RIA Compliance Blog
Even before Robinhood Financial LLC entered the spotlight late last month for having halted trading in Game Stop during that company’s unprecedented short squeeze, Robinhood had already been charged with allegedly violating state securities laws in connection with its business practices. In December of last year, the Securities Division of the Massachusetts Secretary of the Commonwealth sued Robinhood, alleging that the company had engaged in aggressive marketing tactics aimed at young, inexperienced customers. The complaint was based in large part on alleged violations of the duty to act in customers’ best interest, as required by regulations adopted in March 2020 imposing upon broker-dealers the same fiduciary duty applicable to investment advisers operating within the Commonwealth.
According to the complaint, Robinhood failed to act in the best interests of its customers and exposed them to unnecessary trading risks. The Company directed its market at young, inexperienced investors. When they opened accounts, the Company encouraged its customers to use the trading platform frequently and approved unqualified clients for options trading. Although not mentioned in the suit, a 20-year old college student from Illinois committed suicide last summer because he mistakenly thought he owed over $700,000 based on options trades he had made using the Robinhood platform. Earlier this week his parents sued Robinhood, making allegations that echoed the Massachusetts regulator’s charges.
The Massachusetts complaint details Robinhood’s use of video game tactics, described as “gamification,” to lure younger customers. For instance, the platform features an onscreen explosion of confetti whenever a trade is executed. It also created a game by which its customers could obtain access to a new cash management system it rolled out in 2019. In the game, customers placed their names on a waitlist and then tried to raise their status on the list by tapping on a fake debit card as often as possible, up to 1,000 times per day. The more taps, the higher the client’s name moved up the list. Customers who failed to engage with the application saw their names fall toward the bottom of the waitlist.
The platform also prominently features stock lists – such as the “100 most popular” stocks, the “Top Movers,” and the stocks with “Upcoming Earnings.” Although Robinhood claims that it neither recommends securities to be purchased nor conducts suitability analysis, the Massachusetts regulator equated this practice with handing customers a list of securities and then “acting surprised” when the customers actually bought the listed stocks. The alleged goal was to keep customers placing orders, since Robinhood makes money based on the number of orders it can sell to various market makers. The complaint alleges that 670 customers who had limited or no investment experience averaged at least five trades per day, while two customers averaged nearly 100 trades per day. One customer who had no prior investment experience was permitted to execute almost 13,000 trades in a six-month period.
According to the complaint, Robinhood’s criteria for options trading approval were minimal. Namely, the customer had to check a box saying they had some trading experience or have at least four filled orders at Robinhood, plus a risk tolerance of medium or higher. Even with this low threshold, the Massachusetts regulator discovered that Robinhood had approved for options trading 340 customers who had no investing experience and did not have four filled orders at Robinhood. Of the more than 71,000 Massachusetts residence approved for options, over 14,000 had no investment experience before opening the account, and more than 34,000 reported having only limited experience.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.