The Massachusetts securities regulator has launched legal action against the online trading app Robinhood, accusing it of “gamifying” investing and alleging the company did not put in place proper controls to safeguard inexperienced investors.
In its complaint filed on Wednesday, the Massachusetts Securities Division said Robinhood had violated state laws and regulations by aggressively marketing itself to investors in the state “without regard for the best interests of its customers”.
The enforcement office found that large portions of the Massachusetts public that Robinhood had approved to trade options had little or no investment knowledge, and that it had given the green light to some new traders even in violation of the company’s own policies.
The regulator also alleged that Robinhood had failed to maintain the infrastructure supporting its swelling customer base, with as many as 70 disruptions or outages between January and November.
Those trading disruptions have prompted a wave of complaints from consumers who were sidelined from financial markets at times of extreme volatility, including at points during the March sell-off.
“As a broker-dealer, Robinhood has a duty to protect its customers and their money,” said William Galvin, the Massachusetts secretary of the commonwealth. “Treating this like a game and luring young and inexperienced customers to make more and more trades is not only unethical, but also falls far short of the standards we require in Massachusetts.”
Mr Galvin’s office also said that Robinhood had provided lists of securities that were the most popular among its customers in an effort to encourage trading on its app and site. The company generates sales by funnelling trading on its platform to market makers that match trades with other parties.
“This is no different from a broker-dealer agent handing a list of securities to a customer, pretending to be surprised when the customer purchases securities from that list, and then proclaiming that he made no recommendations to the customer,” the complaint said.
The complaint singled out one customer that the regulator said had no investment experience who made 12,700 trades within a six-month period.
The action taken by the securities regulator is the first since the state began enforcing a new fiduciary rule, which requires broker dealers to have a duty of loyalty to their customers. That new rule obligates brokers to prioritise customer interests and avoid, eliminate or limit conflicts of interest.
Robinhood said it disagreed with the allegations in the complaint and that it intended to vigorously defend itself. The company denied that it made investment recommendations.
“We’ve worked diligently to ensure our systems scale and are available when people need them,” it said in a statement. “We’ve also made significant improvements to our options offering, adding safeguards and enhanced educational materials.”
Robinhood has grown at a frenetic pace and turned a new crop of retail investors to day trading. The company has attracted 13m customers, lured in part by its sleek app, zero-commission stock trades and the ability to trade on margin.
But it has attracted criticism as it has grown and as stock markets — and some hot technology stocks in particular — have raced higher in 2020, driven in part by the enthusiasm of retail investors on the platform.
Robinhood has been accused of blurring the boundaries between an easy to use customer interface and gamification, which encourages trading with email alerts and in-app prompts encouraging customers towards more complex, higher-risk investment products. When trades are completed on the platform, customers are sent emoji-laden messages prompting them to purchase additional shares.
Academics found that, because the platform highlights top-performing shares, investors are drawn to buy those popular stocks, driving up prices and hurting their returns.
“Half of Robinhood users are first-time investors,” a group of researchers led by Brad Barber at the University of California, Davis, wrote in a paper in November. “Inexperienced stock investors are likely to be more heavily influenced by attention and by biases that led to return chasing.”