Securities Industry Commentator by Bill Singer Esq

June 30, 2021

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Robinhood Financial LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Robinhood Financial LLC became a FINRA member firm in 2013 and launched its online trading in December 2014; and the firm has about 770 registered representatives at six branches. The AWC asserts that Robinhood had entered into a December 2019 AWC addressing order flow issues with FINRA for which a Censure and $1,250,00 fine and an independent-consultant undertaking was imposed; and a December 2020 settlement with the SEC addressing order flow issues for which the federal regulator imposed a Cease-and-Desist, Censure, a $65,000,000 civil money penalty, and an independent-consultant undertaking.  

The 2021 FINRA AWC imposes upon Robinhood a Censure, $57 million fine, $12,598,443.16 in restitution, and an independent-consultant undertaking.  As alleged in part in the 122-page FINRA AWC under "Overview" [Ed: footnotes omitted]:

Robinhood is an introducing broker-dealer that provides commission-free trading to retail customers through its website and mobile applications. The firm's stated mission is to "democratize and de-mystify finance for all," and to "make investing friendly, approachable, and understandable for newcomers and experts alike." Since launching its online trading platforms in December 2014, Robinhood has quickly attracted customers-many of whom are relatively young and new to investing -including through offerings such as no-minimum, commission-free trading and a user interface "designed to . . . appeal to a new generation of investors who are more comfortable trading on smartphones." Through these and other initiatives, Robinhood has experienced dramatic growth-from fewer than 500,000 customers in 2015 to over 31 million today.

False and misleading information distributed to customers - Despite Robinhood's mission to "de-mystify finance for all" and to make investing "understandable for newcomers and experts alike," during certain periods since September 2016, the firm has negligently communicated a wide array of false and misleading information to its customers. Among others: 

  • Robinhood falsely told "Robinhood Instant" customers that they had to upgrade to "Robinhood Gold" to trade on margin when, in fact, Robinhood allowed "Instant" customers to place options trades that could trigger the use of margin. 

  • Robinhood falsely told "Robinhood Gold" customers that they could "disable" margin in their accounts when, in fact, Robinhood allowed "Gold" customers to place options trades that could trigger the use of margin even after they had "disabled" margin.

  • Robinhood displayed inaccurate cash balances to certain customers. Some inaccuracies were significant. For example, Robinhood displayed to many customers negative cash balances that were twice as large as they actually were. 

  • Robinhood provided false information to customers about the risks associated with certain options transactions. For example, Robinhood falsely told customers that they would "never lose more than the premium paid to enter [a] debit spread" when customers could, and many did, lose vastly more than the premiums they paid. 

  • Robinhood issued to certain customers erroneous margin calls and margin call warnings, telling them that they were in "danger of a margin call" when they were not. 

As a result of these and other false and misleading statements, Robinhood violated FINRA Rule 2010, which prohibits FINRA member firms from making misrepresentations to customers. Robinhood's negligent dissemination of false and misleading information to its customers separately violated FINRA Rules 2210 and 2220, which set forth content standards for firms' communications with customers. Because Robinhood failed to have a reasonably designed supervisory system and procedures to achieve compliance with FINRA rules and applicable securities laws requiring that communications with customers be truthful and not misleading, it also violated FINRA Rules 3110 and 2010. 

Failure to exercise due diligence before approving options accounts - Since Robinhood began offering options trading to customers in December 2017, the firm has failed to exercise due diligence before approving customers to trade options. Although the firm's written supervisory procedures assign registered options principals the responsibility of approving accounts for options trading, the firm, in practice, has relied on computer algorithms-known at Robinhood as "option account approval bots"-with only limited oversight by firm principals. This system suffers from a number of flaws, including the following: 

  • The bots were programmed to approve options trading based on inconsistent or illogical information, including for customers who were younger than 21 years old but who claimed to have had more than three years' experience trading options. 

  • The bots approved certain customers with low risk tolerance for options trading, even though the firm's written procedures prohibited the firm from approving those customers from trading options.

  • The bots were programmed only to take into account the most recent information provided by customers, meaning that the firm approved for options trading customers whom it had previously rejected for options trading-often only minutes earlier. 

As a result of these flaws and Robinhood's overall failure to exercise due diligence before approving customers for options trading, the firm has approved thousands of customers who did not satisfy the firm's eligibility criteria or whose accounts contained red flags that options trading may not be appropriate for them, in violation of FINRA Rules 3110, 2360, and 2010. 

