On June 30, 2021 FINRA announced that it has ordered Robinhood Financial LLC to pay approximately $70 million dollars for its system-wide supervisory failures and widespread harm inflicted on its millions of customers. The consent order includes a $57 million fine as well as approximately $12.6 million in restitution payments to thousands of affected Robinhood customers. These penalties amount to the single largest financial fine ever ordered by FINRA. The SEC has previously fined Robinhood for other misstatements and non-disclosures. FINRA’s investigation uncovered a number of regulatory violations committed by Robinhood including its providing of false or misleading account information, its March 2020 systems outages, failures to report customer complaints, and its improper approval of thousands of unqualified customers for options trading—many of whom were under 21 years old.
Taking a swipe at Robinhood’s stated goal of innovating and “demystifying finance for all,” FINRA reiterated that all brokerage firms must comply with the stated rules governing the brokerage industry. These rules, stated FINRA, have been put in place to protect both investors as well as the integrity of the stock markets, and cannot be overlooked simply because a firm seeks to innovate securities trading.
Robinhood’s Bots Improperly Approved Young Customers for Options Trading
In its order, among other things, FINRA found that Robinhood failed to exercise the required due diligence before approving its customers for options trading. Because Robinhood relied on computer algorithms known as “option account approval bots,” there was very limited oversight by the firm’s options principals as required by FINRA rules. Because of this obvious lack of human oversight, the automated bots often approved customers for options trading based on both inconsistent or illogical information. The use of these bots led to Robinhood’s improper approval of thousands of its customers for options trading. These customers should not have been approved for options trading because they either did not satisfy the firm’s options eligibility criteria, or their accounts contained red flags alerting the firm that options trading may be inappropriate for them. Many of these customers were under 21 and had represented to Robinhood that they had at least three years of options trading experience, when in fact they were prohibited from trading in accounts when they were under 18 years of age.
Robinhood’s System for Options Approval Did Not Look all Available Information
Since allowing options trading on their platform beginning in December 2017, Robinhood’s system for approving customers for such options trading has been almost entirely automated. This is true for all levels of options trading provided by Robinhood. Level 2 approval for options trading allows for basic options trading, including cash-secured puts as well as covered calls. Level 3 approval allows for more advanced trading, such as engaging in options spreads. In conducting the analysis for its customers to be approved to trade options, Robinhood’s bots review customer responses to numerous eligibility questions, and then automatically (and in most cases almost instantaneously) either approve or reject the customer’s options application based on the responses. FINRA found that because those bots failed to look at all the account information available to the firm, Robinhood’s has routinely approved customers for options trading who nevertheless do not meet their eligibility criteria.
Robinhood Improperly Approved Young Customers For Level 3 Options Trading
FINRA’s investigation found that Robinhood’s bots only take into account the information that the customer provided in their most recent options application—without comparing this information to those customers’ prior options applications or to any other information the customers have provided to Robinhood previously. In a glaring example, FINRA found that before September 2020, the options approval bots could approve customers to trade level 3 options who represented that they had three years of options trading experience—even if that customer was younger than 21 or if that customer had previously represented (just a few minutes earlier) that they had absolutely no experience in options trading. This occurred despite that, beginning in April 2020, Robinhood’s own operating manual noted that because customers must be at least 18 in order to open an account, any customer under 21 years old who had certified to having at least three years of experience in options trading had provided false information regarding suitability. Moreover, despite that level 3 options trading allows Robinhood’s customers to trade option spreads, its bots approved for level 3 trading customers who had previously certified that they did not understand options. Finally, Robinhood’s bots allow new options applications by customers whose prior options applications the bot has denied. And, Robinhood does not require its customers to wait before reapplying to trade options. Thus, FINRA found that Robinhood’s customers have often reapplied for options trading (and approved) just mere minutes after being rejected. Often, this approval was based on information inconsistent with information just supplied by those customers in their rejected application. Moreover, FINRA found that from December 2017 to February 2021, with respect to customers who were rejected for options trading, Robinhood would identify the portions of those customer’s investment profiles making them ineligible for options trading (such as a “low” risk tolerance) and prompt the customer to “update” those responses.
Robinhood Insufficiently Reviewed Options Trading Bot Approval
While the regulator found Robinhood does review some accounts it has approved for options trading, it found these to be inadequate. Its options principals initially conducted a weekly review of less than 0.1% of its accounts to make certain that the options approval bots were functioning as programmed. Hundreds of thousands of options approval applications were reviewed by Robinhood’ bots every month, but the firm’s principals were previously reviewing only 20 applications per week. In May 2021, this review was increased to approximately 500 weekly applications. However, FINRA found that the reviews were limited to simply ensuring that the bots function as they were programmed. The Robinhoood options principals did not evaluate whether the information the bot reviewed was consistent with the other information the customer provided to Robinhood. And, the options principals did not review whether options trading was appropriate for the approved customer.
