Robinhood will pay as much as $10.2 million to settle charges by several states for “significant operational issues” spanning years, according to the North American Securities Administrators Association.
The settlements conclude an investigation by regulators in Alabama, Colorado, California, Delaware, New Jersey, South Dakota and Texas on the firm’s alleged compliance shortfalls. The Alabama Securities Division, led by Joe Borg, was the “lead state” in the investigation.
The penalty is only the latest in a number of settlements with Robinhood, including a mammoth $70 million fine from the Financial Industry Regulatory Authority in 2021, the largest in its history. In that instance, FINRA alleged Robinhood misled customers, let compliance lapse in a March 2020 outage and allowed thousands of customers to trade options that may have been inappropriate.
In an interview with WealthManagement.com, Borg, who has helmed the Alabama Securities Division since 1994, said multi-state efforts are somewhat common. With Alabama as the lead state, Borg acted as a point-person working with other regulators and Robinhood.
While there were similarities between the FINRA and NASAA probes, Borg said the states took a closer look into Robinhood’s customer service issues. Since Robinhood’s structure was a new model heavily dependent on tech during the lapses, technology became one of the “critical factors” in state regulators’ investigation.
“They had to get (tech) right, because that was the only methodology customers had to contact Robinhood,” he said.
New York State financial regulators also fined Robinhood’s cryptocurrency unit $30 million last year, alleging it violated anti-money-laundering and cybersecurity requirements. Robinhood also agreed to a $65 million penalty from the Securities and Exchange Commission for not telling customers the firm received payment from trading firms for routing orders their way. It’s also faced inquiries by Congress and the Justice Department.
State regulators detailed how Robinhood faced “multiple outages” in March 2020, as the market was rocked by COVID-19’s initial spread, according to consent orders filed by the Texas State Securities Board and Alabama regulators. Therefore, customers weren’t able to enter buy or sell orders and couldn’t take advantage of changes in the price of securities.
According to Texas’ state regulators, Robinhood also offered two options account levels for traders, with one allowing basic option contracts and the other allowing for more advanced strategies (including option spreads). The app also included margin account options for customers to borrow money using their own accounts as collateral.
To apply for the levels, customers entered information on their account, employment status, net worth, income, risk tolerance and investment experience. The app relied on an automated process, employing an algorithm that would automatically approve or deny a customer’s application without any manual review.
“Robinhood’s automated account approval process allowed for customers that were denied option and margin trading to re-submit and be approved by utilizing different responses to the eligibility questions,” the Texas order read.
After the FINRA settlement in fall 2021, FINRA announced a sweep looking into how broker/dealers oversaw their options account trading. FINRA posted an update on the sweep in November of last year, including guidance for firms to determine whether they had adequate supervision in place.
Texas also cited findings from the FINRA settlement to support its case, including that Robinhood didn’t have a customer identification system “appropriate for the firm’s size and business” between June 2016 and Nov. 2018. Robinhood also poorly oversaw the tech it used to provide B/D services until February 2021, according to Texas and Alabama.
“Instead, Robinhood outsourced the operation and maintenance of its technology to its parent company, Robinhood Markets Inc.—which is not a FINRA member firm—without broker/dealer oversight,” the Texas order read.
The firm also failed to do its due diligence before approving options accounts, and “negligently misrepresented” the risks in options spread trading, leading at least 630 customers to lose more than $5.7 million.
When it came to customer service, the Texas order stated Robinhood struggled to support the volume of customer inquiries coming in by 2020. Instead, the firm initially used an automated system before using multiple customer support agents to respond to a single ticket without addressing the problem.
“Robinhood should have been aware through its monitoring that some customers were not receiving adequate customer support,” the Texas order read.
Robinhood was “pleased” to put the issue behind it by resolving the states’ investigation, according to Lucas Moskowitz, deputy general counsel and head of government affairs at Robinhood Markets.
“The settlement relates to past issues that Robinhood has since invested heavily in improving, including the launch of 24/7 chat and phone support, expanding our library of educational materials, and strengthening the way we supervise our technology,” Moskowitz said. “We remain focused on continuing to break down barriers to the markets for those who were previously kept out.”
According to the consent order, Robinhood has moved forward on some of the mandates from the FINRA settlement, including changes to its customer support system and its mobile platform, and has conducted weekly reviews of its options trading customers as of May 2021.
As a part of the FINRA settlement, Robinhood hired a third-party compliance consultant, and Borg said thus far, the firm has largely kept up its end of the bargain (part of the reason the states delayed their own actions were to be sure Robinhood was following through on promises made in the FINRA order).
But Robinhood also agreed to pay for a multi-state team of regulators to examine the firm within two years’ time, to make sure they’re fulfilling their compliance mandates, according to the state orders.
“It’s so tech-heavy and tech-dependent that we want to make sure that everything’s working as it should be,” Borg said.