FINRA the Sheriff of Nothing-ham and Robinhood

January 31, 2022

By now, you'd think that Wall Street's regulatory community would want something akin to full disclosure to the investing public about successful public customer lawsuits against Robinhood. Certainly, you'd think that FINRA Dispute Resolution Services is mindful of the clamor surrounding Robinhood: meme stocks, gamification, payment for order flow, systems outages. Going by the lack of a fact pattern and rationale in a recent public customer arbitration against Robinhood, FINRA seems to think that disclosing nothing is sound public advocacy. Ah yes, FINRA, the Sheriff of Nothing-ham, and a modern-day Robinhood!

Zeyafatzadeh FINRA Arbitration Award Against Robinhood Financial

In a FINRA Arbitration Statement of Claim filed in September 2021, public customer Claimant Zeyafatzadeh sought $21,488.19 in compensatory damages from Respondent Robinhood Financial, LLC. In the Matter of the Arbitration Between Armin Zeyafatzadeh, Claimant, v. Robinhood Financial, LLC., Respondent (FINRA Arbitration Award 21-02256 / January 27, 2022)

Yeah, I know, I didn't offer a spoiler alert that Claimant Zeyafatzadeh won $21,488.19 from Respondent Robinhood. Frankly, the Zeyafatzadeh FINRA Arbitration Award angers me because of its lack of explanation about the underlying dispute between public customer Claimant Zeyafatzadeh and the brokerage firm Robinhood. 

Case Summary

Rather than be accused of spinning things to make a point, let the FINRA Arbitration Award's "Case Summary" fill you in:

In the Statement of Claim, Claimant asserted unauthorized transfers as the sole cause of action. The cause of action relates to Claimant's account held at Respondent. 

In the Statement of Answer, Respondent denied the allegations made in the Statement of Claim and asserted various affirmative defenses.

That's it? The only thing that the Award will disclose is that the dispute involves "unauthorized transfers." No when? No what? No why? Not even the name(s) of the securities? Not even the dollar amounts?

Final Resolution

Oh, and while I'm letting the FINRA Arbitration Award speak for itself, here's the full explanation of what the sole FINRA Arbitrator found and why he ruled as he did:

After considering the pleadings, the Arbitrator has decided and determined in full and final resolution of the issues submitted for determination as follows: 

1. Respondent is liable for and shall pay to Claimant the sum of $21,488.19 in compensatory damages. 

2. Respondent is liable for and shall pay to Claimant interest on the above-stated sum at the rate of 1.00% per annum from April 22, 2021 through and including January 24, 2022. 

3. Any and all relief not specifically addressed herein are denied. 

I mean, seriously? Are you shitting me?? That's it???

Rule 12904

Just for the hell of it, let's reprint in full FINRA Code of Arbitration Procedure for Customer Disputes Rule 12904: Awards [Ed: highlights added]:

