Robinhood is back in Washington’s crosshairs after leverage glitch

Robinhood Markets Inc. is once again getting unwanted scrutiny in Washington after some of the brokerage’s customers took advantage of a flaw that allowed them to make highly leveraged trades without putting down enough cash to back the transactions.

The glitch, labeled the “infinite money cheat code” by Reddit Inc. users, was exploited by about 20 customers and triggered estimated losses of less than $100,000, according to a person with knowledge of the matter who asked not to be named because Robinhood hasn’t disclosed the figures. The episode has also prompted questions from brokerage regulators, who could fine Robinhood if they find compliance lapses.

Though the money involved appears to be small, it’s the latest black mark for a fintech start-up that is seeking credibility in a highly regulated industry. The setback comes at a less-than ideal time for Menlo Park, Calif.-based Robinhood, which is seeking to grow its business by obtaining a banking license from the U.S. Office of the Comptroller of the Currency.

Robinhood already had a high-profile misstep last December when it botched the rollout of a new checking account by falsely saying customer deposits would be backed by the Securities Investor Protection Corp., a Washington nonprofit that insures consumers against losses if their brokerage fails or their investments are stolen. SIPC quickly made clear that the assertion was bogus.

The leverage glitch was taken advantage of by users of Robinhood Gold Service, where traders can “supercharge” their wagers on stocks and other assets by paying $5 a month to trade on margin, or money borrowed from the company.

“We recently identified a small number of accounts engaging in problematic trading activity on our platform,” Robinhood spokesman Jack Randall said in a statement. “We’ve quickly restricted these accounts, and made a permanent update to our systems intended to prevent anyone from engaging in this pattern of trades. We’ll continue to monitor closely for any type of abusive activity on our platform and will take action as appropriate.”

The trades described on Reddit involve customers entering into option transactions with money borrowed from Robinhood. The more money a user borrows, the more money Robinhood will lend them for future investing. One trader bragged about taking an eye-popping $1-million position based on a $4,000 deposit.

Robinhood believes it has fixed the glitch, said the person. Still, some Reddit users posted comments Thursday insinuating that flaws might be persisting.

The stakes are high for Robinhood in demonstrating its systems are up to snuff. The company closed a round of funding in July that valued it at $7.6 billion.

Founded in 2013, Robinhood has become a Silicon Valley darling for its popularity among millennials, who use its mobile app to invest in stocks, exchange traded funds and cryptocurrencies. A major selling point has been that Robinhood lets customers trade for free, something industry stalwarts such as Charles Schwab Corp., TD Ameritrade and Fidelity Investments have followed suit on.

Brokerages are policed by both the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority, a watchdog that is funded by the firms that it oversees.

Both agencies engage in routine inspections of brokerages, and typically ask pointed questions when firms suffer system failures. The SEC and Finra can also penalize brokerages for failing to safeguard client and firm funds.

SEC and Finra spokesmen declined to comment.

Robinson and Verhage write for Bloomberg.