Compliance implications of Robinhood’s record $70M FINRA fine

Robinhood neither admitted nor denied the charges but consented to the entry of FINRA’s order, which included a censure; a $57 million fine; and $12.6 million in restitution, plus interest, to thousands of harmed customers.

“The fine imposed in this matter, the highest ever levied by FINRA, reflects the scope and seriousness of Robinhood’s violations, including FINRA’s finding that Robinhood communicated false and misleading information to millions of its customers,” said Jessica Hopper, executive vice president and head of FINRA’s Department of Enforcement, in a press release.

Additionally, Robinhood must retain, at its own expense, a third-party consultant “to conduct a comprehensive review of the adequacy of Robinhood’s compliance” with the consent order. The consultant will be allowed access to Robinhood’s and its affiliates’ files, books, records, and personnel and must report to FINRA on its activities.

Further, upon request, Robinhood must make available to FINRA “any and all communications” between the company and the consultant, as well as any documents reviewed by the consultant in connection with this review.

“This action sends a clear message: All FINRA member firms, regardless of their size or business model, must comply with the rules that govern the brokerage industry,” Hopper said. “Compliance with these rules is not optional and cannot be sacrificed for the sake of innovation or a willingness to ‘break things’ and fix them later.”

Investigation findings

Robinhood, over a period of at least five years, “failed to establish and maintain a supervisory system that was reasonably designed to achieve compliance with FINRA rules and applicable securities laws and regulations,” the self-regulatory organization stated.

FINRA said Robinhood “failed to address numerous red flags” that it was noncompliant with FINRA rules and applicable securities laws and regulations and “failed to timely correct or address deficiencies even when the firm identified them.”

“Compliance with these rules is not optional and cannot be sacrificed for the sake of innovation or a willingness to ‘break things’ and fix them later.”

Jessica Hopper, Head of FINRA’s Department of Enforcement

The regulator also took into account the “widespread and significant harm” suffered by Robinhood customers who received “false or misleading information” from the firm; were affected by systems outages in March 2020 that prevented placing trades; and received Robinhood approval to trade options even when it was not appropriate for customers to do so.

According to FINRA’s order, Robinhood has over 31 million users today, 18 million of which have funded accounts.

The regulator’s findings are discussed in greater detail below:

Communicated false and misleading information. Despite Robinhood’s self-described mission to “demystify finance for all,” during certain periods since September 2016, the firm communicated misleading information to customers concerning “a variety of critical issues, including whether customers could place trades on margin, how much cash was in customers’ accounts, how much buying power or ‘negative buying power’ customers had, the risk of loss customers faced in certain options transactions, and whether customers faced margin calls,” FINRA explained.

The organization cited the widely reported story of a 20-year-old user of the platform who took his own life in June 2020 after, according to his family, seeing what he perceived to be a negative balance of $730,000 in his account that was later found to be an inaccurate interpretation. As part of the settlement, Robinhood must pay more than $7 million in restitution to customers who suffered losses because of the company’s misstatements.

Failure to exercise due diligence. Since Robinhood began offering options trading to customers in December 2017, the firm “failed to exercise due diligence before approving customers to place options trades,” according to FINRA. The firm relied on algorithms—known at Robinhood as “option account approval bots”—to approve customers for options trading, with only limited oversight by firm principals.

“Those bots often approved customers to trade options based on inconsistent or illogical information,” FINRA stated. “As a result, Robinhood approved thousands of customers for options trading who either did not satisfy the firm’s eligibility criteria or whose accounts contained red flags indicating that options trading may not have been appropriate for them.”

Technological failures. From January 2018 to February 2021, Robinhood allegedly failed to reasonably supervise the technology it relied upon to provide core broker-dealer services, such as accepting and executing customer orders. Between 2018 and late 2020, the platform experienced a series of outages and critical systems failures. The most serious incident occurred in March 2020, when Robinhood’s Website and mobile applications shut down, “preventing Robinhood’s customers from accessing their accounts during a time of historic market volatility,” FINRA stated.

Although the firm had a business continuity plan at the time of the March outage, “it did not apply it because the plan was unreasonably limited to events that impacted the firm’s physical location,” FINRA said. “Robinhood’s inability to accept or execute customer orders during these outages resulted in individual customers losing tens of thousands of dollars.” Under the settlement, Robinhood must pay more than $5 million in restitution to affected customers.

Reporting lapses. Between January 2018 and December 2020, Robinhood failed to report to FINRA “tens of thousands of written customer complaints” regarding the failures alleged above. “Robinhood’s reporting failures were primarily the result of a firm-wide policy that exempted certain broad categories of complaints from reporting, even though those categories fell within the scope of FINRA’s reporting requirements,” the regulator stated.

Compliance and governance enhancements

In its order, FINRA acknowledged both Robinhood Financial and its parent company, Robinhood Markets, have undertaken numerous remedial measures since early 2020:

Enhanced legal, compliance, risk, and anti-fraud functions. Over the past year, Robinhood has made several new hires, including the appointment of a chief legal officer; two chief compliance officers; and new heads of financial crime, enterprise risk, and audit.

“We continue to grow and enhance our legal, compliance, and risk functions and programs and have hired dozens of experienced professionals in the past year alone,” Robinhood stated.

Strengthened supervisory structure. Robinhood said it also made “significant improvements” to the way it supervises its technology and engineering infrastructure.

“For example, we’ve taken steps to address the root causes of the March 2020 outages, reduce the risk of future outages, and increase the resilience of relevant systems, including by increasing system redundancy, better distributing load on Robinhood’s systems, and deploying a risk-based testing system,” the company stated.

Remediated customer communications and data displays. Robinhood said it added customer disclosures concerning the use of margin and corrected former inaccuracies in the display of buying power, cash balances (including negative cash balances), historical performance figures, and customer communications regarding the risk of loss in debit spread transactions.

“We have also provided customers with additional educational resources,” the company stated.

Improved supervision of options. In September 2020, Robinhood implemented “more rigorous criteria for customers’ eligibility for options trading and has continued to improve its options approval process. We also augmented our supervision of options trading by implementing systematic monitoring of options customers to confirm their ongoing eligibility for options trading. Since April 2020, we have conducted monthly account reviews and downgraded options accounts that no longer meet the eligibility criteria.”

More to come?

The FINRA settlement is not Robinhood’s first regulatory enforcement action. In December 2020, the company agreed to pay $65 million as part of a settlement with the Securities and Exchange Commission for misleading customers about how it makes money and failing to secure the best sale prices.

Additionally, during virtual testimony to Congress in May, SEC Chairman Gary Gensler said he requested the agency’s staff to produce a report on the “meme stocks” craze from earlier this year that led to wild fluctuations in several previously overlooked stocks, like GameStop and AMC Entertainment Holdings.

Specifically, Gensler said the SEC is examining who benefits from the “gamification” of stock trading, as well as payment for order flow, in which companies like Robinhood Financial derive revenue by delivering orders to other partners to execute. Gensler said he wants to understand whether those practices prey on inexperienced traders.