The apparent suicide of a 20-year-old investor on Robinhood Markets Inc.’s phone-based securities trading app after what appeared to be significant losses has attracted scrutiny in Congress, with lawmakers contemplating legislation or hearings on the matter.
The app, which the company says has 10 million users, allows people to trade stocks, options and cryptocurrencies without fees. Lawmakers on the House Financial Services Committee say the company may allow customers to access risky trading strategies without proper due diligence, which Robinhood denies.
Hours before his death in June, Alexander Kearns’ app displayed a negative balance of $730,000, according to family members. His suicide note — shared by Rep. Sean Casten, D-Ill., at a Financial Services subcommittee hearing last month — read in part: “I was a 20-year-old with no income able to be assigned almost a million dollars worth of leverage … I had no clue what I was doing now in hindsight. There was no intention to take on so much risk.”
Kearns, who was a student at the University of Nebraska, died in his parents’ home in Naperville, Illinois, a Chicago suburb home to three congressional districts. His death brought swift congressional scrutiny to Robinhood, led by members representing his state and hometown.
In conversations with CQ Roll Call, members voiced concerns about investors’ access to options and margin trading through the app and questioned whether Robinhood adequately screened customers before granting access to riskier strategies.
Rep. Bill Foster, a Democrat representing a district neighboring that of Kearns’ parents, said the “staggering complexity” of options transactions can pose hidden risks to retail investors, who lack the sophisticated models available to professionals. Options let investors buy or sell stocks at a certain price but dramatically ramp up potential gains or losses compared with buying the underlying stock.
“There’s certainly a chance that unsophisticated users will be enticed into investing in complex trades that they don’t fully understand,” Foster said, adding that Kearns’ note indicates he was trading options on borrowed money.
Foster was one of six members of Congress who wrote to Robinhood this month demanding answers about the company’s practices. Illinois Democratic Sens. Richard J. Durbin and Tammy Duckworth and Reps. Casten and Lauren Underwood also signed the letter, as did Rep. Brad Sherman, D-Calif.
The company said it will answer their questions.
Ted Daniels, president of the Society for Financial Education and Professional Development, says that based on his work with college students as a financial educator, someone Kearns’ age would “absolutely” lack the sophistication to take on options and margin trading. Trading on margin allows investors to buy securities with money borrowed from a broker. That means investors can be left on the hook for more money than they put up if a trade goes south.
Daniels is a member of the Securities and Exchange Commission Investor Advisory Committee, although he said he did not speak on behalf of the group.
When speaking to college students, Daniels said he recommends starting conservatively, typically with a mutual fund that mixes stocks and bonds. “I never get to the point where I suggest options or margin accounts,” he said.
Holding fintech accountable
Casten says Robinhood is part of a class of financial technology companies designed to skirt regulations that apply to traditional players.
“There are a ton of really useful things that fintech is doing, streamlining processes that were gummed up before,” he told CQ Roll Call. “But there are a whole lot of fintech models where their basic business proposition is not value creation but regulatory arbitrage.”
By dodging regulations, companies “have imposed a significant risk on precisely that part of the population that those regulations are designed to protect,” Casten said. “There’s a larger conversation that we’ve started to have but need to have more forcefully around the rise of fintech.”
Rep. Trey Hollingsworth, R-Ind., said he agreed that fintech companies must be held to the same “robust” standards as traditional financial firms — though in the case of Robinhood, it’s too early to determine whether the company evaded rules, he said.
Fintech companies have expanded access to financial services for many Americans, Hollingsworth said, adding that with expanded access comes additional responsibility to protect customers.
It’s incumbent on Robinhood to make sure investors understand the risk they take on when they buy options or trade with borrowed money, he said.
It falls to Congress to ensure that there’s a disclosure regime in place that would alert investors to risk and, if necessary, to place a “speed bump” between investors and riskier products, such as options, Hollingsworth said.
‘No evidence’ of compliance
Micah Hauptman, financial services counsel at the Consumer Federation of America, said there are regulations in place that should prevent inexperienced investors from engaging in excessive speculation through options trading.
The Financial Industry Regulatory Authority, an independent regulator of broker-dealers, requires brokers to collect information from clients — including investment objectives, job status, age, estimated net worth and income, and experience — before allowing them to trade options.
“The question isn’t whether there are relevant rules that apply to this situation, the question is whether these rules are being followed and being enforced,” Hauptman told CQ Roll Call.
Robinhood, a FINRA member, seems to be on the permissive side of the spectrum when it comes to allowing customers to access riskier, more speculative options, he said, although he noted he hadn’t spent time on the app.
“I hope this is a wake-up call to FINRA that there seem to be investors who don’t wholly understand how options work or what they entail,” he said.
Sherman said that based on Kearns’ access to options and margin trading, there’s “no evidence” that Robinhood complied with FINRA’s requirements.
FINRA declined to comment on Sherman’s assertions. It’s against the regulator’s policy to comment on individual brokers’ compliance.
Sherman, chairman of the House Financial Services Subcommittee on Investor Protection, said the company needs to share the questions it asked Kearns, how he answered and how Robinhood decided he was eligible to trade options. If Kearns told Robinhood his age, investment experience and income, and the company approved him for a margin account, “then they’re crazy,” Sherman said in an interview.
A spokesperson for Robinhood said the company doesn’t share the details of individual accounts for privacy reasons.
Robinhood follows FINRA’s rules and know-your-customer requirements when determining access to options, the spokesperson said. The company requires federally mandated minimum deposits in margin accounts and assesses an investor’s “experience, goals and sensitivity to risk” to assess eligibility, said a spokesperson who spoke anonymously.
The company is considering whether to include additional qualifications for its most advanced tier of options trading, the spokesperson said.
“Our mission at Robinhood has always been to bring in those who’ve been left out of the system by making investing more approachable,” the spokesperson said in a statement provided to CQ Roll Call. “We do so with educational content, by reducing barriers like commissions, through products like fractional shares, and through product design.”