1. Misalignment of Interests: While RIAs are held to a fiduciary standard by the Investment Advisers Act of 1940, this does not entirely eliminate the risk of self-interest affecting an RIA’s advice. For instance, RIAs might favor only those investment products from firms that are paying significant commissions to the RIA for selling that product. This means there is a significant potential conflict of interest causing an RIA to recommend the same small set of investment products to every potential client.
2. Limited Product Offering: Many RIAs have a limited range of investment products due to affiliations with certain investment companies. This could mean you may not have access to the full spectrum of investment options that might be more suitable for your retirement needs.
3. Lack of Transparency: Even though RIAs are required to disclose all material facts to their clients, the complexity of the investment products such as annuities and life insurance products may result in you not fully understanding certain investments, the adviser’s commission for selling a specific product, or the risks involved in an investment strategy recommended by the RIA.
4. Qualifications and Experience: RIA’s expertise and experience can vary significantly. While some have extensive experience and hold multiple qualifications, others might be newer to the industry and less experienced. A less qualified RIA might not provide the best advice or understand the intricacies of complex investment strategies. Further, it is important to check your adviser at brokercheck.org and investigate their history. There are plenty of RIAs who are and RIA because they are unable to be a stockbroker (yes, there is a huge difference.)
5. Costs: RIAs usually charge a fee based on a percentage of assets under management, which might be higher than what you’d pay if you managed your investments independently or did not invest in annuities or life insurance products. Additionally, some RIAs may have hidden costs or might charge additional fees for specific services on top of the percentage fees they charge.
6. Poor Communication: In some cases, you might find that your RIA does not communicate effectively or regularly. This could leave you feeling uninformed about your investment decisions and progress toward your retirement goals.
7. Inadequate Personalization: Some RIAs might use a one-size-fits-all approach to investment strategies, which could result in your retirement assets not being fully able to meet your specific goals, risk tolerance, and timeline to, or in, retirement.
8. Limited Accessibility: Depending on the RIA, you may face issues regarding the accessibility of your adviser. If they manage a large number of clients, they might not be available when you need them, impacting your ability to make timely decisions. This applies to the investment products that RIAs may recommend to you because the investment products often have significant penalties for early ‘surrender’ and withdrawals, or even have no option to gain access to your money.
9. Risk Management: Not all RIAs are skilled in managing risk effectively. A failure to appropriately assess and mitigate risk could potentially result in substantial losses for your retirement portfolio.
10. Lack of Oversight: While RIAs are regulated by either the Securities and Exchange Commission (SEC) or state regulators, this does not guarantee that your investments are safe. If the oversight body does not effectively regulate the RIA’s practices, your retirement assets could be at risk. Another oversight issue is that many RIA’s have no insurance to provide coverage to you for the RIA’s potential negligent or fraudulent handling of your account.

Despite these potential problems, it’s important to remember that many RIAs provide excellent service and can significantly contribute to the growth and protection of your retirement assets. The key is doing your due diligence in selecting an adviser. Check their qualifications, regulatory records, and references. Understand their fees, services offered and their investment philosophy. Good communication is essential, so ensure you feel comfortable discussing your needs and goals with them. Finally, always remember that it’s your retirement – stay informed and involved in the management of your assets.

Retirement planning can be a complex process, but knowing the potential pitfalls of entrusting your retirement assets to an RIA can help you make an informed decision that aligns with your retirement goals and financial situation.

A margin account is a type of investment account that allows investors to borrow funds from their broker-dealer to purchase securities. With a margin account, investors are able to leverage their trades by borrowing against the value of their portfolio. This means that investors can potentially earn larger returns on their investments but also exposes them to increased risk.

Broker-dealers have a number of responsibilities when it comes to margin accounts. One of their primary responsibilities is to ensure that investors understand the risks associated with trading on margin. This includes providing investors with a detailed explanation of how margin accounts work, the potential risks and benefits, and any costs or fees associated with trading on margin.

Another important responsibility of broker-dealers is to ensure that investors meet the eligibility requirements for trading on margin. These requirements may vary depending on the broker-dealer, but typically include factors such as an investor’s financial standing, trading history, and investment objectives. Broker-dealers must also maintain appropriate documentation to demonstrate that investors meet these requirements.

Once an investor has been approved for a margin account, broker-dealers are responsible for monitoring the account to ensure that the investor is maintaining sufficient collateral to cover any potential losses. This is known as a margin call. If the value of the investor’s portfolio falls below a certain level, the broker-dealer may issue a margin call, requiring the investor to deposit additional funds or securities to maintain the required level of collateral.