(a) All awards shall be in writing and signed by a majority of the arbitrators or as required by applicable law. Such awards may be entered as a judgment in any court of competent jurisdiction.
(b) Unless the applicable law directs otherwise, all awards rendered under the Code are final and are not subject to review or appeal.
(c) The Director will serve the award on each party, or the representative of the party.
(d) The panel shall endeavor to render an award within 30 business days from the date the record is closed.
(e) The award shall contain the following:
(1) The names of the parties;
(2) The name of the parties' representatives, if any;
(3) An acknowledgement by the arbitrators that they have each read the pleadings and other materials filed by the parties;
(4) A summary of the issues, including the type(s) of any security or product, in controversy;
(5) The damages and other relief requested;
(6) The damages and other relief awarded;
(7) A statement of any other issues resolved;
(8) The allocation of forum fees and any other fees allocable by the panel;
(9) The names of the arbitrators;
(10) The dates the claim was filed and the award rendered;
(11) The number and dates of hearing sessions;
(12) The location of the hearings; and
(13) The signatures of the arbitrators.
(f) The award may contain a rationale underlying the award.
(g) Explained Decisions
(1) This paragraph (g) applies only when all parties jointly request an explained decision.
(2) An explained decision is a fact-based award stating the general reason(s) for the arbitrators' decision. Inclusion of legal authorities and damage calculations is not required.
(3) Parties must make any request for an explained decision no later than the time for the prehearing exchange of documents and witness lists under Rule 12514(d).
(4) The chairperson of the panel will be responsible for writing the explained decision.
(5) The chairperson will receive an additional honorarium of $400 for writing the explained decision, as required by this paragraph (g).
(6) This paragraph (g) will not apply to simplified cases decided without a hearing under Rule 12800 or to default cases conducted under Rule 12801.
(h) All awards shall be made publicly available.
(i) Fees and assessments imposed by the arbitrators under the Code shall be paid immediately upon the receipt of the award by the parties. Payment of such fees shall not be deemed ratification of the award by the parties.
(j) All monetary awards shall be paid within 30 days of receipt unless a motion to vacate has been filed with a court of competent jurisdiction. Absent specification to the contrary in the award, when arbitrators order opposing parties to make payments to one another, the monetary awards shall offset, and the party assessed the larger amount shall pay the net difference. An award shall bear interest from the date of the award:
(1) If not paid within 30 days of receipt;
(2) If the award is the subject of a motion to vacate which is denied; or
(3) As specified by the panel in the award.
Interest shall be assessed at the legal rate, if any, then prevailing in the state where the award was rendered, or at a rate set by the arbitrator(s).

Just going by the three highlighted sections above in FINRA Rule 12904, a customer-dispute FINRA Arbitration Award should contain a "summary of the issues, including the type(s) of any security or product, in controversy. . ." The Award will be made publicly available and, go figure, but when it comes to stating a rational for the disposition of the case, in its infinite wisdom and in a half-assed nod to investor protection, FINRA decided that the best option is that an Award "may contain a rationale underlying the award." Not shall contain. Not must contain. Not should contain. But, y'know, "may" contain. Of course, FINRA cynically offers the so-called "Explained Decision" option but that require "all parties jointly request an explained decision," which may explain the paucity of such explained decisions because if one of the parties won't join in with the request then the Rule says it ain't gonna happen. On top of that, FINRA imposes a $400 honorarium for the privilege of having the Chair of the Arbitration Panel write the Explained Decision.

In the Zeyafatzadeh FINRA Arbitration Award, I don't think we even got a "summary of the issues" as required by Rule 12904, and I sure as hell think the sole Arbitrator emphasized the "may" aspect of providing a "rationale," and opted to say nothing. 

BrokerCheck Disclosure

Making matters worse, should you turn to FINRA's much-vaunted online BrokerCheck database for some regulatory information about Zeyafatzadeh's claims, this is what you find -- and I've reprinted it in full:

Disclosure 3 of 3 
Reporting Source: Regulator 
Type of Event: ARBITRATION 
Arbitration Forum: FINRA
Case Initiated:  09/08/2021 
Case Number: 21-02256
Disputed Product Type:
Sum of All Relief Requested: $21,488.19
Disposition Date: 01/27/2022
Sum of All Relief Awarded: $21,488.19 

There may be a non-monetary award associated with this arbitration. Please select the Case Number above to view more detailed information.

Okay, so, here we are, nearly February 2022, and you'd think that the regulatory community would want something akin to full disclosure to the investing public about successful public customer lawsuits against Robinhood. Certainly, you'd think that FINRA Dispute Resolution Services is mindful of the clamor surrounding Robinhood: meme stocks, gamification, payment for order flow, systems outages. Going by the lack of a fact pattern and rationale in the Zeyafatzadeh FINRA Arbitration Award, it doesn't appear that FINRA gives a crap. The more disconcerting concern is why doesn't the regulator care?

