Robinhood Markets: Were You Approved for a Risky Trading Strategy?
Regulator FINRA says Robinhood did not offer enough oversight for risky options trading strategies.
According to a recent regulatory action by the Financial Industry Regulatory Authority (FINRA), Robinhood Financial “failed to exercise its due diligence before approving customers to place options trades.” Faulty algorithms allegedly approved investors for options trading even though Robinhood should have flagged these investors as ineligible based on their experience and risk tolerance. Kurta Law is interested in speaking with investors who lost money on unsuitable options they purchased using Robinhood’s trading platform.
What is an Option?
Options are investment contracts that give investors the “option” to buy or sell shares at a certain price, referred to as the “strike price.” When you buy an option, you purchase either a put option or a call option. Both put and call contracts have strict deadlines. Once the deadline arrives, investors can either exercise their option or let it expire.
- Call options give investors the right to buy a security at a certain price by a deadline. Investors who purchase call options are betting that the price of the security is going to go up.
Example: Suppose an investor pays $1,000 to buy a call option for a stock currently valued at $5,000 per share. If a stock goes from $5,000 to $10,000 by the time the option deadline arrives, the investor can buy a $10,000 stock at $5,000, and then sell it for a $4,000 profit: $10,000 — $5,000 — $1,000 = $4,000.
- Put options give investors the right to sell a security at a certain price by a deadline. Investors who purchase put options suspect that the price of a security is going to decline.
How Do Investors Lose Money on Options?
If you spend $1,000 on a call option, only to have the price of the stock plummet, you could easily lose your $1,000. Investors should only gamble with money they are prepared to lose.
FINRA $70 Million Fine for Robinhood
In June of 2021, Robinhood Financial LLC agreed to pay a $70 million FINRA fine following allegations that the brokerage misled investors and approved ineligible traders for risky strategies. FINRA also alleged that Robinhood had harmed investors due to its technical faults and trading blackouts in March 2020. This is the largest fine ever levied by FINRA.
Of that $70 million, $12.6 million will serve as compensation for investors who lost money. Investors who are not compensated by FINRA can still recover losses through FINRA arbitration.
Why Did Robinhood Approve Inexperienced Investors for Options Trading?
Options come with significant risk and are only suitable for sophisticated investors who have enough money to tolerate substantial losses. Robinhood relied on an algorithm, referred to as “option account approval bots” to approve customers for options trading. FINRA alleges that these bots approved investors who obviously could not tolerate the risk.
For instance, investors had to state they had at least three years of investing experience to be approved for level 3 options, and yet the bots approved investors who were younger than 21. Investors must be 18 to open brokerage accounts, so it is impossible for someone of this age to have three years of experience. Investors could also quickly be approved for options trading by simply changing their risk tolerance from low to high.
Firm principals, FINRA alleged, provided limited oversight. According to FINRA, they only ensured that “the bots functioned as programed,” without evaluating pertinent information about investors.
FINRA requires brokerages to have a system in place to ensure that investors take on suitable levels of risk. Enforcement Chief Jessica Hooper said in an interview, “We’re fine with innovation, but innovation can’t be at the cost of creating compliance supervision systems.”
What Should I Do If I Lost Money Because of Options Trading on Robinhood?
If you were approved for a risky options trading strategy using the Robinhood app, you may be able to recover your losses through FINRA arbitration. Experienced securities lawyers like Jonathan Kurta can evaluate your case for free, and only get paid if they win you a FINRA arbitration award. Get in touch today — call 212–658–1502 or email firstname.lastname@example.org.