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Archives for December 29, 2020

Is Robinhood Violating the Fiduciary Conduct Standard in Massachusetts?

December 29, 2020 by Channelchek Leave a Comment

investment research_Gamestop

A complaint against Robinhood has been filed by the state of Massachusetts. The action is based on a new state law that it began to enforce in September. This filing comes in the same week that the self-directed brokerage firm settled a suit with the SEC by paying $65 million. The new action is based on regulations unique to broker-dealers conducting business in Massachusetts, it charges the online broker with “gamification” of its platform.

Back in March, the Massachusetts Securities Division adopted amendments to one of their codes in response to the U.S. Circuit Court which threw out the Department of Labor’s fiduciary rule two years prior. The DOL regulation sought to curb conflicts of interest in financial advice by holding broker-dealers to the highest standard of doing what is in the clients’ best interest, rather than the lesser suitability standard they had been operating under. The amendment to the state’s existing code included language that held the broker-dealer community to a similar standard as wealth managers when providing investment advice.

What’s in the Amended Code?

The regulations cited in the action became effective on March 6, 2020, while enforcement of the regulation began on September 1, 2020. According to the Secretary of State for the Commonwealth of Massachusetts website, the regulations make a broker-dealer or agent subject to a fiduciary duty to clients when providing investment advice, recommending investment strategy, moving assets to an account, or the purchase, sale, or exchange of securities. Commissions are allowed under the current law; however, it requires that a broker-dealer or agent make recommendations and provide investment advice without regard to the financial or any other interest of anyone other than the customer. The fiduciary conduct standard also requires that the broker-dealer or agent must take all reasonably practicable efforts to avoid conflicts of interest and reduce conflicts that cannot reasonably be avoided.

Unsolicited trades, defined as one in which the client initiates the transaction without the idea having first come from the investment professional, have not been subject to the fiduciary conduct standard. The standard applies in connection with recommendations or advice provided by a broker-dealer. Activities of a broker-dealer in connection with unsolicited trades are subject to both state and federal conduct rules.

What’s in the Complaint?

Robinhood has 486,000 brokerage accounts in Massachusetts with total assets of $1.6 billion. The complaint alleges that Robinhood exposed Massachusetts investors to “unnecessary trading risks” by “falling far short of the fiduciary standard” The 24-page complaint from the Office of the Secretary, William Galvin, focuses on the tactics that Robinhood uses to keep investors engaged. The implication is that the self-directed broker-dealer encourages users on the platform through what it calls “gamification.” Examples cited within the complaint include one Robinhood customer with no investment experience that made more than 12,700 trades in just over six months.

Referring to Robinhood’s business practices, Galvin said, “They know that their investors are primarily younger. It’s because they think there are more unsophisticated investors among them — we heard from some of them”. He charged, “They’ve exploited the current situation with the pandemic. They contributed to the frothiness of the market, bringing people in who don’t know much about it. They’re not responsible fiduciaries.”

A Robinhood spokeswoman disputed the allegation, “Those who dismiss new and younger investors, who come from increasingly diverse backgrounds, as unsophisticated or unserious perpetuate the myth that investing is only for the wealthy,” she said. “History is littered with startups criticized by the establishment that are now strong, longstanding businesses.”

Robinhood plans to defend itself.

What it Could Mean for Robinhood?

There are two main charges in the Massachusetts complaint against the broker. First is that Robinhood encourages risky trading. The second is that they ignore their own options-approval rules by allowing margin accounts for users of their app with little or no market experience. Proving that they encourage risky trading because of the alleged gamification of the platform may be difficult. The marketing of most retail platforms includes some method of added appeal related to the target demographic. The challenge is in the difficulty of proving that Robinhood encouraged speculation. The second main charge seems to depend on more clear-cut evidence. The complaint alleges about 68% of Massachusetts Robinhood account owners that are approved for margin trading have been identified as having limited or no investment experience. Since margin accounts provide Robinhood with additional order flow and the ability to extend credit for which Robinhood does earn daily interest, they may be in violation. Their own rules on extending credit demonstrate they believe clients should have a minimum level of experience. If it’s accurate that the broker’s questionnaire records indicate 68% of Massachusetts Robinhood margin account owners did not have this experience when they first had margin made available to them, Robinhood’s conduct does not meet the state’s code and Secretary Galvin’s complaint is valid.

On December 8, 2020 Robinhood selected Goldman Sachs to lead preparations for an initial public offering (IPO) which could be valued at more than $20 billion. The Massachusetts complaint, or any fines stemming from it, are not expected to have a material impact on the companies plans or valuation.

