Friday, February 5, 2021

Robinhood's Interface

After Ben posted about the GameStop Affair last week, Joan predicted that the saga would be a “great gift to law professors.”  That seems about right, because here I am with a post about the subsidiary issue of Robinhood, or rather, Robinhood’s platform.

FINRA just issued a report on its current Risk Monitoring and Examination Activities, which highlights certain areas that FINRA will be investigating going forward.  It doesn’t mention Robinhood by name, but it flags some of Robinhood’s practices for special attention and, in particular, its game-like user interface.  In specific, it says:

we are increasingly focused on communications relating to certain new products, and how member firms supervise, comply with recordkeeping obligations, and address risks relating to new digital communication channels. This focus includes risks associated with app-based platforms with interactive or “game-like” features that are intended to influence customers, their related forms of marketing, and the appropriateness of the activity that they are approving clients to undertake through those platforms (e.g., under FINRA Rule 2360 (Options)).

While such features may improve customers’ access to firm systems and investment products, they may also result in increased risks to customers if not designed with the appropriate compliance considerations in mind. Firms must evaluate these features to determine whether they meet regulatory obligations to…comply with any Reg BI and Form CRS requirements if any communications constitute a “recommendation” that requires a broker-dealer to act in a retail customer’s “best interest”…

Brokers must act in the customer’s best interest when making investment recommendations.  Interfaces that encourage more trading simply to generate revenue for the platform – rather than based on a personalized assessment of the customer’s needs – aren’t going to comply with that standard, so the question is whether these kinds of encouragements are, in fact, recommendations.

This is an issue more broadly for electronic platforms that use algorithms to do everything from bringing certain items to the customer’s attention to providing responses to customer-initiated searches.  For example, Regulation Crowdfunding creates a new kind of entity known as a Funding Portal; basically, a website where investors can browse available offerings by issuers.  Funding Portals are exempt from broker-dealer registration as long as they limit their activities, including refraining from giving investment advice or making any investment recommendations.

The problem is that when you’re talking about a website, where algorithms determine the order in which investments appear on a page and which ones are highlighted at a particular time and which ones pop up when you type in search words, it’s very hard to tell what counts as “investment advice.”  Is it “advice” to say “These investments are trending”?  To say “These companies have been profitable for a year”?  Does it matter if the customer first searched for these criteria, or if they just popped up on the screen, unprompted?  What if the platform itself contains suggested search criteria?

The SEC tried to address this problem in Regulation CF Rule 402(b), which permits portals to highlight particular offerings based on “objective criteria.”  The adopting release contains a long discussion of the issues, and as you can see, this is ... not easy to resolve.

Back to Robinhood.  As readers are probably aware, Massachusetts is currently suing Robinhood over its interface, and that’s the gravamen of the complaint as well: That Robinhood’s interface is functionally making recommendations to customers when it highlights particular securities based on purportedly objective criteria, like “100 most popular,” “Food and Drink,” and so forth.  The app even says things like “Can’t decide which stocks to buy? Check out the most popular stocks.” 

And then, of course, there’s the question whether more subtle aspects of the platform – like confetti graphics congratulating customers on a trade – are encouraging more trading and therefore are also, in a sense, making recommendations (i.e., a recommendation of churning).

All of which is to say, this is apparently what FINRA plans to confront going forward.

Finally, I’ll add, if it turns out the Robinhood interface was designed with little regard for FINRA’s rules, it might turn out to be relevant that Robinhood’s CEO is not registered with FINRA, and there’s a legitimate question whether he’s improperly managing Robinhood’s operations.  Per CNN:

Unless granted an exemption, FINRA generally requires that the CEOs of registered broker-dealers be registered with the agency….

The CEO of a parent company that owns a broker-dealer does not necessarily need to be registered. ​

In this case, Tenev is the CEO of Robinhood Markets, the parent company that is not registered with FINRA. Robinhood Markets owns a broker-dealer and a clearing broker.

Robinhood told CNN Business that Tenev does not directly manage the FINRA-registered leaders of the broker-dealer or clearing broker — but declined to say who does. None of Tenev's direct reports appear to be registered with FINRA. ​…

So, we can perhaps put that on the list of issues as well.

Ann Lipton | Permalink


Instead of trying to burden these innovators and visionaries with job-killing regulations, the government bureaucrats should be thanking them for disrupting the securities business. Moreover, any attempt to shut them down would violate their freeze peach rights!

Posted by: hardreaders | Feb 6, 2021 10:59:10 AM

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