Robinhood accrues $33.1M in legal and regulatory contingencies at end of Q3 2021

Shortly after posting its financial report for the third quarter of 2021, Robinhood Markets Inc (NASDAQ:HOOD) has filed its 10-Q report with the Securities and Exchange Commission (SEC). On top of details about its financial performance for the three months to the end of September 2021, Robinhood provided some updates on litigation and regulatory matters in which it is involved.

Robinhood explains that it records an accrual for legal and regulatory matters at management’s best estimate when it determines that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Amounts accrued for legal and regulatory contingencies in the aggregate were $39.5 million as of December 31, 2020 and $33.1 million as of September 30, 2021.

The sum may seem substantial but it is relatively small when compared to the bill Robinhood might face if it loses big lawsuits such as the one concerning the January short squeeze. Moreover, several regulators are looking into certain practices that Robinhood employs. Hence, additional monetary penalties may be imposed on the broker.

Putting it otherwise, there are many matters (210 lawsuits in US courts, for instance) for which no accrual has been made or which have a potential loss in excess of amounts accrued, Robinhood believe, based on current knowledge, that any losses or ranges of losses (in excess of amounts accrued, if applicable) as of September 30, 2021 that are reasonably possible and can be reasonably estimated will not, in the aggregate, have a material adverse effect on its business, financial position, operating results, or cash flows.

For many of the matters, particularly those in early stages, Robinhood admits that it cannot reasonably estimate the reasonably possible loss (or range of loss), if any. In addition, the ultimate outcome of legal proceedings involves judgments, estimates, and inherent uncertainties and cannot be predicted with certainty. Any judgment entered against Robinhood, or any adverse settlement, could materially and adversely impact Robinhood’s business, financial condition, operating results, and cash flows.

Robinhood has produced a list of matters in which there is at least a reasonable possibility that a material loss could be incurred. The broker stresses that it intends to continue to defend the pending matters vigorously.

  • Best Execution, Payment for Order Flow, and Sources of Revenue Matters

In May 2019, the SEC’s Division of Enforcement commenced an investigation into RHF’s best execution and payment for order flow (PFOF) practices, as well as statements concerning its sources of revenue, including the fact that, in FAQs on Robinhood’s website describing how it made money, and in certain communications with customers addressing the same issue, RHF had omitted PFOF when it described its revenue sources.

On December 17, 2020, RHF, on a neither admit nor deny basis, consented to the entry of an SEC order (i) requiring RHF to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act and Section 17(a) of the Exchange Act and Rule 17a-4 thereunder; (ii) censuring RHF; and (iii) requiring RHF to pay a $65 million civil penalty in December 2020. RHF paid the $65 million penalty in cash and also agreed to engage an independent compliance consultant.

Beginning in December 2020, seven putative securities fraud class action lawsuits have been filed against RHM, RHF and/or RHS. The lawsuits generally allege that we violated the duty of best execution and misled putative class members by publishing misleading statements and omissions in customer communications relating to the execution of trades and revenue sources (including PFOF).

One of the cases was voluntarily dismissed without prejudice and five cases have been consolidated in the United States District Court for the Northern District of California. An amended consolidated complaint was filed in In re Robinhood Order Flow Litigation in May 2021, asserting a claim for violations of Section 10(b) of the Securities Exchange Act of 1934 and various state law causes of action, and seeking damages, restitution, disgorgement and other relief. In June 2021, Robinhood filed a motion to dismiss the amended consolidated complaint and a motion to deny class certification, which remain pending.

The final lawsuit, filed in the United States District Court for the Southern District of Florida against RHF as well as several market makers, alleges that RHF breached its fiduciary duties to customers and that the market makers aided and abetted RHF’s breach. In October 2021, RHF and the market-maker defendants moved to transfer the case to the Northern District of California, or in the alternative, to dismiss the complaint.

  • March 2020 Outages

Beginning in March 2020, 15 putative class actions and one individual action were filed against Robinhood in state and federal district courts relating to service outages on Robinhood’s stock trading platform on March 2-3, 2020 and March 9, 2020. The lawsuits include, among other things, claims for breach of contract, negligence, gross negligence, breach of fiduciary duty, unjust enrichment and violations of certain California consumer protection statutes. The lawsuits generally seek damages, restitution, and/or disgorgement, as well as declaratory and injunctive relief. In October 2021, plaintiffs filed a motion for class certification, which Robinhood intends to oppose.

Robinhood also received notice that approximately 1,600 jointly represented customers may pursue arbitration of individual claims against the broker arising out of the March 2020 Outages, in addition to other alleged system outages.

FINRA conducted an investigation and certain state regulatory authorities are conducting investigations, regarding the March 2020 Outages and related procedures. Robinhood entered into a settlement with FINRA with respect to certain matters.

  • Options Trading and Related Customer Communications and Displays

The SEC Examinations Division conducted an examination and identified deficiencies, to which Robinhood responded, with respect to account takeovers, identity theft in connection with new account opening, processes for approving or rejecting certain accounts for options trading and customer support response times. Certain state regulatory authorities are conducting investigations regarding Robinhood’s options trading and related customer communications and displays and options trading approval process.

FINRA also conducted an investigation and reached a settlement with RHF regarding the same options trading issues.