Failure to supervise technology critical to providing customers with core broker-dealer services - From January 2018 to February 2021, Robinhood failed to reasonably supervise the operation and maintenance of its technology, which, as a FinTech firm, Robinhood relies upon to deliver core functions, including accepting and executing customer orders. Instead, Robinhood outsourced the operation and maintenance of its technology to its parent company, Robinhood Markets, Inc. (RHM)-which is not a FINRA member firm-without broker-dealer oversight. Robinhood experienced a series of outages and critical systems failures between 2018 and late 2020, which, in turn, prevented Robinhood from providing its customers with basic broker-dealer services, such as order entry and execution. The most serious outage, which occurred on March 2- 3, 2020, rendered the website and mobile applications inoperable. During the March outage, all of Robinhood's customers were unable to trade. These outages persisted despite two warnings from FINRA that the firm was not reasonably supervising its technology. 

Because Robinhood failed to reasonably supervise the operation and maintenance of the technology it relied upon to provide core broker-dealer services, Robinhood violated FINRA Rules 3110 and 2010. 

Failure to create a reasonably designed business continuity plan - At the time of the March 2-3 outage, Robinhood's business continuity plan (BCP) was not reasonably designed to allow the firm to meet its obligations to customers in the event of a significant business disruption, as required by FINRA Rule 4370. Robinhood's BCP was limited to events that physically prevented employees from working from the firm's premises. As such, the firm did not consider applying its BCP to technology-related business disruptions, including the March 2-3 outage, which Robinhood considered an "existential" threat to its business. In addition, the firm's BCP was not reasonably 5 tailored to the firm's tailored to the firm's business model. For example, the BCP referenced backup methods for accepting and executing customer orders that the firm did not have. As a result, Robinhood violated FINRA Rules 4370 and 2010. 

Failure to report customer complaints to FINRA - Between January 2018 and December 2020, Robinhood failed to report to FINRA tens of thousands of customer complaints that it was required to report under FINRA Rule 4530, including complaints that Robinhood provided customers with false or misleading information and that customers suffered losses as a result of the firm's outages and systems failures. As a result of its failure to report these, and other, customer complaints, Robinhood violated FINRA Rules 4530(d) and 2010. 

Failure to have a reasonably designed customer identification program - From June 2016 to November 2018, Robinhood failed to establish or maintain a customer identification program that was appropriate for the firm's size and business. The firm approved more than 5.5 million new customer accounts during that period, relying on a customer identification system that was largely automated and suffered from flaws. For example, even though Robinhood received alerts flagging certain applications as potentially fraudulent-including applications where the customer's purported Social Security number belonged to a person who was deceased-Robinhood's customer identification system "overrode" those alerts and approved the applications without any review. In all, Robinhood approved more than 90,000 accounts from June 2016 to November 2018 that had been flagged for potential fraud without further manual review. As a result of its failure to have a reasonably designed customer identification program, Robinhood opened thousands of accounts despite red flags of potential fraud or identity theft, in violation of FINRA Rules 3310 and 2010. 

Failure to display complete market data information - Between January 2018 and November 2019, Robinhood failed to display complete market data information on its website and mobile applications, as required by Rule 603(c) of Regulation NMS of the Exchange Act. As a result, Robinhood violated Rule 603(c) and FINRA Rule 2010.

Bill Singer's Comment: I'm sorry but this is not regulation. This is generating revenue for FINRA. This is about indulging a cynical cost-benefits analysis. There is no consequence here at all because Robinhood clearly has the bucks to hire the legal talent to negotiate this settlement and clearly has the cash to pay off the fine without so much as a wince. If this were a small FINRA member firm, heads would have rolled -- as in human beings would have been suspended and fined. There is no such head count in this AWC. Further, given the notoriety of some of the cited events, which went back to 2016, this settlement is years late and dollars short. How is it that FINRA supposedly performs inspections of its member firms but when it came to Robinhood, so much was missed for so long? READ: 
"A History Of SOES, Daytrading, NASD, NASDAQ, DOJ, SEC, Congress, And Robinhood" ( Blog /  September 1, 2020)
Just going by the recently published SEC Order settling the federal regulator's case against Neovest, Inc., you'd think that the show of hands was five in favor and none against. As in unanimous. But it wasn't. It seems to have been a Majority Decision. Which is okay. But "okay" doesn't mean that you avoid all reference to any Dissent in the Order. Publishing a Dissent as a standalone document sort of defeats the purpose -- and sure as hell screws up the context. Wall Street regulation should not operate part in the light and part in the dark. It's difficult for those of us who practice law in this area to divine the messages hidden in a regulatory penumbra. It's even more difficult for those who are not lawyers and regulated by the SEC.

