Bitcoin ‘death cross': What is it and what does it mean for crypto

Bitcoin ‘death cross': What is it and what does it mean for crypto

The first IRS child tax credits arrive on Thursday, July 15—here’s when the other checks will come

FINRA Is Bearish On FinTech (For Now) With Its Record Fine Against Robinhood

I am certain that, by now, you have read the Robinhood AWC. Here is a fascinating take on that settlement, and what it portends for the securities industry, as well as for FINRA, by Denise. – Alan

There’s no question that FinTech firms are on the rise, and attempting to revolutionize the financial services space for the better. One such FinTech firm is none other than the notorious Robinhood. A technology company at heart, but a broker-dealer by definition, Robinhood wants its users to take trading into their own hands (or should I say smartphones?). While it’s true that more Americans are turning to the self-directed, commission-free trading model via FinTech apps, this sometimes comes at a cost, too. On June 30, 2021, FINRA announced that it reached an AWC with Robinhood, imposing a $70 million record-breaking monetary sanction against the FinTech firm. Although FINRA cited various violations of its rules, ultimately, its message to the industry goes beyond Robinhood’s underlying misconduct: FINRA is bearish on FinTech – at least for now.

FINRA acknowledges that FinTech is alive and well, even providing a loose definition of the term in a footnote (“FinTech refers to new uses of financial technology”). Yet, FINRA hasn’t quite fully accepted the FinTech brokerage model. As Jessica Hopper, FINRA’s Head of the Department of Enforcement, said, “compliance with these rules is not optional and cannot be sacrificed for the sake of innovation or a willingness to ‘break things’ and fix them later.” As a further testament to that, FINRA, through its findings in the AWC, concluded that Robinhood relied too extensively on its automation to conduct its brokerage operations, and did not conduct adequate supervision over its technology-based brokerage model. While Robinhood may want to revolutionize the financial markets, FINRA wants to continue regulating them in the way it knows how. In furtherance of this point, here are some of the key findings from the AWC.

False and Misleading Information Distributed to Customers.

FINRA found that Robinhood made various false and misleading communications to its customers, including misinformation regarding its “Free Stock” program, inaccurate cash balances and buying power, and the ability to place trades on margin, among other things. Although FINRA took issue with the misleading communications, it also brought up the corollary issue that no firm principals supervised those communications. Specifically, FINRA found that “Robinhood did not establish reasonable procedures to supervise the accuracy of the account information it displayed to customers via its website and mobile applications,” and further explained that “the firm relied on mathematical models and formulas to calculate much of the data it displayed to customers, but it did not require that a supervisory principal review the accuracy of those models and formulas.” Yet, this is only one of FINRA’s many findings that focus on the fact that Robinhood failed to employ firm personnel to supervise critical brokerage operations. Apparently, not all regulatory requirements can be outsourced to “new uses of financial technology” as FINRA sees it.

Failure to Exercise Due Diligence Before Approving Options Accounts.

This is one of the more interesting findings in the AWC. The issue here is that FINRA Rule 2360(b)(16) requires that either a Registered Options Principal or a General Securities Sales Supervisor (i.e., a person) approve a customer account for options trading, so Robinhood’s almost entirely automated system cannot satisfy the rule’s requirements. As a workaround to this rule, Robinhood employed some firm principals to review options account approvals. In reality, though, FINRA found that the FinTech giant was approving customer options accounts based almost entirely on its computer algorithms with very limited principal review (“Although Robinhood’s algorithms currently approve hundreds of thousands of options applications every month the firm’s team of principals previously reviewed only 20 applications per week; in May 2021 the firm increased its principals’ review to approximately 500 applications per week.”) As FINRA stated, “Robinhood used an almost entirely automated system for approving customers for the two levels of options trading offered by the firm.” It seems that by largely automating its options account opening process, Robinhood chose to ask FINRA for forgiveness rather than permission.

Failure to Supervise Technology Critical to Providing Customers with Core Broker-Dealer Services.

FINRA also drew an important distinction between brokerage operations and broker-dealer oversight when it found that Robinhood (the broker-dealer) failed to supervise the activities of its parent company, Robinhood Markets Inc. (RHM), which is responsible for operating and maintaining technology related to its brokerage operations. Specifically, FINRA found that:

From January 2018 to February 2021, Robinhood failed to reasonably supervise the operation and maintenance of its technology, which, as a FinTech firm, Robinhood relies upon to deliver core functions, including accepting and executing customer orders. Instead, Robinhood outsourced the operation and maintenance of its technology to its parent company, Robinhood Markets, Inc. (RHM)—which is not a FINRA member firm—without broker-dealer oversight. Robinhood experienced a series of outages and critical systems failures between 2018 and late 2020, which, in turn, prevented Robinhood from providing its customers with basic broker-dealer services, such as order entry and execution.

