Robinhood's Legal Troubles: Violating Which Laws?

Robinhood Markets Inc. is an American financial trading platform that gained prominence during the 2021 meme stock trading mania. The company has been embroiled in several lawsuits and regulatory actions, including allegations of restricting trades on meme stocks and providing false and misleading information to customers. In 2021, Robinhood was fined $70 million by the Financial Industry Regulatory Authority (FINRA) for misleading customers and system outages, with the company paying tens of millions in additional fines to the Securities and Exchange Commission (SEC). The company has also faced lawsuits from investors who allege that Robinhood colluded with market maker Citadel Securities LLC to block them from trading high-flying stocks, resulting in billions of dollars in losses. While some lawsuits have been dismissed, Robinhood continues to face scrutiny and legal challenges over its business practices.

Robinhood was fined $70 million for misleading customers and system outages

Robinhood Financial, the online stock-trading app, was fined $70 million for misleading customers and system outages. The fine was imposed by the Financial Industry Regulatory Authority (FINRA), which is the securities industry's self-regulator. This was the largest fine ever imposed by FINRA.

The fine was a result of a series of failures by Robinhood that hurt its customers. These failures included false and misleading information, system outages in March 2020, and approving customers to trade options when it was not appropriate for them to do so. FINRA said that Robinhood's actions resulted in "widespread and significant harm" to its customers.

In its statement, FINRA said it "considered the widespread and significant harm suffered by customers, including millions of customers who received false or misleading information from the firm, millions of customers affected by the firm's systems outages in March 2020, and thousands of customers the firm approved to trade options even when it was not appropriate for the customers to do so".

Robinhood's system outages occurred during a period of especially wild trading amid the outbreak of the Covid-19 pandemic. The outages left clients unable to trade equities, options, or cryptocurrency. Robinhood has been criticised for its lack of due diligence before approving customers to trade options and for its false and misleading communications to customers.

Robinhood neither admitted nor denied the charges but said it had "invested heavily in improving platform stability, enhancing our educational resources, and building out our customer support and legal and compliance teams". The company was expected to go public in the coming months with a valuation of more than $30 billion.

A lawsuit accused Robinhood of violating state laws by restricting trades on meme stocks

A U.S. federal court dismissed a lawsuit accusing Robinhood Markets Inc of violating state laws by restricting trades on "meme stocks" during a January 2021 rally. Chief Judge Cecilia Altonaga of the federal court in Miami ruled that retail investors could not pursue negligence and breach of fiduciary duty claims against the commission-free brokerage, citing Robinhood's customer agreement, which allowed it to restrict trading.

The lawsuit was part of a wave of litigation after the brokerage temporarily barred customers from buying certain stocks, including GameStop Corp and AMC Entertainment Holdings Inc, as their value soared during the social-media-fuelled rally. The investors alleged that Robinhood had lured customers with promises of expanding access to the stock market but was indifferent to known risks tied to increased demand.

The lawsuit sought damages on behalf of Robinhood customers and traders who lost money on GameStop, AMC, and 11 other stocks. While traders were "gravely disappointed" by the plunge in meme stock prices that occurred after trades were restricted, Judge Altonaga wrote in her 66-page opinion that "the law does not afford relief to every unfulfilled expectation."

Robinhood was pleased with the decision, with spokesperson Jacqueline Ortiz Ramsay stating, "Once more, this confirms that the unfounded allegations against Robinhood have no basis." Another meme-stock lawsuit alleging Robinhood violated securities law is pending, and Robinhood has sought to dismiss these claims.

Robinhood's crypto platform could face charges from the Securities and Exchanges Commission

Robinhood's cryptocurrency platform has been threatened with charges from the Securities and Exchanges Commission (SEC). The trading app received a Wells Notice from the SEC, indicating a preliminary determination to file an enforcement action against Robinhood Crypto for alleged violations of federal laws governing securities brokers. The SEC has cracked down on the largely unregulated crypto trading world in recent years, arguing that many digital currencies are securities, which means crypto brokers must register with the SEC and follow securities laws.