Supreme Court Affirms Federal Right of Eminent Domain Over Objecting States
PennEast Pipeline Company, LLC, Petitioner, v. New Jersey, et al.,
(Opinion, United States Supreme Court, No. 19-1039; 594 U.S. ___(2021))
In an historic Opinion delivered by Chief Justice Roberts in which Justices Breyer, Alito, Sotomayor, and Kavanaugh joined; Gorsuch dissented and was joined by Thomas; and Barrett dissented and was joined by Thomas, Kagan, and Gorsuch, the Supreme Court affirms the federal government's right to condemn all necessary rights-of-way notwithstanding a nonconsenting State. As preliminarily explained in introductory thoughts from Chief Justice Roberts' Majority Opinion:

Eminent domain is the power of the government to take property for public use without the consent of the owner. It can be exercised either by public officials or by private parties to whom the power has been delegated. And it can be exercised either through the initiation of legal proceedings or simply by taking possession up front, with compensation to follow. Since the founding, the United States has used its eminent domain authority to build a variety of infrastructure projects. It has done so on its own and through private delegatees, and it has relied on legal proceedings and upfront takings. It has also used its power against both private property and property owned by the States. This case involves one of the ways the federal eminent domain power can be exercised: through legal proceedings initiated by private delegatees against state-owned property. Specifically, we are asked to decide whether the Federal Government can constitutionally confer on pipeline companies the authority to condemn necessary rights-of-way in which a State has an interest. We hold that it can. Although nonconsenting States are generally immune from suit, they surrendered their immunity from the exercise of the federal eminent domain power when they ratified the Constitution. That power carries with it the ability to condemn property in court. Because the Natural Gas Act delegates the federal eminent domain power to private parties, those parties can initiate condemnation proceedings, including against state-owned property.
As alleged in the DOJ Release:

Cedric Chanu, 42, of France and the United Arab Emirates, was convicted by a federal jury on Sept. 25, 2020. Based on the evidence presented at trial, Chanu, who was employed as a precious metals trader at Deutsche Bank in Singapore and, later in London, engaged in a scheme to defraud other traders on the Commodity Exchange Inc., which was a public exchange. The defendant, together with James Vorley and other Deutsche Bank traders, defrauded other market participants through a deceptive trading practice known as "spoofing." Specifically, Chanu placed fraudulent orders that he did not intend to execute in order to create the false appearance of supply and demand and to induce other traders to transact at prices, quantities, and times that they otherwise would not have traded. Vorley was sentenced on June 21, also to 12 months and a day in prison.
Isaiah Leslie Goodman, 34, pled guilty to one count of mail fraud in the United States District Court for the District of Minnesota, and he was sentenced to 84 months in prison plus three years of supervised release, and ordered to forfeit his equity in real estate, a vehicle, and other items of personal property. As alleged in part in the DOJ Release, from at least 2017 through November 2020, Goodman:

defrauded at least 23 of his investor clients out of approximately $2,335,797.19. Goodman was a registered investment advisor and broker who owned Becoming Financial Group, Inc., and Becoming Financial Advisory Services L.L.C. Goodman also owned and operated MoneyVerbs, a business that claimed to provide customers with financial guidance through an internet-based app. Through Becoming Financial Group, Inc., and Becoming Financial Advisory Services L.L.C., Goodman represented that he would provide his clients with financial planning and investment advice, including purporting to place his clients' savings and retirement funds into financial accounts that Goodman claimed were safe, secure, and profitable.

According to court documents, as part of his scheme to defraud, Goodman lied to prospective and existing clients about his use of their money, the security and profitability of the financial accounts he claimed to administer on their behalf, and the status and performance of their funds. During in-person sales pitches or through email messages and phone calls, Goodman provided clients with materially false and fraudulent information, including investment proposals and bogus online account information. Goodman also misrepresented to clients that their funds would be returned to them upon request, when, in fact, Goodman either kept all of the money or provided investors with refunded payments that were late, incomplete, or both, or that were refunds actually funded by other clients' money.