Broker-dealers should clarify for investors that the broker-dealer has almost unfettered control over the margin account. The broker-dealer, in the face of a ‘margin call,’ can raise money to meet the margin call by selling stocks from an investor’s account without first asking the investor. The broker dealer can even sell out the entire account without the client’s authority to protect the broker-dealer.

Broker-dealers are also subject to the Financial Industry Regulatory Authority’s (FINRA) rules regarding margin accounts. These rules require broker-dealers to provide investors with a risk disclosure statement outlining the risks associated with trading on margin. Broker-dealers must also provide investors with regular statements outlining the status of their margin accounts, including the amount of margin used and any potential margin calls. Additionally, broker-dealers must also comply with all applicable laws and regulations governing their conduct, including the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

Another important responsibility that broker-dealers have is the responsibility to ensure that all investors are treated fairly and with integrity. This includes providing investors with accurate and timely information about their margin accounts, as well as ensuring that any fees or charges associated with trading on margin are reasonable and transparent. Broker-dealers must also have adequate safeguards in place to protect investors’ assets and prevent unauthorized access or theft.

Margin accounts offer investors the opportunity to potentially earn larger returns on their investments, but such accounts also come with increased risk. Broker-dealers have a number of important responsibilities when it comes to margin accounts, including ensuring that investors understand the risks and benefits of trading on margin, monitoring accounts to ensure sufficient collateral, preventing illegal trading practices, and complying with applicable regulations. As an investor, it’s important to work with a reputable broker-dealer who is committed to transparency, fairness, and integrity when it comes to margin accounts.

One of the biggest benefits of AI in investing is the speed and accuracy of decision-making. With the ability to process large amounts of data quickly, AI algorithms can analyze market trends and identify profitable investments much faster than human traders. In addition, AI algorithms can be programmed to avoid psychological biases that can negatively impact human traders’ decision-making. This could result in more rational and profitable investment decisions.

Another potential benefit of AI in investing is the ability to identify patterns in data that humans might miss. AI algorithms can analyze vast amounts of data, including financial data, news articles, and social media, to gain a comprehensive understanding of a company and its potential for growth. This can provide investors with a more accurate picture of a company’s financial health and future prospects, allowing them to make better investment decisions. AI algorithms can also be used to develop predictive models for stock market performance. These models can take into account historical data, market trends, and other factors to forecast future stock prices. This information can be extremely valuable for investors, as it can help them identify stocks that are likely to rise in value and make informed investment decisions.

A further benefit of AI in investing is the ability to automate the trading process. AI algorithms can be programmed to make trades based on predetermined criteria, such as a specific stock price or market trend. This can save investors time and effort, as they no longer have to spend hours researching and making investment decisions themselves. It can also reduce the risk of human error, as AI algorithms are not subject to the same emotional or psychological biases as human traders. Despite the many potential benefits of AI in investing, there are also some concerns about the technology. For example, there is a risk that AI algorithms could be programmed to make unethical or illegal trades. In addition, there is a risk that AI algorithms could be vulnerable to hacking or other forms of cyber-attack, which could result in significant financial losses for investors.

Another concern is the potential for AI algorithms to exacerbate market volatility. If a large number of investors use AI algorithms to make trades, this could lead to rapid shifts in stock prices and market trends. This could result in increased volatility, making it more difficult for investors to make informed investment decisions. Despite these concerns, it is clear that AI has the potential to greatly impact the world of investing in the stock market. The technology has the potential to bring about many benefits, including faster and more accurate decision-making, better predictive models, and more efficient trading processes. However, it is important for investors to be aware of the potential risks associated with AI and to carefully consider how they use the technology in their investment strategies. In conclusion, the impact of AI on the stock market will likely be significant in the coming years. While there are still some uncertainties about the technology, it is clear that AI has the potential to bring about many benefits for investors. However, it is important for investors to be aware of the potential risks associated with AI and to use the technology carefully in their investment strategies. As AI continues to evolve, it will be interesting to see how it continues to impact the world of investing and the stock market as a whole

FINRA noted three major violations from its investigation into Robinhood’s conduct and operations as a stock-trading app, each of which merited its own penalties.

