Author: Juliana M. Ness, Cosgrove Law Group, LLC
In early September of this year, Robinhood (a brokerage app) became the subject of investigations by both the U.S. Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (FINRA). Both regulators cite two central concerns regarding Robinhood. The first relates to Robinhood’s practice of selling client orders to high-speed trading firms such as Citadel Securities and Two Sigma Securities. The second relates to trading outages that occurred on Robinhood’s platform in March of 2020, the longest of which lasted 17 hours.
The SEC and FINRA investigations regarding Robinhood’s practice of selling client orders to third parties mainly focuses on disclosures. Robinhood did not have public disclosures regarding its third-party relations until 2018. This practice is one of Robinhood’s primary sources of income. (Nearly 70% of Robinhood’s income comes from high-speed trading.) The SEC investigation aims to determine whether the lack of disclosure by Robinhood could be considered Civil Fraud. If determined that Robinhood’s actions were Civil Fraud, Robinhood may face an SEC fine upwards to 10 Million Dollars.
The SEC and FINRA are also reviewing trading outages within Robinhood’s platform. Robinhood’s defense to the investigation regarding the March outages includes the discussion of extreme volume increases. Robinhood claims that in March, high market volatility and a record number of new accounts generated stress on the brokerage application’s infrastructure. The unusually high demand for trading in March short-circuited Robinhood’s platform, causing the outage. More than 400 complaints against Robinhood were filed in this year’s first quarter, possibly sparking SEC and FINRA interest. Yet the trading outages have not been resolved. A similar event occurred in late August after stock splits from Apple and Tesla generated an increased demand for trading. This resulted in service outages not only at Robinhood but other brokerages such as Vanguard, Charles Schwab, TD Ameritrade, and Merrill Lynch. In June, Robinhood reported an astonishing 4.32 million new accounts. The app continues to gain users, which puts it in a position for review by regulatory agencies.
The investigations into the outages also sparks an important question--Is technological failure result responsibility of brokerages when the failure resulted in possible investor losses? This question becomes more complex regarding technical issues that relate to an increase in user demand generating outages. Brokerages may not be able to reasonably foresee these issues. Robinhood is also a new company, established in 2013, and follows a business model different from most large brokerages. Since Robinhood’s platform does not use financial advisors, how much responsibility does the brokerage have when it comes to the service it provides to the client? More investment applications similar to Robinhood are popping up, and regulators are working on ways to better regulate this new trend.
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