diverse investors don’t have a place in the markets,” said Robinhood, which also hit back at the Massachusetts Securities Division yesterday with its own legal case over the regulator’s actions targeting the app.
Here are some of the claims the state’s securities enforcement lawyers are making for why Robinhood should lose its license:
1. Encouraging trading by customers with “little or no investment experience”
The securities division first filed a regulatory action against Robinhood in December over an alleged failure to implement controls to protect traders, but yesterday the agency filed an even tougher administrative complaint. Lawyers for the state argued the company had “continued a pattern of aggressively inducing and enticing trading among its costumers — including Massachusetts customers with little or no investment experience.”
Those tactics included pursing “the deposit of customer stimulus checks offering ‘free cash’ for deposits starting at as little as $200.00,” as well as expanding margin lending and “plans to allow its customers to participate in initial public offerings — including its own,” the enforcement lawyers wrote.
“Respondent’s actions continue to demonstrate a firm culture which has not changed subsequent to the filing of the [original complaint in December] — and represent a culture which continues to entice and induce inexperienced customers into risky trading,” the agency said.
2. Not properly accounting for fractional shares
The securities division alleged the company failed “to properly account for fractional shares traded by customers on its platform.”
An analysis of regulatory data by Reuters earlier this month found that Robinhood failed to report trades of fractional shares to appropriate trade execution facilities — a must for brokerages in order to ensure that prices of stocks that trade over-the-counter are recorded properly for all market participants. It was unclear to Reuters how many trades went unreported by Robinhood, but the app failed to supply information about those trades for a little over a year after first launching its fractional share service in December 2019, according to the news organization.
3. Lacking adequate technological infrastructure
Fueled by lockdowns, with many new investors sitting at home and day-trading, Robinhood grew by leaps and bounds during the pandemic. As more users piled onto the site, its tech infrastructure showed signs of strain. Outages were common.
From January 1, 2020 through November 30, 2020 there were as many as 70 trading service disruptions, according to the securities enforcement lawyers. The most severe of those was a lengthy outage that occurred in March 2020, on a day when Dow Jones surged a record 1,290 points.
The agency said Robinhood “failed to protect its customers by adequately maintaining and updating its platform infrastructure” to support its rapid growth.
4. Failing to screen investors, consider suitability of investments
The state lawyers also alleged that the company failed to supervise the review and approval of traders granted permission to trade in options, a form of security that can be riskier than traditional stocks because losses can be magnified.
Nearly 70 percent of the 71,744 Robinhood customers in Massachusetts that the app approved for trading in options had limited or no investment experience, the agency said. About 700 didn’t even meet the company’s own criteria for approval.
Meanwhile, the company distributed lists of stocks to investors, including “100 Most Popular,” “Top Movers,” “ETFs,” “IPOs,” “Cannabis,” “Pharma,” and other categories chosen based on popularity on the Robinhood platform, and offered a variety of incentives to encourage newbie investors to trade often.
“Despite providing these lists to all customers by default, Robinhood does not conduct a suitability analysis of the securities continued in the lists for customers,” the regulator said. “By promoting securities through the use of lists without conducting suitability analysis for customers, Robinhood encouraged risky, unsuitable trading inconsistent with its obligations as a Massachusetts-registered broker-dealer.”
About the Data:
Thinknum tracks companies using the information they post online, jobs, social and web traffic, product sales, and app ratings, and creates data sets that measure factors like hiring, revenue, and foot traffic. Data sets may not be fully comprehensive (they only account for what is available on the web), but they can be used to gauge performance factors like staffing and sales.