Massachusetts’ state securities regulator has filed the first action enforcing
Robinhood allegedly uses aggressive tactics to attract rookie investors, manipulates them with gamification strategies and doesn’t do enough to prevent frequent outages and disruptions to its trading platform, according to an administrative complaint filed by William Galvin, the state’s top financial regulator.
Robinhood disputes the allegations and plans to defend itself “vigorously,” according to an emailed statement from a spokesperson.
“Robinhood is a self-directed broker-dealer and we do not make investment recommendations,” the spokesperson says. “Millions of people have made their first investments through Robinhood, and we remain continuously focused on serving them.”
The app surpassed 13 million users in 2020, with three million signing up during the first fourth months of the year, according to Bloomberg.
Galvin claims Robinhood, which earns revenue on customers’ trades, entices inexperienced investors with free trading and uses gamification strategies to drive constant use of the app. Users are treated to digital confetti after each trade, according to the regulator.
Customers were also encouraged to repeatedly tap on a virtual debit card for early access to a new cash management feature. More interaction, as many as 1,000 taps per day, improved one's position on the waitlist. Failing to interact daily cost customers their place in line, according to the regulator
The app allows users to execute an unlimited number of trades, including in riskier investments, such as options, without proper screening, according to the complaint. Of the Massachusetts customers approved for options trading, 68% report having limited or no investment experience. The complaint details several investors who allegedly executed thousands of trades in a short time frame despite having no previous investing experience. The median age of a Robinhood customer is 31 years old, and the firm has nearly half a million Massachusetts customers.
“As a broker-dealer, Robinhood has a duty to protect its customers and their money,” Galvin said in a statement. “Treating this like a game and luring young and inexperienced customers to make more and more trades is not only unethical, but also falls far short of the standards we require in Massachusetts.”
Options trading on Robinhood faced
Robinhood co-founders Vladimir Tenev and Baiju Bhatt
Galvin also accuses Robinhood of failing to keep up with its rapidly expanding user base, citing
Months later, a hacking attack sparked outrage from users. At one point in October, access to more than 10,000 email login credentials tied to Robinhood accounts were available on the dark web.
“Despite its inability to maintain an adequate infrastructure, Robinhood continues
to invite more and more customers to open accounts, and once these accounts are open, encourages customers to use the platform constantly,” the complaint states. “Once individuals become customers, Robinhood relentlessly bombards them with a number of strategies designed to encourage and incentivize continued and repeated engagement with its application.”
A Robinhood spokesperson says the company has “worked diligently to ensure our systems scale and are available when people need them,” and has made “significant improvements” to its options trading, including new safeguards and enhanced educational materials.
The complaint raises some interesting claims, but omits allegations of wrongdoing from the legal analysis, says Max Schatzow, an attorney with Stark & Stark who works with RIAs and broker-dealers. The Massachusetts regulator is trying to portray Robinhood’s failures as either instances of misleading advertising, fraudulent or unethical conduct, or breaches of fiduciary duties, Schatzow says.
While the claims involving advertising and breaches of fiduciary duty are likely to fail, accusations of Robinhood breaching its own policies and procedures regarding options trading could be construed as dishonest or unethical practices, he adds.
“I think there is a bit of window-dressing here, but there are obviously legitimate customer protection concerns,” Schatzow says.
The regulator is seeking an administrative fine and an order requiring Robinhood to work with an independent compliance consulate to review its infrastructure, policies and procedures. The regulator did not respond to a request for additional comment.
“As with all enforcement actions, the question remains how much flesh is [Massachusetts] seeking and whether Robinhood will agree to any settlement,” Schatzow says. “If I had to bet, I think the parties would reach a settlement that includes the retention of consultants and compliance professionals, but the disgorgement and restitution claims will probably be dropped.”
Robinhood is already facing scrutiny from federal regulators. The SEC and FINRA are investigating the company’s handling of the March outages following a deluge of customer complaints that it was unresponsive to their concerns,
The SEC is separately probing whether Robinhood properly informed brokerage clients that it sold their stock orders to high-frequency traders and other Wall Street firms. The investigation is focused on Robinhood’s disclosures prior to 2018, when it altered its website to make information easier for customers to find.
Last year, FINRA fined Robinhood $1.25 million over how it routed customer orders,
Massachusetts is one of several states that have implemented or started to put in place fiduciary rules following the demise of the Obama-era regulation. Massachusetts’ fiduciary rule went into effect in September.
--Additional reporting from Bloomberg News