Robinhood, founded in 2013, expanded its trading platform to include cryptocurrency trading in 2018. The company offers zero-fee trading, making it popular among younger retail traders. However, critics allege that it has allowed inexperienced users to make risky investments without fully understanding the risks involved. Robinhood's crypto platform received a Wells Notice from the SEC staff on May 4, indicating that the agency had made a preliminary determination to file an enforcement action against the company.

The Wells Notice suggested that Robinhood Crypto may have violated federal laws governing securities brokers. Robinhood's Chief Legal, Compliance and Corporate Affairs Officer, Dan Gallagher, expressed disappointment in the SEC's decision and stated that the company believes the assets listed on their platform are not securities. Robinhood intends to engage with the SEC to refute any allegations and highlight the weakness of any potential case against them.

The potential charges against Robinhood Crypto come amidst increasing scrutiny of the crypto trading industry by the SEC. Popular crypto trading platforms, including Binance, FTX, and Coinbase, have faced enforcement actions, lawsuits, and criminal charges. The SEC argues that many digital currencies are securities, which would require crypto brokers to register with the SEC and adhere to securities laws. However, cryptocurrency platforms have largely disputed this assertion.

Robinhood has faced multiple lawsuits and regulatory actions in the past. In 2022, a class-action lawsuit was filed against the company, alleging negligence due to outages in March 2020. Additionally, Robinhood settled a lawsuit related to restricting trades on "meme stocks" like GameStop and AMC during a rally in January 2021. The company has also faced accusations of colluding with Citadel Securities LLC to block traders from trading certain stocks during this period.

Robinhood colluded with Citadel Securities to block investors from trading high-flying stocks

In January 2021, Robinhood restricted trades on certain "meme stocks", including GameStop and AMC Entertainment Holdings, as their value soared during a social-media-fuelled rally. This move was alleged to have resulted in billions in losses for investors.

A US federal court dismissed a lawsuit accusing Robinhood of violating state laws by restricting trades, citing Robinhood's customer agreement which allowed it to restrict trading. However, investors claimed that Robinhood had courted customers with promises of expanding access to the stock market and was indifferent to known risks tied to increased demand.

One of the lawsuits alleged that Robinhood and Citadel Securities LLC colluded to halt a "short squeeze" that was causing billions of dollars in losses for hedge funds that had bet against the stocks championed by retail investors. Citadel Securities and Robinhood denied these allegations, and the judge dismissed the lawsuit. However, the plaintiffs were allowed to file an amended version of the lawsuit, and the case is still ongoing.

The US House Committee on Financial Services published a press release stating that Robinhood and Citadel Securities engaged in "blunt" negotiations regarding lowering Payment for Order Flow (PFOF) rates just a night before trading restrictions were imposed. The committee's "GameStopped" report highlights Robinhood's lack of liquidity, conversations between Citadel and Robinhood, and the process leading to the halting of "meme stocks".

Robinhood and Citadel have been accused of colluding to prevent investors from profiting from the surge in "meme stocks" and protecting hedge funds from losses. While Robinhood and Citadel deny any wrongdoing, investors feel that they were robbed when brokers restricted trading in AMC, GameStop, and other "meme stocks". The outcome of the ongoing lawsuits and investigations will determine whether Robinhood and Citadel broke the law through their actions.

Robinhood failed to supervise technology critical to providing customers with core broker-dealer services

Robinhood Financial LLC was fined $57 million and ordered to pay $12.6 million in restitution, plus interest, to thousands of customers. This was due to systemic supervisory failures and significant harm suffered by millions of customers.

Robinhood, a FinTech firm, relies on technology to deliver core functions. However, it outsourced the operation and maintenance of its platform to its parent company, which is not a member of FINRA, and failed to provide the necessary oversight. As a result, Robinhood experienced a series of outages and critical failures, including the most severe outage in March 2020, which left all of its millions of customers unable to trade during periods of intense market volatility. These outages persisted even after two warnings from FINRA, and the firm was found to have violated regulations.

Robinhood's platform displayed inaccurate cash balances, including large negative balances, which tragically led to a customer committing suicide. The system also issued incorrect margin calls and warnings, prompting people to sell investments or liquidate accounts unnecessarily.

Robinhood's failure to supervise its technology was one of three key areas of FINRA's findings, the other two being the firm's communication of false and misleading information and its failure to exercise due diligence on options accounts.

Frequently asked questions