  • FINRA Multi-Matter Settlement

On June 30, 2021, Robinhood resolved with FINRA, on a no admit, no deny basis, certain investigations and examinations, including investigations into systems outages, RHF’s options product offering, and margin-related communications with customers, among others. The resolution did not address all the matters FINRA is investigating, including those relating to the Early 2021 Trading Restrictions, account takeovers and anti-money laundering issues, RHS’s fractional shares trade reporting, customer support procedures or customer arbitration agreements.

Robinhood says it will continue to cooperate with FINRA on these matters. The resolution involved the following components: (I) charges of violations of FINRA rules; (ii) a fine of $57.0 million; (iii) customer restitution of approximately $12.6 million; (iv) a censure; and (v) engagement of an independent consultant. In July 2021, we paid the $57.0 million penalty in cash. As of September 30, 2021, Robinhood had paid substantially all of the customer restitution.

  • Anti-Money Laundering, Cybersecurity, and Other Issues

In July 2020, the New York State Department of Financial Services (“NYDFS”) issued a report of its examination of RHC citing a number of “matters requiring attention” focused primarily on anti-money laundering and cybersecurity-related issues. Robinhood and NYDFS have reached a settlement in principle with respect to these allegations, subject to final documentation, in connection with which, among other things, RHC expects to pay a monetary penalty and engage a monitor.

Additionally, in April 2021, the California Attorney General’s Office issued an investigative subpoena to RHC, seeking documents and answers to interrogatories about Robinhood’s trading platform, business and operations, application of California’s commodities regulations to RHC and other matters. RHC is cooperating with this investigation. The broker says it cannot predict the outcome of this investigation or any consequences that might result from it.

  • Account Takeovers

In November 2020, FINRA launched an investigation into Robinhood concerning account takeovers, or circumstances under which an unauthorized actor successfully logs into a customer account, as well as anti-money laundering and cybersecurity issues. Since February 2021, RHF has received requests for documents and information from the SEC’s Enforcement Division in connection with its investigation into account takeovers.

Additionally, state regulators, including the New York Attorney General’s Office, have opened inquiries into Robinhood related to account takeovers.

  • Massachusetts Securities Division Matter

In December 2020, the Enforcement Section of the Massachusetts Securities Division (“MSD”) filed an administrative complaint against RHF, which stems from an investigation initiated by the MSD in July 2020. The complaint alleges three counts of Massachusetts securities law violations regarding alleged unethical and dishonest conduct or practices, failure to supervise, and failure to act in accordance with the Massachusetts fiduciary duty standard, which became effective on March 6, 2020 and had an effective enforcement date beginning September 1, 2020.

Among other things, the MSD alleges that Robinhood’s product features and marketing strategies, outages, and options trading approval process constitute violations of Massachusetts securities laws.

If Robinhood lost its license to operate in Massachusetts, it would not be able to acquire any new customers in Massachusetts, and it expects that its current customers in Massachusetts would be unable to continue utilizing any of the services or products offered on its platform. Additionally, revocation of RHF’s Massachusetts license could trigger similar disqualification or proceedings to restrict or condition RHF’s registration by other state regulators.

Robinhood is currently not engaged in any such settlement discussions with the MSD.

  • Pinchasov v. Robinhood Financial LLC

In November 2020, plaintiff Shterna Pinchasov filed a putative class action in the Circuit Court of the 11th Judicial Circuit of Florida in and for Miami-Dade County asserting claims of negligence and breach of fiduciary duty based on allegations that RHF failed to prevent customers from using its interface for stocks that were subject to a “T1 Halt,” and seeking damages. Text Message Litigation In October 2019, a putative class action was filed by Isaac Gordon against Robinhood in the Superior Court for the State of Washington, County of Spokane. The complaint alleged that RHF and RHM initiated or assisted in the transmission of commercial electronic text messages to Washington State residents without their consent in violation of Washington State law. The action was removed to the Eastern District of Washington.

In August 2021, a new, substantially similar putative class action was filed by Cooper Moore against RHF in the U.S. District Court for the Northern District of California.

  • Early 2021 Trading Restrictions Matters

Approximately 55 putative class actions and four individual actions have been filed against Robinhood in various federal and state courts relating to the Early 2021 Trading Restrictions. In September 2021, interim lead plaintiffs’ counsel filed an amended consolidated complaint against Robinhood for the negligence and breach of fiduciary duty claims, adding new claims for tortious interference with contract and business relationship, civil conspiracy and breach of the covenant of good faith and fair dealing and implied duty of care.

In October 2021, Robinhood moved to dismiss the amended consolidated complaint for the state law claims.

  • “For You” Document Request

In May 2021, the SEC’s Enforcement Division issued a request to Robinhood seeking documents and information related to the “For You” feature, which was available in the past on its website only and is not currently an active product offering on our website or platform, and other features displaying lists of securities to customers. In October 2021, Robinhood also received a request from FINRA for information about the “For You” feature. Robinhood is cooperating with these inquiries.

  • Registration Requirements for Member Personnel

In July 2021, Robinhood received a FINRA investigative request seeking documents and information related to its compliance with FINRA registration requirements for member personnel, including related to the FINRA non-registration status of Vlad Tenev and Co-Founder and Chief Creative Officer Bhatt. Robinhood is evaluating this matter and is cooperating with the investigation.

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