FINRA’s mandate is clear: Robinhood – as a regulated, broker-dealer entity – must adequately oversee its brokerage operations and ensure compliance with FINRA rules, even if those core brokerage activities are conducted through technology-driven processes by its parent company. While FINRA didn’t mind that Robinhood outsourced its operations to its parent company, it did take issue with the fact that Robinhood failed to oversee those operations. This distinction is important in the way that FinTech firms must learn to balance both their business and regulated sides. So, while Robinhood may have passed its brokerage operations off to its parent company so it can be the fun technology company it wants to be, ultimately FINRA reminds us that Robinhood cannot avoid its role as a boring, old, regulated broker-dealer entity.

Failure to Have a Reasonably Designed Customer Identification Program.

In another consequential finding, FINRA determined that Robinhood did not have a reasonably designed customer identification program in violation of its AML rules. FINRA’s main concern here was the fact that Robinhood delegated most of its account opening processes to algorithms “without any effort to verify that the information provided by the customers was accurate.” Here, FINRA set an expectation that FinTech firms should engage in some type of “manual review” conducted by personnel in order to ensure compliance with its AML rules. This is what FINRA had to say about it:

Robinhood failed to establish or maintain a customer identification program that was appropriate for the firm’s size and business.” The firm approved more than 5.5 million new customer accounts during that period, relying on a customer identification system that was largely automated and suffered from flaws.

FINRA also raised the fact Robinhood did not have any employees whose primary job responsibilities related to its customer identification program during the period, and that a single principal approved more than half of the more than 5.5 million new accounts that were opened. These findings reinforce the AWC’s principal theme: an automated brokerage model cannot run on its own without meaningful human oversight.

In all, these AWC findings, along with the others, formed the basis for the largest fine ever issued against a broker-dealer. FINRA’s award against Robinhood is monumental, and not just because of it is record-breaking amount, but also because it establishes a new regulatory precedent for FinTech firms to follow.

Still, it seems that the real winner here at the end of the day is: Robinhood. Just one day after the AWC was entered against it, Robinhood filed for its IPO under the catchy ticker, “HOOD,” showing its playing power in this industry. With over 31 million users and counting, Robinhood isn’t going anywhere anytime soon.

The question remains: Will it be FINRA that decides to update its rules to adapt to the rise of FinTech or will FinTech firms need to continue accommodating their operations until FINRA catches up with the trend? While it may be the latter for now, my prediction is that FINRA will eventually have no choice but to accept the rise of FinTech as more investors are choosing this financial path. In the end, it may be FINRA that needs to adapt to the FinTech model instead of the other way around – and FINRA may find itself bullish on FinTech after all.

3 Stocks to Avoid into the Summer

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A happier title for today’s note is: Three stocks to buy going into the holidays. However I mean to scare readers by sounding more bearish than I really am about these companies. In the long run, these are stocks to buy with confidence but from better vantage. For now they are stocks to avoid.

The price action on Wall Street last week was incredibly exciting. We had a rec session on Thursday and it felt like the end of the world. Hours later stocks were breaking records. Costco (NASDAQ:COST) and Amazon (NASDAQ:AMZN) to name two extended their runs into open air.

One thing is for sure is that the bulls are in complete control of the equity markets. Therefore writing about caution makes me a contrarian today. However, I look at it that I am preparing a shopping list for stocks to buy after the summer correction. I should explain that I am not bearish any of my three picks today. In fact, my concern comes from an angle of fandomship. Else I wouldn’t even consider them a buy at all – now or after a dip. I am simply a bit weary of the levels that their stocks have reached.

The fundamentals in question are solid and they have longstanding track records. I am a fan of all of them. Over the years I have written more positive notes about them. The perspective I am using today is for someone looking to deploy new investment money for the long term.

The simplest way to describe my opinion for all three is that this is not an obvious point of entry. I would not short them either, so my caution is not a reason to short. I bet that investors will have much better entry points this year.

Enough with the suspense, and on to the three stocks to avoid for summer:

Eli Lilly (NYSE: LLY )

(NYSE: ) Nike (NYSE: NKE )

(NYSE: ) Apple (NASDAQ:AAPL)

Stocks to Avoid into Summer: Eli Lilly (LLY)

Source: Charts by TradingView

Eli Lilly has had a lustrous past, and has over the years touched all of humanity. Their efforts helped solve serious global problems. The list is long and it includes cancer, polio, depression, diabetes, infections and more. They even helped us grow better crops. There is hardly a family that hasn’t benefited from one of their products. This is testament that they are a successful company for a very long time.

They have been in business since 1876, so that’s 145 years of history. I am not here to poke holes in that bullish thesis. They have earned the benefit of the doubt after decades of successes. Therefore it is only natural that LLY stock is doing this well. In 2018, it broke out from $90 in a big way, and hasn’t looked back. Clearly this is a winning equity.

