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)[1].
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[2]. The second relates to
trading outages that occurred on Robinhood’s platform in March of 2020, the
longest of which lasted 17 hours[3].
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[4]. (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[5]. 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[6]. 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[7].
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.
[1] Brasseur,
K. (2020, September 01). Robinhood adds two CCOs amid reported SEC probe.
Retrieved October 07, 2020, from
https://www.complianceweek.com/grapevine/robinhood-adds-two-ccos-amid-reported-sec-probe/29391.article
[2] Smith,
K. (2020, September 03). Robinhood Facing Multiple SEC Investigations Into Its
Business Practices. Retrieved October 07, 2020, from https://www.forbes.com/sites/advisor/2020/09/03/robinhood-investigation-sec-finra/
[3]Robinson,
M., Alexander, S., & Massa, A. (2020, September 03). Robinhood Probed by
SEC Over Payments From High-Speed Traders. Retrieved October 07, 2020, from
https://www.bloomberg.com/news/articles/2020-09-03/robinhood-probed-by-sec-over-payments-from-high-speed-traders
[4] Gunderia,
E. (2020, September 03). Robinhood Under SEC Investigation. Retrieved October
07, 2020, from https://www.thestreet.com/streetlightning/stock-picks/secinvestigaton-robinhood-paymentforoderflow
[5] Gaus,
A. (2020, September 02). Robinhood Faces SEC Fraud Investigation: Report.
Retrieved October 07, 2020, from
https://www.thestreet.com/investing/robinhood-faces-sec-fraud-investigation-report
[6] Tabacco,
C. (2020, September 03). Robinhood Faces Investigations from SEC and FINRA -
Tech. Retrieved October 07, 2020, from
https://lawstreetmedia.com/tech/robinhood-faces-investigations-from-sec-and-finra/
[7] Ongweso,
E., Jr. (2020, August 31). Tesla and Apple Stock Split, Investors Crash
Robinhood, Nothing Makes Sense. Retrieved October 07, 2020, from
https://www.vice.com/en/article/3azeeb/tesla-and-apple-stock-split-investors-crash-robinhood-nothing-makes-sense
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