A Recent History

Lately, Robinhood has been having a rocky time. A recent headline sort of tells you just about all that you need to know on that issue: "Robinhood faces lingering issues a year after meme-stock mania. / The trading platform, which just reported billions in losses for 2021, is still contending with lawsuits, trading restrictions and regulatory scrutiny." (New York Times by Epharat Livni / January 27, 2022) Additionally, Robinhood successfully defended against a Class Action Complaint arising out of the much-publicized January 2021 Short Squeeze (see: "In re: JANUARY 2021 SHORT SQUEEZE TRADING LITIGATION (This Document Relates to the Robinhood Tranche) (Order, United States District Court for the Southern District of Florida ("SDFL"), 21-02989 / January 27, 2022) but the underlying issues of meme stocks and Robinhood's decision to restrict purchases of same still underscore the broker-dealer's ongoing trials and tribulations.

In light of the fact that Robinhood is purportedly "contending with lawsuits, trading restrictions and regulatory scrutiny," you'd sort of think that the industry's largest self-regulatory-organization, FINRA, might feel an obligation to ensure that its Arbitration Awards disclose enough information about public customer disputes against Robinhood so as to alert the public about any developing trends -- and, you know, while we're at it, howsabout alerting FINRA to emerging problems? On top of that, the way Wall Street works, its customers are forced into mandatory arbitration against FINRA member firms and effectively denied redress for most disputes in court. Strike out the mandatory arbitration provision in any New Account Form and see if any FINRA member firm will open a new account for you; and, for good measure, complain to FINRA about this contract of adhesion and see how the regulator responds. It's one thing when an industry's culture of collaboration forces contracts of adhesion upon the public; however, it's quite another when the industry has been granted to luxury of self regulation but the self-regulatory-organization looks the other way.

A Walk Down Sordid Memory Lane

Consider this article that I penned a few months ago:
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)

Read this 16-month old article that I wrote:

In the 1990s, Wall Street's establishment co-opted NASD into becoming a political tool against the Small Order Execution System ("SOES") Bandits and daytrading in general. Although there were legitimate concerns about the then-emerging era of online daytrading, Wall Street's regulatory establishment was more about preserving turf and protecting the industry's rampant price-fixing than about formulating effective rules to usher in a new, safer age of electronic trading. The Department of Justice's Antitrust Department and the Securities and Exchange Commission took tepid actions in response to the industry's price-fixing, the politicization of Wall Street regulation, and the inappropriate relationship between the NASDAQ market and its NASD self-regulator. On the other hand, those of us who were veterans of those battles recall that it was the Tech Wreck and 9/11 that tossed the SOES community and the old direct-access firms into the dustbin of history. Virtually no meaningful regulation emerged in response to the excesses of direct access/daytrading in the 1990s, and that may be the dangerous legacy before us today. 

Once again, we find ourselves hunkering down in a no-man's-land between regulators and the regulated -- as those who advocate an individual's right to take on risk in their personal trading decisions confront those who advocate a role for rational regulation to stem what they view as financial suicide. We should remember that with the explosion of daytrading in the 1990s, we experienced suicides and even murders as a result traders who lost everything. When we confront the 2020 tragedy of 20-year-old Robinhood daytrader Alex Kearns, we would be wise to recall the 1999 murder spree of daytrader Mark Barton. 

In 2020, we should consider the explosion in daytrading that has been fueled by Zero Commission app-based trading amid the COVID pandemic. There are too many inexperienced traders sitting at home "playing" the market and sliding down the slippery slope of financial suicide. Will the unlearned lessons of the past and some of the more lurid headlines of recent weeks prompt sensible, effective regulation? Likely not because such efforts tend to be eviscerated by powerful and influential Wall Street participants. It's not a new story or a surprising outcome. It is, however, a sad turn of events and a dispiriting way to regulate. 

As recently reported in part in Robinhood's Rise Brings Dark Side of Irate Traders, U.S. Probes (Bloomberg by Robert Schmidt and Benjamin Bain / August 31, 2020), the wheels are already turning as the likely battle lines are being drawn. At Robinhood, for example, former SEC Commissioner Daniel M. Gallagher (2011 to 2015) was brought on board.  In 2008, Gallagher was the SEC's Deputy Director of the Division of Trading and Markets, and from April 2009 through January 2010, he served as the Division's Co-Acting Director. As reported in part by Bloomberg's Schmidt and Bain:

To guide the company through that thicket, Robinhood brought on Gallagher, 48, as chief legal officer in May. An attorney who specializes in the often arcane world of broker regulation, Gallagher is friendly with lawmakers of both parties and more comfortable in the Washington uniform of a suit and tie than the tech world's hoodie and Allbirds sneakers. He's also brought deep relationships with government officials to the firm. Among his close confidants is SEC Chairman Jay Clayton.

