Massachusetts regulators have charged Fidelity with failing to properly vet options applications designed to determine which clients are suited to taking on the additional leverage associated with options trading.
Secretary of the Commonwealth William F. Galvin cited the company’s “half-hearted and lackadaisical attitude” toward safeguarding retail investors in charging Fidelity Brokerage Services with unethical and dishonest conduct and practices.
Galvin’s Securities Division filed the administrative complaint.
Galvin said Fidelity allowed customers to submit multiple applications, each time with the information altered until the customers met the requirements to be approved. According to the complaint, there were customers who had applied as many as 13 times in a month, inflating their financial situations, investment experience and employment information. Fidelity failed to notice, despite having contrary information in its system.
The complaint says one applicant was a recent high school graduate who worked at an automobile oil change shop at the time of submitting a fourth application, and asserted that his or her annual income rose from between $20,001 and $50,000 to $100,001 or more in one day at the same job. The same individual said their net worth jumped from between $30,001 and $50,000 to between $100,001 and $500,000 in one day. This person listed their employment simply as “Job,” the complaint states.
Another claimed to have been promoted from “Scientist” to “CEO” less than a day after Fidelity denied the customer’s previous application.
Yet another claimed to have gained four years of experience trading options in less than a day, and another submitted 11 applications in a week.
Fidelity has experienced an explosion in the number of retail brokerage accounts among people under 35. These investors opened 1.6 million of the 4.1 million accounts that Fidelity gained in the first quarter of 2021, a 222% increase from the same quarter of 2020.
“With the recent increase in interest in online options trading among many young retail investors, as well as the rise of online and mobile applications, broker-dealers need to make sure they’re still maintaining the same standard of care and attention and making sure these investors qualify,” Galvin said. “This is an issue of investor protection and companies cannot be allowed to rubber-stamp these applications without doing their due diligence, all in the name of efficiency.”
According to the complaint, though FBS has more than 30 million retail brokerage accounts, it currently uses a group of only 50 broker-dealer agents to review all options and margin trading applications.
Fidelity issued the following statement in response: “Fidelity Brokerage Services has a longstanding commitment to delivering excellent customer service, operating with integrity and adhering to industry standards and regulations. We have cooperated fully with the Massachusetts Securities Division on this matter.
“We disagree with the characterizations of FBS contained in the complaint, believe that we have effective due diligence processes, and look forward to addressing and resolving this matter through the administrative process. As this is an ongoing Massachusetts Securities Division matter, we feel it is not appropriate to comment further at this time.”
Alan Rosca, a securities lawyer at Goldman Scarlato & Penny in Cleveland, who represents plaintiffs, said there is “a race to the bottom underway,” probably triggered by Robinhood and a bunch of brokerage firms jumping on the bandwagon trying to chase the retail market.
“Unsophisticated people have no business trading options or complex products,” said Rosca, “but they are enticed by messages that make it seem like a computer game, get-rich-quick schemes, let’s make it easier to trade options. There is a reason why there is an options application asking how long have you been doing this. These are highly risky products.”
Lawyers say they get calls from young people who at first sound like they know what they are doing, but then it becomes apparent that they have simply learned the jargon and have no understanding beyond that.
Rosca said from his experience with young people who have lost money, many learned whatever they know from Reddit or watching YouTube influencers.
But in this case, according to the complaint, an industry giant has failed to properly evaluate prospective investors.
“Spiderman’s uncle told him with great power comes great responsibility,” said Rosca. “These firms are eager to tap into this new market. They should spend money implementing adequate controls. They owe it to the public.”
FINRA has said that in the months ahead it plans to issue a separate regulatory notice asking firms for comment about how it should proceed with any new rules about opening options accounts because of the changes in technology that have made these accounts much more accessible.
