Robinhood warns judge of dire industry consequences from Massachusetts case

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The Robinhood App is displayed on a screen in this photo illustration January 29, 2021. REUTERS/Brendan McDermid/Illustration

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  • Robinhood's lawyer says brokerages could leave Massachusetts if it loses challenge
  • State securities regulators accuse Robinhood of relying on "gamification"
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(Reuters) - A lawyer for Robinhood Financial LLC on Wednesday warned a Massachusetts judge that allowing state regulators to enforce a new fiduciary rule against the company could disrupt modern retail trading and drive low-cost brokerages out of the state all together.

Timothy Burke, a lawyer for Robinhood at Morgan, Lewis & Bockius, made those remarks as he urged a state court judge in Boston to block Massachusetts Secretary of State William Galvin from moving forward with his "extraordinary" enforcement case.

Menlo Park, California-based Robinhood sued in April after Galvin moved to revoke the popular online brokerage's license to operate in the case after charging that it encourages inexperienced investors to place risky trades without limits.

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Galvin, the state's top securities regulator, accused the app-based service of using strategies that treated trading like a game to lure young, inexperienced customers, including by having confetti rain down on the user's screen for each trade made on its app.

The case is the first enforcement action brought under a state fiduciary rule, which took effect in September, that raised the investment-advice standard for brokers.

Burke, during arguments held by Zoom before Suffolk County Superior Court Judge Kenneth Salinger, argued that the rule was invalid, asserting that Galvin, a Democrat, lacked authority to adopt it and that federal law preempted the state regulation.

He said the fiduciary rule "was intended and designed to be an obstacle to federal policy," after the Trump-era U.S. Securities and Exchange Commission in 2019 adopted its own rule for brokerages that rejected the standard Galvin was enforcing.

Burke contended that allowing the case to proceed could have broader industry effects, as other brokerages like Fidelity Investments have followed Robinhood's "revolutionary" lead in adopting low-to-no commission trading.

"The resolution of this case will affect the business model of all of those firms," Burke said. "And if the secretary's invalid rule is left in place, it could potentially drive self-directed broker-dealers out of Massachusetts all together."

But Salinger questioned whether he should intervene and consider the issue now or allow an administrative hearing officer overseeing the case to consider the issue first, potentially even allowing it to go to trial.

Salinger said that precedent from the Massachusetts Supreme Judicial Court would potentially allow him the discretion to consider the validity of the rule first, but challenges to an agency's jurisdiction are typically considered by that agency initially.

He also sharply questioned why allowing the case against a single company to run its normal course would "wreak such havoc on the industry," a position the trade group Securities Industry and Financial Markets Association in amicus brief also pushed.

John Donovan, a lawyer for Galvin at Sloane and Walsh, said it would not. He noted that since Galvin first filed the case in December, Robinhood and other brokerages have continued adding customers in the state and making profits.

"There's no evidence that we see that any of the broker-dealers have stopped offering services in Commonwealth or even that Robinhood has changed the matter of its services," he said.

He defended the fiduciary duty rule, saying it was intended to protect investors who use brokerages like Robinhood, "many of whom are neophytes in the investing world."

Salinger said he would "get you and your clients a decision as soon as I can."

The case is Robinhood Financial LLC v. Galvin, Suffolk County Superior Court, Massachusetts, No. 2184CV00884.

For Robinhood: Timothy Burke of Morgan, Lewis & Bockius

For Galvin: John Donovan and Myles McDonough of Sloane and Walsh

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Nate Raymond reports on the federal judiciary and litigation. He can be reached at