The stock has done too well of late. It is up 100% from the pandemic lows and without a rest. The bulls are completely in charge, so they are not letting it dip enough. Small draw-downs are healthy because they let off steam. If a stock rallies too far without a break, it becomes frothy.

Its price-to-earnings ratio is still in line, but its price-to-sales (P/S) is double that of 2017. Also it is now 60% more than its last four year average. P/S is where hopium lives. Buyers of the stock now are giving it credit for 8.5 times its full year sales. That’s double that of Amazon (NASDAQ:AMZN) to name just one.

LLY’s revenue growth isn’t that exciting but they know how to grow the bottom line. Net income now is double that of 2018. Clearly I can’t complain about performance, but I will about their stock chart.

The rise above $170 per share was too violent. It left too many weak points in the chart structure. Therefore my caution today is more technical than fundamental. The goal is to determine if this is a good time to invest in LLY stock long term. I am confident that waiting out a few weeks is the more logical course of action. Jumping in especially with a full position right now is reckless.

Nike (NKE)

Source: Charts by TradingView

Nike management is a genius at marketing. I should know because I’ve been a client for decades. I remember buying my first pair of Nike Wimbledon when I was a teenager. It was a highlight of my summer back then.

The same spirit still lingers even though they often find themselves in hot water with the public opinion. Somehow they manage to turn controversies around into an assets. Case in point was the debate over Colin Kaepernick and his protesting on the football field.

Experts predicted negative impacts to their sales line item. That wasn’t the case but don’t take my word for it. The scoreboard shows that they’ve grown revenues 25% and doubled their net income in the last four years. This is even all the more impressive considering that we had to live through a pandemic class here.

The whole world was in lockdown for almost an entire year. Yet here I am boasting about their retail growth. So far I sound more bullish than bearish right? Here comes the bad part. The stock chart for Nike looks parabolic. Looking back 10 years, these are unique circumstances. Therefore this, by definition, is an extreme situation.

Extremes are wrong and they always correct. Trying to time the letdown is the tricky part, so the easiest thing to do is to avoid it now. This is where I remind us that I don’t condone shorting it. The proper course of action is to delay opening new investment positions in it.

Those investing for the long term often say that a few bucks lower are not going to matter much. I get it, but the same reasoning works the other way. Missing out on a few upside bucks shouldn’t matter either. If I’m not long NKE stock, I missed it for now. That’s just fine because there are hundreds of other stocks I can chase from better vantage points.

Stocks to Avoid into Summer: Apple (AAPL)

Source: Charts by TradingView

Closing today’s cautious article with Apple is almost sacrilegious. Arguably this is the most important company on the planet. It has a market cap of almost $2.4 trillion. Who am I to pick a fight with it? That’s the thing, I am not.

I’m merely cautious going into an earnings season. Apple stock has a habit of rallying into the event and then selling off. Netflix (NASDAQ:NFLX) will kick things off for tech soon. This late into its run, I worry about being late chasing AAPL stock. There still could be more upside but the easy part is too far already. Fast hands could trade that opportunity. But today’s perspective is for investors going into it for the long term.

I have never lost money buying AAPL on dips with conviction. I bet those who chase it after a 40% rally like this cannot say the same. Investors deal with the FOMO in different ways. I would rather miss out on a dozen opportunities then lose on one.

I always strive to do extensive fundamental and technical homework before I engage. Therefore my conviction is high, so I make it count. Apple stock close to $150 does not scream bargain to me. Fast traders can buy high and sell higher, but investors usually buy and hold. At these levels I bet they’d risk holding red for a while.

There’s no need for me to regurgitate how good the fundamentals are for Apple. They sell out of every widget they make and at a premium. Their clientele never complain about price. Apple users are not likely to ever switch out of their ecosystem.

This is an incredible accomplishment by a very competent marketing team. I wouldn’t dare bet against it. If you short it actively, you’re making a mistake. The best course of action with AAPL stock just like the previous two is to avoid it for now.

There Will be Better Entries

Some of the readers are probably thinking that I’m taking it too far. After all, these are solid companies running on rails. They’re not going to dip all by themselves. To that I say that, great stocks more often than not fall through no fault of their own. Calling them stocks to avoid is only temporary.

If the stock market corrects all three of these stocks will fall with it. They might resist for a day or two, but eventually falling indices sink everything with them. We have gone 16 months without one serious dip. Odds are we’re going to face tougher times as we lose big tailwinds.

The Federal Reserve is no longer adding QE, quite the opposite. Their next move is bearish because they told us so. The White House has one last infrastructure bill headline. That too will be the last for a while. In the absence of those helping hands, stocks might stumble a bit going into your end.

On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Nicolas Chahine is the managing director of SellSpreads.com.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.