According to court documents, instead of placing his clients' money into safe and secure investment accounts, Goodman deposited client funds into bank accounts he controlled. Goodman misappropriated his clients' funds for his own use and benefit by, among other things, purchasing and remodeling his home in Maple Grove, using funds for the purchase and construction of a $1.69 million home in Plymouth, buying a 2019 Ford Expedition and a 2020 Ford Explorer, funneling approximately $700,000 toward his other business, MoneyVerbs, and paying for personal expenditures, including a hot tub, a cruise, fitness club memberships, jewelry, and credit card payments.
Seven F. Brown pled guilty in the United States District Court for the Central District of California to one count of wire fraud, and he was sentenced to 51 months in prison and ordered to pay $3,313,346 in restitution.  An SEC Complaint filed in September 2020 against Brown is pending. As alleged in part in the DOJ Release:

Brown controlled and operated Alpha Trade Analytics, Inc., a financial consulting-and-investment company he largely ran out of his home. Neither Brown nor Alpha Trade was a registered broker or dealer in securities. Brown also served as the accountant for a non-profit organization providing dance and theater arts education to children and young adults in Los Angeles, which gave him access to its bank accounts.

From April 2014 to May 2018, Brown solicited investments in Alpha Trade, including from people he encountered through his position at the non-profit, and through his relationship with its executives and employees, which afforded him access to high-net worth individuals.

To encourage those individuals to invest with Alpha Trade, Brown falsely promised that their investments would only be used for foreign exchange (Forex) currency trading and that they would receive guaranteed monthly payouts of around 10%. He also falsely represented that he had extensive experience in Forex investing, regularly made profitable trades, and achieved substantial and growing rates of return that exceeded the industry average.

Contrary to his representations to investors, Brown only used a small portion of the total amount invested in Alpha Trade for Forex trading, mostly in 2015. Instead, he routinely used investor funds for other purposes, including his rent, car payments, restaurant and retail expenses, and lulling payments to other investors.

To induce investors to maintain or supplement their investments with Alpha Trade and to conceal his scheme, Brown periodically provided investors with account statements that reflected fabricated investment returns that often showed steady, significant gains.

Brown made some of the promised recurring payouts and provided demanded refunds, not based on any Forex investment returns, but instead from money stolen from new investors and through funds he embezzled from the dance academy through unauthorized wire transfers, credit card advances and cash withdrawals he was able to make by virtue of his position as the dance academy's accountant.

In total, Brown caused losses of approximately $3,313,346 to 48 victims, including nearly $700,000 in losses to his former employer based on the money he embezzled from it.
In a Complaint filed in the United States District Court for the Central District of California, the SEC charged Matthew J. Skinner, Empire West Equity Inc., Bayside Equity LP, Longacre Estates LP, Freedom Equity Fund LLC, and Simple Growth LLC with violating the securities registration requirements of Sections 5(a) and 5(c) of the Securities Act and the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder; and further charged Skinner with violating the broker-dealer registration requirements of Section 15(a) of the Exchange Act. The DOJ Release alleges in part that between 2015 and 2020, Skinner raised over $9 million from over 100 investors through four unregistered/fraudulent real estate offerings; and that Skinner:

touted himself to investors as a successful real estate investor and dealmaker, made multiple misrepresentations to investors and misappropriated millions of dollars of investor funds.  The SEC contends that Skinner told investors their money would be used to finance specific real estate projects or investments, projecting and, in some cases, guaranteeing double-digit annual returns.  The SEC alleges that instead Skinner spent substantial amounts of investor funds on his personal expenses, including European vacations and payments for a Maserati and an Aston Martin.  The SEC also alleges that Skinner used investor money to pay operational and marketing expenses unrelated to the specific projects, and to make Ponzi-like payments to other investors.  According to the SEC's complaint, Skinner owes investors millions of dollars, and he falsely blamed the COVID-19 pandemic for his failure to pay them, telling investors their money was safe when in fact he had spent it all.  The SEC alleges that Skinner used these false statements to pressure certain investors to extend their investment terms.
In a Complaint filed in the United States District Court for the Northern District of Illinois, the SEC charged Barrington Asset Management, Inc. and Gregory D. Paris with violating the antifraud provisions of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, Section 17(a) of the Securities Act, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940; and further charges Paris, in the alternative, with aiding and abetting Barrington's violations of Sections 206(1) and 206(2) of the Advisers Act. As alleged in part in the SEC Release:

over a four year period Paris reaped more than $630,000 in ill-gotten gains at his clients' expense by cherry-picking trades. Paris allegedly traded securities in Barrington's omnibus account and delayed allocating the securities to specific client accounts until he had observed the securities' performance over the course of the trading day. As alleged, he then allocated profitable trades to his own account while allocating unprofitable trades to client accounts. The complaint also alleges that Barrington and Paris misrepresented to clients that all trades would be allocated fairly and that the firm reviewed all personal trading by its employees.