Suggested Reading:

Investing and trading Skills

College Scholarships for Esports Gamers

Alternative investing, 401K

Sources:

Robinhood is Expected to be a Top IPO – Regulatory Actions Show Hurdles

After Courts Kill a Federal Fiduciary Rule, Massachusetts Launches Its Own

Massachusetts Fiduciary Conduct Standard for Broker-Dealers and Agents

Ahead of an IPO Robinhood Agrees to Pay $65MM to Settle Charges

SEC Charges Robinhood for Misleading Investors

Robinhood Accused of Gamification in Massachusetts

Massachusetts Regulators File Complaint Against Robinhood

The Fiduciary Rule Is Dead. What’s an Investor to Do Now?

 

Filed Under: Finance, Investing, Legal, New & Trends, Slider, Technology

After 2020 Stock Market Outperformance, What Are the Odds for 2021?

December 29, 2020 by Channelchek Leave a Comment

investment research_Gamestop

With the S&P 500 climbing to a new all-time closing high of 3,735.36, what are the stock market valuation indicators tell us? Although 2020 has been an outlier year in many ways, the S&P 500 is up over 70% from its March 23rd pandemic lows, and year-to-date, the index has risen 15.4%. Notably, the YTD rise, if it were to hold through the end of the year, would rank 2020 as the 46th best performing annualized return for the S&P 500 over the last 95 years. Not a bad accomplishment for such a turbulent year. The 2020 return is nearly double the average annual return of the S&P 500 since the 500 stock index was adopted in 1957.

Economists view the stock market as forward-looking, a leading indicator foretelling future economic pace. So, after the 2020 outperformance, what might 2021 look like?

What are the Odds?

The bad news is that the vast majority of historical valuation measures show a significantly overvalued market. For example, the Bull-to-Bear ratio is 3.7, well above the 1.0 neutral territory. The Consumer Comfort Index is 59.5, near the highest level seen since the late 1990s (what happened in late 1999/early 2000 brought pain to the stock market). The S&P 500 Price/Earnings-to-Growth (PEG) ratio of 1.9 is at its highest level since 1985. Tobin’s Q (or “Q Ratio” compares an asset’s market value to replacement value) for non-financials. Currently, at an adjusted 3.3, it is at its highest level since 1952.

The forward P/E ratios for the S&P 500 (large-cap) and the S&P 400 (mid-cap) are at their highest levels since 2006, while the S&P 600 (small cap) forward P/E is near its highest level since 2006. The Shiller P/E is 33.8x, versus a 20-year average of 25.6x and approaching its 20-year high of 37.3. The S&P 500 P/S ratio of 2.68x is at its highest since 2000 and well above the 1.50x median. Finally, market capitalization to GDP, often termed The Buffett Indicator, shows an overvalued market. The market cap of the Wilshire 5000 to GDP is 1.83, well above the 0.8 median average and the highest level since 1970. Looking at both the S&P 500 to GDP and Dow to GDP ratios, these are both at 70-year highs.

How is the Economy?

While above-normal valuations often go hand in hand with above-average economic growth, that does not appear to be the case this time. According to the U.S. Bureau of Labor Statistics, GDP is projected to grow just 2.6% in both 2021 and 2022. While this is better than the 2.1% average from 2010 through 2019, it falls far short of the 3-4% annual GDP growth experienced over the previous 40 years. Unemployment numbers, while well down from the pandemic highs, seemed to have stalled in the mid-6% range, nearly double the pre-pandemic numbers. While a COVID vaccine should help the economy recover to a more normalized state, how fast and far such an impact will have is unknown.

Bright Spots

On a more positive note: one should take into account the outsized influence of the FAANGM stocks on the P/E multiple. FAANGM stands for Facebook, Amazon, Apple, Netflix, Google, and Microsoft. These six stocks now account for nearly 25% of the S&P 500’s entire market capitalization. Since 2013, these six stocks are up 567.5%, compared to just 103.3% for the other 494 stocks. As mentioned previously, the S&P 500 forward P/E is 22.1x. The forward P/E for the FAANGM stocks is 40.1x. If you remove the FAANGM stocks, the adjusted forward P/E for the remaining 494 stocks falls to 19.3x, which is close to the modern era average CAPE P/E of 19.6x, suggesting, at least from an earnings perspective, the market is not as overvalued as it appears. In addition, according to Yardeni Research, the Fed’s Stock Market Valuation model shows the S&P 500 forward P/E at 21.7x, compared to a 114.9x P/E for bonds, implying, stocks remain the superior investment choice to fixed income.

Suggested Reading:

Will Robinhood be Fined on Charges of Gamification

Investing in ESports Industry

Investing & Trading Skills 

Alternative investing, 401K

Filed Under: Finance, Investing, New & Trends, Slider

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