Robinhood faces 'looming regulatory risk' as it gears up for its IPO

The retail trading platform Robinhood is reportedly planning to start trading on the Nasdaq next week, making a public debut that comes with an unusually heavy dose of legal and regulatory disclosures.

Robinhood, which expects a market value of $33 billion, faces "numerous litigation matters," according to a recent securities filing. Those lawsuits, likely to be consolidated if permitted to move forward, include roughly 50 proposed class actions tied to its decision to restrict trading in GameStop (GME) and other so-called meme stocks in early 2021, according to the filing, which Robinhood submitted to the Securities and Exchange Commission (SEC) on Monday.

The platform — whose stated goal is to "democratize finance for all" by offering commission-free trading — said it faces 15 proposed class actions over outages in March 2020. It also said it faces a half-dozen proposed class actions over a controversial practice called payment for order flow, which enables brokerages to make money despite not charging commissions.

But the regulatory risk that Robinhood faces could outweigh even this mountain of pending lawsuits against the platform, one expert said. Indeed, the company's new registration filing mentioned the word “regulation” 215 times. And many of those lawsuits might be dismissed, according to University of Michigan Law School professor Adam Pritchard.

“There are a bunch of lawsuits out there,” Pritchard said. “For a lot of them, there's not much to them.”

Vlad Tenev, CEO of Robinhood Markets, is seen testifying in a frame grab from video during an entirely virtual hearing of the U.S. House of Representatives Committee on Financial Services entitled ?Game Stopped? Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide??, in Washington, U.S., February 18, 2021.   House Committee on Financial Services/Handout via Reuters
Vlad Tenev, CEO of Robinhood Markets, is seen testifying in a frame grab from video during an entirely virtual hearing on February 18, 2021. House Committee on Financial Services/Handout via Reuters

Robinhood's filing pointed to proposed class actions filed on behalf of what could amount to millions of consumers, and another lawsuit filed by Massachusetts' attorney general. Both target Robinhood’s “payment for order flow” fee arrangement, claiming the company failed to inform customers that its commission free trades are supported by payments to broker-dealers.

Ultimately, the suits claim the fees disadvantaged Robinhood consumers by pushing their trading costs higher. So far, the practice has resulted in Robinhood reaching a $65 million settlement with the SEC. Separately the company was fined $57 million by the Financial Industry Regulatory Authority (FINRA) for allegedly violating brokerage industry rules. (Robinhood "accepted" the settlement with FINRA but did not admit or deny the allegations.)

The risk from regulators like these could be a greater threat than the many pending lawsuits, according to University of Notre Dame associate law school professor Patrick Corrigan.

“First is Robinhood’s history of regulatory enforcement actions,” Corrigan said. “They've had settlements with the SEC, with FINRA — and they're facing actions from several state governments.”

“Second, Robinood's business model and practices push the boundaries of what broker dealers are currently doing with customers,” he said. That, he explained, separates the company from traditional financial services companies and underlies why regulators continue to probe the company’s tactics.

'An alarming risk' for investors

The company came under intense scrutiny in February when lawmakers on the House Financial Services committee publicly questioned Robinhood CEO Vladimir Tenev about the company’s payment for order flow revenue model — its largest source of revenue — and its advertising practices.

Pritchard, the University of Michigan law professor, said that while the collection of uncertainties is not ideal for a company that’s going public, Robinhood’s filing shows financial backers appear undeterred, despite the negative media coverage .

“If you were contemplating an [normally] wouldn’t choose the point where you had just been hammered by the media and Congress in the last six months,” Pritchard said.

“It's not customary for a company that's just doing its IPO to have this much on its docket, that it needs to disclose, but you can be certain that the underwriters have talked to prospective investors, and don't think that it's insurmountable,” he added.

Still, David Trainer, CEO of the investment firm New Constructs, said Robinhood’s “mounting regulatory risk" should be a red flag for investors and that the stock should be worth no more than $9 billion.

"Robinhood will likely not be able to continue the robust growth it saw in 2020 due to looming regulatory risk, increasing competition, and an undifferentiated service," he wrote. "If regulators were ever to outlaw payment for order flow, Robinhood’s revenue would be severely affected, creating an alarming risk for investors."

We reached out to Robinhood for comment the regulatory risks it faces and will update this post with any comment we receive.

Alexis Keenan is a legal reporter for Yahoo Finance. Follow Alexis on Twitter @alexiskweed.

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