Last month, Gallagher hired another SEC insider, ex-Clayton Chief of Staff Lucas Moskowitz, to run Robinhood's regulatory, litigation and lobbying efforts. Moskowitz has worked for Republicans on the House Financial Services Committee and the Senate Banking Committee, and he's been an enforcement lawyer at the SEC. Robinhood also named new chief compliance officers at two subsidiaries in August, one who came from Wells Fargo & Co.'s brokerage and another from Fidelity.

Notwithstanding Robinhood's moves to enhance its in-house compliance capacity and to start building a team to deal with a possible Congressional and regulatory onslaught, the firm is still experiencing ongoing operational issues. As recently reported in part in Robinhood, TD Ameritrade Resolve Client Trading Glitches (Bloomberg by Annie Massa / August 31, 2020)

Robinhood had problems related to equities, options and cryptocurrency trading in the morning and said shortly after noon in New York that the issues were fixed. TD Ameritrade said in a statement that clients had experienced high levels of slowness on its web platform and mobile app. Both companies apologized.

Charles Schwab Corp. and Vanguard Group also said they were working to resolve issues with their websites, among other disruptions. Thousands of customers lodged complaints on Downdetector.

Speculation online focused on whether some of the problems were related to the Apple Inc. and Tesla Inc. stock splits effective Monday.

"High levels of slowness?" I guess that's one way of phrasing it. Another alternative is that the firm had a failure of "operational capacity," which might be the result of too-rapid a marketing expansion coupled with a failure to implement protocols to ensure scalability of the trading platform. This is not a new issue or a new concern. This is an ongoing challenge for Wall Street regulation but, sadly, a fumbled ball that tends to bounce around with dire consequences.  It was only a few months ago on March 4, 2020, that the "Securities Industry Commentator" ran the following piece
As reported in part by Kate Rooney:

As U.S. stocks traded actively again Tuesday in wake of a surprise Fed rate cut, Robinhood reported a "major outage" for trading across its platform. Earlier updates on the site said that all trading was "operational," but Twitter users posted screenshots of error messages as U.S. markets opened Tuesday.

"We are experiencing a system-wide outage," a message read on Robinhood's website.

Technical issues Monday lasted through the trading day, leaving users with their hands tied as the Dow Jones Industrial Average's biggest one-day point gain in history. On Tuesday, stocks surged off their lows after the Federal Reserve cut interest rates in an effort to stem slower economic growth from the coronavirus outbreak

Bill Singer's Comment: Maybe the SEC  needs to re-visit "operational capacity"? At some point, either brokerage firms scale their operations to handle market gyrations or they will be held accountable via customer lawsuits. Imagine wanting (needing) to close out a position that's running against you but being unable to access your trading screen -- and, worse, being directed to a telephone system where staffing can't keep up with the flood of calls! 

Of course, it's not as if the SEC and FINRA and other Wall Street regulators are unaware of the whole "operational capacity" issue for Robinhood and its competitors. Consider these remarks from the SEC's Director of Enforcement:

We are experiencing a sharp rise in the number of complaints we receive at the SEC from customers having difficulty accessing their accounts. We received 135 complaints of this nature in 1998 as compared with just 11 in 1997. In addition, a quarter of the firms reviewed in the OCIE on-line broker-dealer sweep placed little emphasis on evaluating systems capacity or had difficulty answering the staff's questions on the subject.

It is important for firms to ensure that they have adequate contingency planning. OCIE found that most firms had alternative means of processing orders, normally by telephone. Some firms, however, lacked adequate staff to process their normal volume of trades in the event of an outage.