First, FINRA found that Robinhood has pervasively and negligently provided false or misleading information to its customers. [1] This false information was circulated in spite of Robinhood’s core mission to “de-mystify finance for all” and “democratize finance,” and ranged from misrepresenting customer account balances and buying power, to erroneous communication about customers facing margin calls. [2]

As a result of Robinhood’s misrepresentations, FINRA is requiring the firm to pay over $7 Million in restitution to customers who suffered related losses. [1]

Second, FINRA found that Robinhood did not exercise proper due diligence in its options trading offerings. [1] Given the financially risky character of options trading, Robinhood improperly outsourced an algorithm powered by artificial intelligence to determine customer options trading eligibility. The technology was riddled with inconsistencies, causing eligibility decisions to be made based upon incorrect customer information, and allowing ineligible customers to engage in options trading. [1]

Finally, FINRA also uncovered issues with Robinhood’s technological supervision of its core business tenets. For example, Robinhood experienced a widespread outage of its platform in early March 2020, during which operations halted. Robinhood customers were unable to access their accounts for a period of two days, during which market volatility was incredibly high. This outage, which was only one of many similar situations, resulted in approximately $5 Million in customer losses, which Robinhood has now been ordered to pay in restitution. [1]

Beyond these three severe offenses, FINRA also found that Robinhood has violated several other rules as a brokerage firm in recent years. Robinhood has failed to report failures and customer complaints which are required by FINRA, and has also failed to show customers complete market data as they make sensitive decisions about securities trading.

Robinhood, for its part, responded to the charges by stating that they are actively improving their educational resources, customer support capabilities, and legal and compliance teams. [2] They are “glad to put his matter behind [them]” with a renewed focus on the continued democratization of finance for all. [2]

FINRA’s message through these sanctions is clear – violate brokerage industry rules, pay the price. Its Head of Enforcement, Jessica Hopper, added that “all FINRA member firms, regardless of their size or business model, must comply with the rules that govern the brokerage industry . . . to protect investors and the integrity of our markets.” [1][2]

Given Robinhood’s exploding popularity among retail investors, particularly during the pandemic, this settlement should be a reassuring sign to investors that FINRA is taking its duty to protect their interests seriously. On the same token, customers of platforms like Robinhood should remain diligent in their financial decisions and report any potential issues for assessment by either the firm or by FINRA itself.

Sources: [1] https://www.finra.org/media-center/newsreleases/2021/finra-orders-record-financial-penalties-against-robinhood-financial [2] https://www.cbsnews.com/news/robinhood-finra-70-million-fine/

There are some situations in which FINRA arbitration is required, such as when a written agreement between the parties mandates it. In order to be eligible for FINRA arbitration, an investor must be seeking to file a claim stemming from the business activities of their broker or brokerage firm, and the event in question must have taken place within the last six years (in most states). [1]

Generally, FINRA arbitration allows an investor to seek either monetary or securities damages resulting from the business activities of their broker or brokerage firm. To get the filing process started, an investor must submit a Statement of Claim, a FINRA Submission Agreement, and related filing fees, all of which are available to view on FINRA’s website. [2]

The format and related fees for the arbitration itself vary based on the amount of money in controversy. When the amount in controversy is below $10,000, a hearing session will be conducted with just one arbitrator, and the session fee will be between $50 and $450. If the amount in controversy is above $10,000, a panel of three arbitrators may be used instead, and the hearing session fee will range from a minimum of $600 to a maximum of $1,575. [3]

Once FINRA receives all of the initial required documents, they analyze the claim and determine whether a one- or three-person arbitration panel will be used. A case number is created, and FINRA will notify the respondent – the party the investor has filed their claim against – about the case. So long as the respondent is registered with FINRA, they will be required to arbitrate.

The respondent then has 45 days to research the claim lodged against them and to respond. FINRA analyzes the response along with any counter claims or cross claims.

Next, the parties choose their arbitrators from a randomly generated list of names supplied by FINRA. FINRA arbitrators are not FINRA employees, instead they are contractors who are evaluated by FINRA on the basis of their employment, professional licenses, and education. They are chosen from diverse backgrounds and must take an oath to remain neutral and decide cases solely on the facts and meris.

Once arbitrators are chosen and agreed upon by both parties, there will be an initial pre-hearing conference, where investors are typically represented by an attorney. The arbitration hearing is scheduled, and discovery begins.

Discovery allows both parties to exchange documents and identify witnesses and is governed by rules within FINRA’s Discovery Guide. After discovery is completed, the arbitration hearing takes place.

The arbitration hearing takes place around a conference table, with arbitrators at the head of the table and the parties on each side. The claimant presents their side of the case first, complete with an opening statement, witnesses, and evidence, and is followed by the respondent. Objections are permitted, and the arbitrators determine whether or not they will accept evidence.

At the completion of the hearing, the arbitrator(s) will deliberate, and render their award, typically within 30 days. The award is legally binding on both parties, and FINRA offers no internal appeals process. While a party may choose to appeal an arbitration award in court, it should be noted that judges rarely overturn these awards.

