And the largest FINRA penalty ever goes to… drum roll please… Robinhood!

Medieval drummersFINRA has awarded the largest penalty ever – $12.6m of restitution, interests and a $57m fine, so $70 million in total – to Robinhood.

Compliance with rules is not optional and cannot be sacrificed for the sake of innovation or a willingness to ‘break things’ and fix them later,” said Jessica Hopper, executive vice president and head of the enforcement unit at FINRA.

The fine imposed in this matter, the highest ever levied by FINRA, reflects the scope and seriousness of Robinhood’s violations.

 

FINRA’s assessment

Robinhood’s spectacular growth, from 500,000 customers in 2015 to 31 million today, was offset by poor performance on trust, people and problem resolution. FINRA cites a string of failures:

  • While the company was advertising its “de-mystification of finance for all“, it was actually making false and misleading statements to customers, notably on margin rules and requirements, on cash availability, on the risks of losses in options…
  • Misstatements to customer made them lose $7m. A user, most likely Alex Kearns, is cited in example; he killed himself after seeing his inaccurate statement.
  • Robinhood used bots to approve individuals for option trading, with little to no oversight from principals, despite the fact that the bot provided illogical and inconsistent information.
  • As a result, many traders were given access to option trading, although they had neither the capacity or experience to do so.
  • The execution technology also had insufficient supervision. There were multiple outages at times of high market volatility, when customers needed reliability.
  • Tens of thousands of written customer complaints were not reported to FINRA, despite the strict obligations.
  • The firm used confetti animation and gamification tactics, to increase the trading volumes.

Amateur drummer

But what would you expect from a CEO who is not even registered to FINRA.…?

 

 

 

Previous enforcement issues

That award is not Robinhood’s first enforcement.

  • FINRA itself fined Robinhood $1.25 m in December 2019, for best execution issues over the 2016-2017 period.
  • The firm received a $65m penalty from the SEC in December 2019 for over-charging its customers by $35m, despite free trading, for ‘gamification’ of trading, for the lack of disclosure of the Payment for Order Flow and its profitability
  • Massachusetts’s secretary is suing Robinhood for its aggressive growth tactics (notably targeting young users), its repeated outages, its gamification strategy, its insufficient supervision for option trading, its lack of consideration for suitability, and its many other fiduciary duty failures.
  • Other states are following the outcome of Massachusetts’s action, as they may follow the example.

If the past is an indication, enforcement fines may just be another cost of doing business.

 

Metal-drummerOther issues not enforced

Multiple studies and articles have indicated other issues not mentioned in those enforcements. Robinhood’s day traders also:

  • barely make any profits,
  • incur large tax loses, due to the wash sales rule,
  • experience significant stress,
  • experience trading addiction from Robinhood’s marketing techniques, akin to casinos’ techniques creating gambling addiction,
  • or experience severe anxiety from the lack of technical support.

 

So how big are the fines?

Robinhood made $986 millions of top line revenues in 2020, but it has never had a profitable year. The just released IPO filing update indicates a net income of $7.45m for 2020 [there is also a $1.46 bn impairment charge related to convertible valuations though], as well as losses of $107m and $278m the previous years. In comparisons to such bottom lines, the FINRA’s fine or the SEC’s fine(s) are relatively big.

Robinhood-superstarBut, when the owners are about to file a $20 bn IPO, $70 m is a slap on their hands. There is little doubt that a class actions in court would have extracted much more.

And now that another legal problem is behind, the IPO price may actually be even higher than the indicated $20 bn.

 

 

 

 

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Written by Gontran de Quillacq

Gontran de Quillacq is an expert witness and a legal consultant. He is a recognized authority in options, trading, derivatives, structured products, portfolio management, hedge funds, mathematical finance, quantitative investment, strategy research and financial markets in general.

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