How do you protect your firm from exposure for a series of system crashes? Simple, remember the basics. Once again, disclosure is your best friend. What impression does a broker-dealer give to its customers when it guarantees 60 second trade execution? Is this guarantee unconditional? Are sufficient risk disclosures made? I would not take for granted that investors know systems may crash and therefore deem risk disclosure unnecessary. As a competitive measure, a few on-line brokers are beginning to market themselves based on the reliability of their systems. Overly bold claims here could wind up getting a firm in hot soup should problems surface. . . .

Yes, I know, those are pretty on-point observations for August 2020, as just witnessed by Monday's online trading issues. The problem is that those comments are not from 2020. Nor are they from the current SEC Director of Enforcement -- you can review the full-text of the above speech at "On-Line Brokerage: Staying on the Right Side of the Line" (Speech by SEC Director of Enforcement Richard H. Walker / November 17, 1999)

Similarly, consider the Syllabus from the SEC's memory lane as set out in "On-Line Trading: Investor Protections Have Improved but Continued Attention Is Needed" (GAO-01-858 / July 20, 2001):

On-line trading continues to be an important part of the securities trading market. The industry reports investing greater resources to improve the performance of their systems, and regulators have made substantial progress in ensuring that investors receive better information in key investor protection areas. However, investors trading on-line continue to file many   complaints about failures and delays in processing orders. GAO believes that providing complete information on the websites of on-line broker-dealers would allow investors to make more informed investment decisions.

Further, the July 2001 report to Congress notes in part that:

Currently, neither SEC, NASD, nor NYSE has a specific rule requiring broker-dealers to maintain records of system delays and outages and their related causes and to disclose the potential for service disruptions on their Web sites, nor is there currently a definition of delays and outages. OCIE's report does state that broker- dealers should consider maintaining records of capacity evaluations and systems slowdowns and outages, including details of the cause and impact. In addition, OCIE suggests that firms make every reasonable effort to inform customers of operational difficulties and provide all new customers with information in plain English on the risks of systems delays or outages. Although the OCIE report provides some useful guidance on operational capability issues, SEC has not yet defined what constitutes an outage or delay.

According to an SEC official, SEC staff is currently considering proposing a rule that would implement operational capability standards for broker-dealers and address the problem of defining the term outage. That is, SEC staff is reconsidering a rule it had first proposed in March 1999. That proposed rule would have required, as a condition of conducting securities business, that broker- dealers have sufficient operational capacity to enter, execute, clear and settle orders, and deliver funds and securities promptly and accurately. In response to the March proposal, SEC received numerous comment letters generally stating that the proposed rule was "overly vague." . . .

at Page 23 of the July 2001 Congressional Report

Finally, recall these opening remarks of Senator Susan M. Collins (R. Maine), Chairman of the Senate Permanent Subcommittee on Investigations of the Committee on Governmental Affairs from February 24 and 25, 2000, as set forth in "Day Trading: Everyone Gambles But The House" (Sen. Hearing 106-505)

As the testimony today will show, most day traders are not breaking even. In fact, they are losing money, big money. The consumers who will testify before us today, for example, lost tens of thousands of dollars.

The same cannot be said, however, for the day trading industry. It seems to be doing quite well. The 15 firms that we examined reported aggregate gross revenues of over $491 million in 1999 and aggregate profits of about $144 million. The Subcommittee found that the industry is growing by leaps and bounds. Indeed, the revenues of day-trading firms that we analyzed grew by a whopping 276 percent from 1997 to 1999.

Everyone, even the industry, appears to agree that day trading is highly speculative and extremely risky. Both the Chairman of the SEC and the President of NASAA, that is the State Securities Regulators Association, went so far as to call day trading gambling during the Subcommittee's hearing last fall. The Electronic Traders Association, the trade organization for the industry, objects strongly to that analogy, contending that day trading requires skill, state-of-the-art technology, and hard work.

That may be true, but many day traders seem comfortable with the comparison to gambling. The president of 1 day-trading firm was quoted in the press as saying that day trading is like blackjack. Documents obtained by the Subcommittee also indicate 
that some firms consider day trading to be essentially gambling.

Bill Singer's Comment

Keep in mind that technically there is a difference -- and a critical one -- between on-line trading versus daytrading. The former is more of a convenience, whereas the latter is a style of investing. I trade online. I daytrade. I have no issues with either. 