Beginning in April 2020, Robinhood did implement a system whereby, on a monthly basis, it created “downgrades” for its customers who had previously been approved to trade options during the prior month but where Robinhood found there to be “inconsistent logic in customers’ account profile characteristics.” These new reviews began after Robinhood discovered its approval of over 1,190 customers for options trading who were under 21 who certified that they had more than three years of experience trading options. This new system for identifying “inconsistent logic” took over six months to put in place. This program, put in place in April 2020, is called the “bulk downgrade.” It identifies customers who are younger than 21 who were approved for level 3 options trading due to the customers’ representations that they had at least three years of experience in trading options. These bulk downgrade reviews also identify customers who were approved for options trading but then changed their investment profile information making them ineligible to trade options (such as then their risk tolerance is changed from medium to low). Using these reviews, Robinhood has downgraded, on a monthly basis, many customers whom it has identified as not meeting the firm’s options eligibility criteria. As part of this bulk downgrade process, in February 2021 Robinhood downgraded 39,940 accounts just for that month alone.
While Robinhood did implement its “bulk downgrade” procedures in April 2020, and while it also revised, in September 2020, its options eligibility, FINRA found that the firm’s bots continue to approve options customers based on inconsistent information. Often options trading occured in these accounts prior to the monthly automated “bulk downgrade” wherein Robinhood revokes its option trading approval.
Robinhood Improperly Approved Customers Under 21 for Options Trading
FINRA found that since December 2017, Robinhood has approved for options trading thousands of accounts that were not eligible under the firm’s criteria for trading options, or where those accounts had red flags indicating that approval for options trading was inappropriate.
In an internal review in April 2020, Robinhood identified many customers who should not have been approved for trading options—but only after it allowed these customers to trade options (over periods of months or sometimes years). In that review, Robinhood identified around 3,200 accounts that had provided “false suitability information” by representing that the customer had at least three years’ of experience trading options when those customers were still younger than 21. Robinhood also flagged another 1,200 accounts which its bots had approved for level 2 or 3 options trading, although the customers had revised their risk tolerance, making them ineligible under Robinhood’s option approval criteria. Moreover, the firm found another 5,350 accounts which it had approved for level 3 options trading which were only suitable for level 2 options trading.
FINRA took a sample of a four month window of data during the years 2018-2020. In each of those four month periods, FINRA found that Robinhood improperly approved the following accounts for options trading:
- Over 700 accounts were approved for level 2 or level 3 options trading where the customer provided a risk tolerance that made them ineligible for options trading under Robinhood’s approval criteria.
- Over 1,680 accounts were approved to trade level 3 options where the account holder represented that they had three years of options trading experience but were under the age of 21.
- Over 3,380 accounts were approved to trade level 3 options where customers claimed that they had three years of investment experience but, during the prior three years, had provided information to Robinhood that they had no prior investment experience.
Robinhood Approved Options Trading for Customers By Allowing Them to Change Their Answers to Options Approval Questions
The following examples of this improper approval were provided by FINRA:
- A 20 year old customer opened a Robinhood account and represented having both “limited” investment experience as well as a “low” risk tolerance. Just two days later, the same customer applied, but was rejected, for options trading. Then, a mere three minutes after this rejection, the same customer changed his risk tolerance to “medium” and revised his stated options trading experience to at least three years. Based upon these revisions, 13 seconds later, Robinhood approved this customer for level 3 options trading, even though he was just 20 years old—and, according to Robinhood’s internal operating procedures, clearly had provided “false suitability information” by representing that he had at least three years of options trading experience. FINRA found that since its August 2018 approval of this particular customer for level 3 options, that Robinhood had not downgraded this customer’s options trading level.
- Another Robinhood customer opened his account at 19 years old. A quick seven minutes after opening his account he applied, but was rejected, for level 3 options trading approval because he reported a low risk tolerance and represented that he did not understand options spreads. Just 13 minutes later, the same customer again applied for level 3 options, after changing his risk tolerance to “high” and changing his options trading experience to at least three years from his prior “N/A” response. Significantly, this customer never changed his representation which stated that he did not understand options spreads. Despite this, Robinhood immediately (within one minute) approved this customer for level 3 options trading, enabling him to trade options spreads. More than one year later, Robinhood downgraded this customer to level 2 options as part of its April 2020 “bulk downgrade” review.
- Yet another Robinhood customer opened her account in August 2020 reporting that she had a low risk tolerance and no investment experience. Eight days later, she applied for options trading approval after changing her risk tolerance to medium, and revising her options trading experience to “1–2 years.” Robinhood immediately (that same minute) approved this customer for level 2 options trading. That same day, after this customer applied for, but was rejected, for options trading 14 more times, the customer revised her stated options trading experience to 3 or more years, and then Robinhood immediately gave her approval for level 3 options trading. This account approval was not flagged by Robinhood for review, even though this customer had reported—eight days earlier—that she had no prior investment experience. FINRA also found that Robinhood had not downgraded this customer’s options trading approval.
Having failed both to reasonably supervise its system for approving customers for options trading and to exercise due diligence in approving customers for options trading, Robinhood was found to have violated a number of FINRA rules. Because of these violations, Robinhood approved thousands of customers for options trading when those customers did not meet the firm’s approval criteria or where their account information contained red flags indicating that options trading was not suitable.
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Not everyone who loses money in options trading has a claim against their brokerage firm. However, under certain circumstances where misconduct or violations of securities laws and rules have occurred, investors may have the right to seek legal recourse. If you or a loved one have suffered investment losses as a result of an online options investment or any other type of investment fraud or broker negligence, contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States. Contact us by filling out our online contact form, or calling 844-635-1609 or 305-349-2336.