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Explainer: The regulatory and authorized headwinds Robinhood faces

© Reuters. This July 1, 2021 illustration shows the 3D printed Robinhood logo. REUTERS / Dado Ruvic

By Chris Prentice and Michelle Price

WASHINGTON (Reuters) – Robinhood Markets Inc, the online broker at the heart of this year's retail frenzy, announced previously unreported regulatory risks in its long-awaited IPO filing Thursday.

Amid an increasingly hostile climate in Democrat-led Washington, Robinhood's growing regulatory scrutiny could turn off some potential investors.

Fines aside, Robinhood found that government investigations could lead to business restrictions, heightened compliance controls, changes to products and services, and brand damage.

The 18 million-customer company imposed government penalties for system failures and misleading disclosures before it caused an outcry by curbing trading in some stocks at the height of the "meme stocks" saga in January.

This episode sparked multiple investigations and stepped up the review of Robinhood's business model.

To date, the startup has paid more than $ 136 million to resolve allegations of misconduct, including a $ 70 million fine announced Wednesday by the Financial Industry Regulatory Authority (FINRA).

While these penalties are minor by Wall Street standards, Robinhood's legal costs are rising rapidly, rising from $ 1.4 million in 2019 to $ 105 million last year, the records show.

Here are some of the regulatory threats Robinhood encountered in connection with its IPO.

& # 39; MEME STOCK & # 39; PROBES

Robinhood said regulators issued subpoenas or solicited testimony and information from the company and CEO Vladimir Tenev as part of an investigation into trade restrictions imposed by the brokers during the volatility of meme stocks in January.

Regulatory agencies included the U.S. Attorney General for the Northern District of California, the Securities and Exchange Commission (SEC), FINRA, the New York Attorney General, other attorneys general, Congress, and some state securities regulators.

Perhaps the biggest revelation, however, was that authorities also took the unusual step of seizing Tenev's cell phone, Robinhood said without elaborating.

OTHER INVESTIGATIONS, LEGAL RISKS

Robinhood also revealed a seemingly unreported investigation by the New York Department of Finance (DYFS) that focused on anti-money laundering and cybersecurity issues, which the company is expected to settle with approximately $ 15 million.

In addition, the California attorney general issued a subpoena in April requesting documents and information about Robinhood's trading platform, business and operations, and the application of California's raw materials regulations to the platform. The company said it was cooperating with the probe.

Regardless of the meme stock episode, the Massachusetts Securities Division (MSD) sued Robinhood in December on charges of unethical and dishonest conduct and failure to comply with its fiduciary duty, among other things. Robinhood is fighting the suit.

NYDFS, attorneys general of New York and California, and FINRA declined to comment. The SEC and MSD did not immediately respond to a request for comment.

The company is also the target of more than 50 personal lawsuits related to the January trade restrictions and other issues.

NEW REGULATIONS

Because of the meme-share saga, policymakers are questioning the core practices of Robinhood's business model, particularly Payment-for-Order-Flow (PFOF), in which brokers forward retail orders to wholesale brokers for payment.

PFOF and other transaction discounts made up 75% of Robinhood's $ 959 million in 2020, Robinhood said.

SEC Chairman Gary Gensler said PFOF raises conflicts of interest and competition concerns, and he has asked employees to recommend new rules.

The agency is also looking into gamification, the use of game-like features to encourage trading, and other rules related to liquidity and risk management.

New regulations in these areas could require "significant changes to our business model," warned Robinhood. With its competitors less reliant on PFOF, increased regulation of the practice "could have an overwhelming impact on our results," said Robinhood.

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