The more compelling regulatory issue for me is the ongoing challenges to brokerage firms' "operational capacity," and the frustrating persistence of trading platforms that freeze, lock-up, and crash. When customers are unable to access real-time quotes or asset valuations during a trading day, their efforts to obtain redress from their brokerage firm is typically inadequate if not futile. As I have personally experienced and as I have been told by many public customers seeking to retain my services to sue their brokerage firms, when your trading screen crashes, efforts to reach someone at the brokerage firm are often infuriating. During such crises, a customer may be on "hold" for 20 or more minutes trying to reach customer service. In many cases, there is inadequate staffing of on-line chat and telephone services. When a human being finally answers a call, that individual frequently seems to lack expertise to understand the issue or resolve it. In many cases, a customer finds herself bought-in or sold-out during such platform outages, and unable to obtain a reasonable resolution from the firm. Out of frustration, many customers will simply close out open positions as part of an understandable reaction to not wanting to be exposed to dramatic market intra-day swings while "blinded" by a locked-up trading screen. Frequently, those customers report getting the runaround when trying to obtain some recompense for any losses they suffered.

In recent weeks, I have noticed an odd development whereby many telephone conversations that are almost always tape recorded by a brokerage firm, suddenly seem not to have been subjected to that default protocol. Oddly, tape recordings memorializing the customer's timely complaint about operational capacity issues either were not made or, gee, sorry, but, what can I tell you, I asked the back office to pull the tape and they can't find it. I understand the whole missing tape thing. At times, someone forgets to activate the taping or there was some digital snafu. On the other hand, I continue to hear the same tale about missing tapes, and it seems to conveniently occur on days of extraordinary market volume. Yeah, I'm suspicious of one too many coincidences.

I'm an adult. I want to take risk when I want to take it and to the extent that I want to take it. That being said, intelligent regulation often confronts such an independent streak and tries to balance my desire to place $1,000 on one roll of the dice versus what may be in my own best interest, in that of my family, and, ultimately, "in the public interest." That is the tension by which regulations are promulgated. It's a balancing act between what some folks resist and others demand. It is a balancing act between keeping the flame of capitalism alive in the markets versus allowing that flame to burn down the planet. No -- there are no easy solutions. On the other hand, as today's blog makes clear, there is history -- and we should try to learn from our past mistakes and be wary of those proposing dubious solutions. Today, there are those who support wearing masks in response to COVID. There are those adamantly opposed to being forced to wear masks. We're barely regulating that public health crisis. Hopefully, the operational capacity of online trading will prove more susceptible to rational debate and prudent rulemaking. Candidly, I remain a skeptic and a cynic. Anyone know of a place where I can place a large bet that we don't get any workable regulation?

Finally, consider this article about the gamification charges against Robinhood:

We awoke yesterday to news that the State of Massachusetts/Securities Division filed an administrative Complaint against Robinhood Financial, LLC. In the Matter of Robinhood Financial, LLC, Respondent (Administrative Complaint, Docket No. E-2020-0047, Office of the Secretary of the Commonwealth of Massachusetts / Securities Division / December 16, 2020) 
The Massachusetts Complaint alleges in part that Robinhood has engaged in:  

1) aggressive tactics to attract new, often inexperienced investors; 2) failure to implement policies and procedures reasonably designed to prevent and respond to outages and disruptions on its trading platform; 3) use of strategies such as gamification to encourage and entice continuous and repetitive use of its trading application; 4) failure to follow its own written supervisory procedures regarding the approval of options trading; and 5) breach of the fiduciary conduct standard required by the Act and Regulations.


Overall, the State makes out an interesting case per those five points. Not sure that I buy the somewhat fanciful "gamification," but, hell, I give the Securities Division a lot of credit for doing something beyond settling a pre-packaged action and publishing an over-the-top press release patting itself on the back -- which is what far too many Wall Street regulators confuse for effective regulation. As such, bravo for this innovative Complaint!