From start to finish, FINRA arbitration cases that don’t settle before their hearing take approximately 16 months. The process allows for a streamlined and more private alternative to litigation in the courtroom, as FINRA arbitration documents are not made public like court documents. We invite you to contact us for details and support on your potential FINRA arbitration claim.

Sources: [1] https://www.finra.org/arbitration-mediation/arbitration-overview] [2] https://www.finra.org/sites/default/files/Education/p117486.pdf [3] https://www.finra.org/rules-guidance/rulebooks/finra-rules/12902]

Let’s consider an example of margin investing with Robinhood. An investor deposits $5,000 cash into a margin account, and Robinhood lends another $5,000 to allow the investor $10,000 worth of securities. The “margin” is the difference between the value of the securities and the loan from Robinhood. This type of investing increases both purchasing power and financial leverage. [1]

If the securities in the margin account increase in value, the investor has the opportunity for a higher profit than they would have had they invested $10,000 of their own.

On the other hand, if the securities decrease in value, the margin investor is at risk of losing more than they would have had they invested $10,000 of their own.

One of the most significant risks of margin investing stems from margin calls. Because securities purchased on margin are used as collateral against the loan Robinhood extends, Robinhood sets “margin maintenance requirements” on each margin account. These requirements are minimum portfolio values that must be maintained by the investor, and they help Robinhood protect the money they’ve loaned. [2]

So, if the market is volatile, as it has been recently, and the value of securities in a margin account falls too far, Robinhood will issue a margin call. The investor must then either deposit additional cash into their account to meet the margin maintenance requirement or close out their position(s).

However, per Robinhood’s Margin Account Agreement and Margin Disclosure Statement, when Robinhood issues a margin call, they also have the right to sell the account holder’s securities without notice nor consultation. [3],[4]

The language of the agreement specifically states that Robinhood is authorized to liquidate or sell the securities in a margin account to cover any margin deficiency, and that they are not required to notify the account holder before making such a sale. The agreement also stipulates that Robinhood has the sole authority to choose which securities are sold in order to satisfy a margin call, and that Robinhood’s margin maintenance requirements are subject to increase at any time, with no advanced written notice required. [3],[4]

Based on this agreement, which all Robinhood margin investors are required to sign, Robinhood has quite a bit of power over margin accounts. Understood in context, however, these stipulations are designed not to put the investor at risk, but instead to allow Robinhood to protect the money they’ve loaned to investors via immediate liquidation and/or covering losses by requiring additional cash deposits. [3],[4]

Margin investors should also be aware that Robinhood’s margin account agreement explicitly states that any disputes must be resolved via arbitration, so neither party to the agreement may sue one another in court. If a dispute arises, an arbitration case would be filed with the Financial Industry Regulatory Authority (FINRA) in order to reach a resolution or settlement. [3],[4] FINRA arbitration is designed to create a fair and expedited alternative to a traditional court case, but it’s important to understand the arbitration process before deciding to make the leap into margin investing.

So, depending on your risk tolerance, margin trading may or may not be an investment tool you want to use in your accounts.

In our next post, we’ll be sharing a start-to-finish overview of what you can expect from the FINRA arbitration process, particularly as it pertains to margin investing.

Sources: [1] https://www.investopedia.com/ask/answers/041315/why-purchasing-stocks-margin-considered-more-risky-traditional-investing.asp [2] https://robinhood.com/us/en/support/articles/margin-overview/ [3]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Customer%20Margin%20and%20Short%20Account%20Agreement.pdf [4]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Margin%20Disclosure%20Statement.pdf

As has been widely reported this week, when Reddit retail investors discovered that hedge fund managers were widely shorting GameStop, AMC, and others, they urged fellow users to begin buying up these stocks. This frenzy of investment activity resulted in a short squeeze, sending GameStop’s stock price soaring, causing hedge funds to incur huge losses on their short positions, and placing popular online trading platforms in a precarious financial situation. GameStop shares closed the week of January 25, 2021 up 400% in spite of market volatility and restrictions, and without any material change to the prospects of company.

But how did we get here?

For one, through the rise of simple, fee-free, online investment platforms like Robinhood. These platforms have empowered retail investors by providing an easy-to-use interface to enter the market and trade shares at the click of a button. But this innovation hasn’t come without its critics, who counter that the platforms may paint investments as form of gambling for users who may not have the requisite knowledge to make informed decisions about the risk they take on in their accounts.

As trading activity exploded on Robinhood this week, the platform became strained and suspended trading on a group of 13 popular stocks on Thursday, January 29^th. The restrictions disallowed further purchasing of the stocks but allowed selling – making it difficult for prices to continue to rise. As reported by the New York Times, in order to continue operating Robinhood needed funds to pay both its clearing facility and its users who were owed money from prior trades. To that end, Robinhood raised over $1 billion from its credit lines on Thursday night, enabling trading to resume on Friday, albeit with significant stock-quantity restrictions.