SEC Charges Investment Adviser with Fraudulent Offer and Sale of Unregistered Funds (SEC Release)
In a Complaint filed in the United States District Court for the District of Georgia, the SEC charged John Robert Jones, Jr. with violations of the antifraud provisions of Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, and Sections 206(1), 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8(a) thereunder, and the securities registration provisions of Sections 5(a) and 5(c) of the Securities Act. As alleged in part in the SEC Release, Jones purportedly engaged in the fraudulent offer and sale of two private unregistered funds he founded and controlled -- PED Index Fund, L.P. and PED Index Fund A1, L.P. -- and he:

induced at least 24 investors to invest at least $5.1 million in the two funds by falsely promising growth and safety with limited risk. According to the complaint, from October 2017 through December 2018, Jones marketed the funds to investors, claiming that investors could lose only 10-15% of their principal investment, that investors' principal was insured, and that his investment strategy was created in concert with a purported national financial organization. As alleged, however, investors' downside exposure was not limited to 10-15%, there was no insurance protecting investors, and the national financial organization did not exist. The complaint further alleges that Jones received a 2% annual management fee, collecting at least $86,823, while investors lost approximately $2.6 million, or on average, 57%.
The SEC appointed current New Jersey Attorney General Gurbir S. Grewal as the next Director of Enforcement.  As set forth in part in the SEC Release;

As New Jersey's Attorney General, Grewal heads the Department of Law & Public Safety, which employs more than 3,700 uniformed officers, 750 lawyers, and thousands of additional public servants, including investigators, regulators, and administrative staff. Before becoming Attorney General, Grewal served as Bergen County Prosecutor, the chief law enforcement office of New Jersey's most populous county. Earlier in his career, he was an Assistant U.S. Attorney in the Criminal Division of the U.S. Attorney's Office for the District of New Jersey, where he served as Chief of the Economic Crimes Unit from 2014 to 2016 and oversaw the investigation and prosecution of all major white collar and cybercrimes in the District of New Jersey. He also previously served as an AUSA in the Criminal Division of the United States Attorney's Office for the Eastern District of New York, where he was assigned to the Business and Securities Fraud Unit. Grewal worked in private practice from 1999-2004 and from 2008-2010.

Grewal graduated cum laude with a Bachelor of Science in Foreign Service from the Georgetown University School of Foreign Service in 1995. He obtained his law degree from the College of William & Mary, Marshall-Wythe School of Law in 1999.

NOTE: In the sole discretion of the Securities Industry Commentator, the name of this Respondent has been redacted.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Respondent submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Respondent was first registered in 2008, and by 2018, he was registered with Joseph Stone Capital L.L.C.  In accordance with the terms of the AWC, FINRA found that Respondent violated FINRA Rules 2111 and 2010, and  imposed upon him a $5,000 fine $7,653.21 in restitution plus interest, and a three-month suspension from associating with any FINRA member in all capacities.  As alleged in part in the FINRA AWC [Ed: "REDACTED" not in original FINRA AWC but added by SIC]:

Between May 2018 and March 2019, while he was registered through [REDACTED] engaged in excessive and unsuitable trading in the account of one customer (Customer 1). During the relevant period, [REDACTED] recommended that Customer 1 place 33 trades in his account, and Customer 1 accepted [REDACTED]'s recommendations. Although Customer 1's account had an average monthly equity of approximately $33,600, [REDACTED] recommended trades with a total principal value of more than $588,000, which resulted in an annualized turnover rate of more than 15. Collectively, the trades that [REDACTED] recommended caused Customer 1 to pay $7,653.21 in commissions and other trading costs, which resulted in an annualized cost-to-equity ratio in excess of 20 percent- meaning that Customer 1's account would have had to grow by more than 20 percent annually just to break even.
Way back in pre-Covid 2017, a disgruntled Schwab customer filed a FINRA Arbitration Statement of Claim complaining about the release of his records to the IRS. Then the dispute wound up in federal court. Then back in arbitration -- sort of. Then back in federal court. Fours year after the hostilities began, we're in 2021, we got Zoom arbitrations. The customer doesn't want to argue his case via Zoom. He says that's not what he bargained for way back when things started. Now, we got Zoom regulatory hearings. We got Zoom court proceedings. So -- who's zooming whom?

( Blog) whistleblower agreement/
A decade ago, the Dodd-Frank Wall Street Reform and Consumer Protection Act launched Wall Street's federal whistleblower program. A keystone of the Act was that it prohibited efforts to impede communications by tipsters to the SEC. Confidentiality agreements that enabled employers to threaten reprisals against employees who contacted the SEC were deemed a prohibited practice. Some companies got the message. Others not quite so.