Online trading app Robinhood has been hounded by regulators for years, but now it’s going on the offensive.
The company is suing the state of Massachusetts in response to a lawsuit from the state’s securities regulator that accuses it of violating a new fiduciary standard that requires stock brokers in the state to put the interest of their customers ahead of their own.
Massachusetts first took administrative action against the broker in December, arguing that Robinhood’s practices of providing lists of popular securities, employing tactics like push notifications and game-like graphics, both encouraged users in the state to buy securities that were not suitable for them and to trade more than was in their best interest.
On Thursday, William Galvin, the state’s top securities regulator, filed a motion to amend last year’s complaint to request that Robinhood’s broker-dealer registration be revoked after the company “has continued a pattern of aggressively inducing and enticing trading among its customers,” a move that would block any Massachusetts resident from using the Robinhood app.
Robinhood is fighting back against these allegations, lodging its own lawsuit against Galvin and the Massachusetts Securities Division, claiming that the fiduciary rule he implemented last September violates both state and federal law, and that even under the standard, Robinhood is a self-directed broker, and therefore cannot be operating against its customers’ best interests.
“The complaint reflects the old way of thinking: That new, younger, and more diverse investors don’t have a place in the markets. By trying to block Robinhood, the division is attempting to bring its residents back in time and reinstate the financial barriers that Robinhood was founded to break down,” the company said in a Thursday blog post.
“We don’t believe our customers are naive as the Massachusetts Securities Division paints them to be. Showing a list of companies in a certain sector is not a recommendation. Giving people information about the movement of the stocks they own or watch is not a recommendation,” the company said.
Valentino Vasi, an attorney who deals with regulatory compliance issues at the firm Seward & Kissel, told MarketWatch that he doesn’t believe Robinhood will successfully get a court to overturn Massachusetts’ fiduciary rule. But he said the company is on firmer ground when it says that it’s a self-directed broker that doesn’t make security recommendations, and therefore the fiduciary rule doesn’t apply to them.
That said, the case could become long and drawn out just when Robinhood has been attempting to put various regulatory issues behind it as it prepares for a potential initial public offering.
“Usually there’s an opportunity for negotiation, with Massachusetts initially giving Robinhood 11 reforms and remedies it could have made” to get back in the state’s good graces, Vasi said. “It looked like things didn’t work out and that’s because both sides are taking really hard positions. Now that Massachusetts said we’re seeking termination, I don’t know if that prompts negotiation, but it looks like it’s going the other way.”
Vasi added that he could easily see this issue ending up before a judge, further increasing the public spotlight on Robinhood at the same time that the U.S. Securities and Exchange Commission is under increased pressure to examine the same issues of fiduciary responsibility and gamification that Massachusetts is concerned with.
The company recently settled with the SEC over charges that it misled its customers about the revenue it earns from market makers, who pay to have Robinhood route customer orders their way and for failing to execute trades for customers at the best price. Robinhood said at the time that “the settlement relates to historical practices that do not reflect Robinhood today.”
Following an incident in January — when Robinhood blocked customers from purchasing shares of GameStop Inc.
and other so-called meme stocks — CEO Vlad Tenev was brought before Congress to answer questions related to the blockage, the company’s revenue from market makers and the same sort of “gamification” practices Massachusetts has taken it to court over.
“Robinhood seems to have perfected the gamification of trading, providing the user with the perception that investing through the app offers recreational game playing with little or no downside risk,” said Rep. Nydia Velazquez, a Democrat from New York, during a Financial Services Committee hearing last month. Her comments echoed the concerns of other Democrats who’d like to see stricter regulation on application interfaces so they don’t manipulate users into trading more frequently than they otherwise would.
The Financial Industry Regulatory Authority, the broker-dealer industry’s self regulatory body overseen by the SEC, is already on the case, saying in February that it would be investigating mobile-application design to determine whether app-based brokers are complying with existing regulations. Pressure from lawmakers will likely only create more urgency in crafting new rules.
FINRA is also reportedly investigating a number of incidents that led to the Robinhood app being unavailable to customers, which have been the subject of several class action lawsuits of late and are part of the proposed Massachusetts administrative action. On Friday, Robinhood customers experienced outages related to cryptocurrency trades amid the surge in the price of a cryptocurrency called Dogecoin
As of noon Eastern time Friday, the company reported that crypto trading was restored for all customers.