The Scorpion and the Frog

Having praised Massachusetts's action, now let me offer a few sobering thoughts. Why? What can I tell you -- it's the way I'm wired. Once a gadfly, always a gadfly. All of which is pretty much explained by the story of the frog and the scorpion. 

Alas, as much as I love and admire the Complaint against Robinhood, I also am left with some discomfort as a libertarian -- that's the scorpion part of me. 

It is not government's role or place to ensure that every investment we make is profitable. Virtually no successful trader exists who has not been forced to eat losing trades and learn the invaluable lessons that failure teaches. Inherent in all investments is the success of the buyer at the loss of the seller, or vice versa -- it is an arena where the zero-sum game plays out in each and every trade. Wall Street is not the place for awarding Participation Certificates. The regulation of Wall Street is not supposed to be an exercise in social engineering. To the extent that the State seeks to make a case against Robinhood because foolish investors make foolish investments, that I cannot abide when the nature of the relationship is self-directed investing. 

The Lottery Gamification

Without question, Massachusetts has raised a novel and largely compelling charge via "gamification." Perhaps as the State fleshes out that third of the five prongs of its case, I might be brought into the fold on that one point. For now, I'm left a tad uneasy about what seems a dubious albeit clever cause of action via "gamification." My discomfort is prompted, in part, by my awareness that Massachusetts sells lottery tickets. Frankly, I've been stuck on line behind some idiot who's buying 50 lottery tickets and also playing his lucky numbers, and, to be polite, the guy doesn't quite look like he can afford the dollars involved in playing out his hunches. As far as I know, there is no means test by which the State pre-screens wannabe gamblers desiring to play the lottery. Since 1972, the Massachusetts State Lottery has generated over $126 billion in revenue on which it paid over $7.2 billion in commissions. In Fiscal Year 2019, the State yielded a record $1.104 billion in net profit from its Lottery. You know, on second thought, maybe it's not such a minor sin after all. Maybe Robinhood would see a double-standard?

Even more uncomfortable for the State, if you visit and use the pulldown menu for "Games," you find that the gamification of the lottery comprises such games as "Draw and Instants," "Pull Tabs," "Charitable Games," and "Season Tickets." I know that the Lottery is committed to "responsible gaming practices." That commitment tends to play out about as well as Wall Street's ridiculous Suitability Standard. As a long-time advocate of the Fiduciary Standard, I'm not quite sure that Massachusetts can fairly attack Robinhood for inviting the gamification of Wall Street when the State collects billions of dollars in annual fees from its own games. 

FINRA's Best Execution Ain't Good Enough

About a year ago, FINRA, Wall Street's exalted self-regulatory-organization, concluded its own investigation of Robinhood that spanned the years from 2016 to 2017, and, lo and behold, on December 2019, FINRA hit Robinhood with $1.25 million in fines for Best Execution issues.  See: "FINRA Fines Robinhood Financial, LLC $1.25 Million for Best Execution Violations" (FINRA Release / December 19, 2019)

Best execution? 

Y'all didn't find nothing else going on at Robinhood when you wrapped up your investigation in December 2019? Just to throw it out there but, geez, you folks at FINRA wonder how a whole year later, there was enough meat left on the old Robinhood regulatory bones for Massachusetts to pick over and file a fairly historic Complaint? Not a complete loss for FINRA, however, because the regulator did collect $1.25 million from Robinhood. That's the scorpion's sarcasm in me.

Ultimately, even if flawed by one of five claims, the Massachusetts Complaint raises many valid points in furtherance of investor protection. I do not and will not fault the State for filing an edgy pleading when the press is daily filled with horror stories about recurring outages at Robinhood and other online firms. In this online brokerage sector, operational capacity does not seem able to keep pace with growth. At some point, as the Complaint suggests, in-house compliance loses containment, and unresolved problems cross over into sanctionable regulatory events. Like I said, I'm not going to criticize Massachusetts for its laudable efforts to seek redress for many allegedly victimized traders. To that extent, my comments are more critique than criticism. On the other hand, I am going to criticize FINRA for being an ineffective regulator but a very effective cash register. For FINRA, Wall Street regulation seems more about ringing up fines rather than pursuing innovative regulation.