Of course, this period of restricted trading has raised some important legal and regulatory questions. First, some Robinhood users viewed the trading restrictions as unjust behavior in the free market, with over a dozen lawsuits, including a class action, filed against the company this week. The lawsuits claim that Robinhood breached its contract with users when it began restricting their trading activity. Further, the class action lawsuit claims that Robinhood’s “actions were done purposefully and knowingly to manipulate the market for the benefit of people and financial institutions who were not Robinhood’s customers.”

According to several legal experts cited by Thompson Reuters, it is unlikely that these lawsuits will succeed, because Robinhood’s user agreement reserves the right to “prohibit or restrict” its users from trading securities at its own discretion. Additionally, federal securities law places strict limits on class actions against brokers, and users will face the tough task of proving the specific damages they suffered because of the restrictions. They will also likely need to show concrete evidence that Robinhood’s restrictions were made for an some “improper reason, such as to favor certain investors” to succeed.

Given the intense public scrutiny and media attention, it’s difficult not to wonder what comes next. In the regulatory realm, the SEC has released a statement vowing that they “will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.” In fact, the SEC has already had its eyes on Robinhood in recent months. They issued a $65 million fine against the company in December 2020, alleging that Robinhood misled its customers about their main revenue source, causing users to lose $34.1 million between 2015 and 2018.

With commitment this week from both the White House and Treasury to monitor the situation, along with bipartisan support in Congress to investigate, this fast-evolving situation will be one to watch in the coming weeks.

It is fundamental to full and fair disclosure that if an individual investor wants to know whether their financial adviser, or a financial adviser they want to hire, has any legal or regulatory problems, that this information is easy for an investor to obtain. To that end, the Securities and Exchange Commission (“SEC”) sought to simplify the process by which an individual investor can access this information. The result of the SEC’s efforts was the “Form CRS.” “CRS” stands for customer (or client) relationship summary.

This information has been available. However, for the average “Main Street” individual investor, the information was not easy to find. And when the customer complaint and regulatory history was found, the disclosures were difficult to understand. The Form CRS[2] was intended to address this complexity and difficulty through simplification. Thus, the SEC created what SEC Chairman Jay Clayton said in November 2018 would be a “clear and concise” document. I think they succeeded. Wall Street, however, failed.

One question on the Form CRS asks is “Do you or your financial professionals have legal or regulatory history.” This is a simple yes or no question. Or so you would think. The SEC’s instructions for Form CRS elaborate, telling financial advisers to answer ‘yes’ if they or their financial professionals have disclosed such legal or regulatory history. The SEC instructs financial advisers to disclose if they or their advisers have disclosed any legal disputes with customers, regulatory penalties or have been terminated while working at prior employers.

Pretty straight forward, right? Well, apparently not if you are a financial professional! According to the Wall Street Journal’s analysis, an astonishingly high number of firms failed to report legal and regulatory issues. 1,300 firms failed to list disclosures on approximately 2,300 individual employees. The Wall Street Journal reports that their analysis shows that approximately 1,600, or almost 70%, of the non-disclosures related to customer complaints.

The failure to answer ‘yes’ approximately 2,300 times by almost 1,300 financial firms on this Form CRS is more than a mistake.

It is the financial industry’s continued attempt to hide this important information from investors. Transparency is important and by ignoring the rules and intentionally (or at least grossly negligently) hiding customer complaints from investors, these firms weaken investors’ trust.

This mass failure to be transparent can only be seen as an intentional attempt by Wall Street to mislead Main Street investors.

When seeking to hire a financial professional, the prudent investor will try to find out if the financial professional they want to hire is trustworthy or has any customer complaints. This information is vital not only to protect individual investors, but it is important to help ‘clean up’ the financial industry by helping to rid the industry of those financial professionals that have significant or numerous customer complaints. Even with the SEC’s simple Form CRS, the Main Street individual investor is at a disadvantage since the firms are not properly disclosing the information.

It is my hope that the SEC acts strongly to prevent a re-occurrence of the Wall Street’s attempt to hide the truth from investors. I also hope that Wall Street becomes more transparent so that individual investors can finally move towards having a level playing field. Proper disclosure by financial professionals of their legal and regulatory history is a big step in the right direction.

[1] https://www.wsj.com/articles/financial-firms-fail-to-own-up-to-advisers-past-misdeeds-11598698800?mod=searchresults&page=1&pos=1 [2] https://www.sec.gov/info/smallbus/secg/form-crs-relationship-summary