Protocol | Fintech

He used to serve on the SEC. Can he help Robinhood avoid its wrath?

Dan Gallagher is pushing back on accusations that Robinhood has turned trading into a game.

Robinhood Chief Legal Officer ​Dan Gallagher

As the online broker's top lawyer, Dan Gallagher is gearing up for big legal battles.

Photo: Robinhood

Dan Gallagher, Robinhood's chief legal officer, joined the company in the spring of 2020, just as the COVID crisis was giving the online brokerage an unexpected lift.

The lockdowns and sudden shift to remote work sparked a surge in users who turned to Robinhood to buy and sell stocks, turning investing into a pandemic pastime.

But that spike in traffic and users led to a big crisis. In January, the GameStop trading frenzy brought new force to claims that Robinhood had turned stock trading into a dangerous game.

Gallagher said nobody at the company saw that coming.

"I don't think too many people could have predicted the confluence of events like we had on Jan. 28, the idea of a band of retail traders getting together to short squeeze a hedge fund by buying the stock of companies who are suffering greatly because of the pandemic," he told Protocol.

But he argued that it's wrong to blame Robinhood for the GameStop fiasco. Gallagher also pushed back on criticisms of payment for order flow, the rebates Robinhood earns for sending trade orders to market makers, from which the company draws a big chunk of its revenue.

"It's a false narrative to say that payment for order flow or gamification or something else caused Jan. 28," he said. "If you take a step back, social media created a phenomenon that resulted in a lot of market activity. To me, it's an age-old issue. I mean it certainly is as old as the internet."

Gallagher has been around long enough to know how the internet has changed the way the stock market works, including as a federal regulator.

As an intern at the SEC in the 1990s, he worked on the Systems of Excellence insider trading case which involved promoters talking up the company's stock in online newsletters. Part of Gallagher's job was to dig up the online chatter related to the controversy.

"I had to read the Yahoo Finance chat board, trying to figure out who people were and all that," he said. "It was mind-numbing, some of it. But it's the same thing. It was people getting in a chat room, talking about stocks, sharing ideas and doing other things to drive activity. … What's changed, obviously, is just how much more pervasive it is."

Gallagher later served as an SEC commissioner from 2011 to 2015 before moving to the private sector; he worked briefly at law firm WilmerHale's securities practice before joining Robinhood.

As the online broker's top lawyer, he is gearing up for big legal battles. That includes possible showdowns with the SEC, now led by Gary Gensler, whom Gallagher got to know and even worked with during his time as a federal regulator. Gensler was a commissioner of the Commodity Futures Trading Commission when Gallagher was with the SEC.

"I've known Chairman Gensler for a really long time," Gallagher said. "I have a lot of respect for him."

Gensler could pose a major challenge to Robinhood. He has rattled the fintech world with strong signals that the ways by which fintech powerhouses, led by Coinbase and Robinhood, operate and make money are flawed.

Gensler has been particularly critical of the crypto industry, which has recently gone from a sideline to the main show in Robinhood's trading business. He recently compared stablecoins to "poker chips," and Coinbase recently cancelled a planned coin-lending service after the SEC threatened to sue the crypto marketplace. He has also spoken out against payment for order flow, even suggesting the agency could ban the practice, as some other countries have done.

In an interview with Protocol, Gallagher talked about this new potential challenge for Robinhood, how his SEC experience is helping him in his role and how his team plans to take on the legal fights ahead.

(This interview has been edited for brevity and clarity.)

What do you think of Gensler's stint as SEC chairman so far? There's a view that the agency is being too heavy-handed.

I've known Chairman Gensler for a really long time. I've known him since he started as CFTC chairman back in '09. I was a staffer at the SEC and got to know him in that capacity and then when I was on the commission, he was still chairman [of the CFTC] and we got to work together. So I think — I hope — I have a really good relationship with him. I have a lot of respect for him.

I'm sort of amazed by the breadth of his agenda. You know anyone who's been at the agency knows that it takes a really long time usually to get things done, especially on the rulemaking side. There's a lot of process and comment and meetings and study and all these things.

He's got an incredibly ambitious agenda that he put together and it's all so disparate as far as subject matter. It might be ESG [environmental, social and corporate governance] disclosure for public companies on one side and equity market structure issues on another and proxy advisory firms on another. It's really a very, very broad agenda, and I would say I don't think the SEC has had an agenda like this since Congress handed the agency 100-plus rulemakings in Dodd-Frank back in 2010.

The big issue for you is payment for order flow. Gensler has sent a strong signal that they could propose changes or even ban it. You said recently that you don't think that's going to happen. Can you elaborate on that?

It's certainly on the table. That was his phrase. So clearly the SEC will review this and maybe even make proposals in a rulemaking context that impact payment for order flow, up to and including banning. So all of that is clearly within the realm of potential here.

My point that I made is that I personally — and this is just given my personal experience at the SEC — believe that when they undertake the process that's required to create a rule, when they get comments and when they have meetings with the industry and others, I believe, based on what I've seen by way of evidence, that they're going to see that payment for order flow is very beneficial for retail investors. And when they see that they're not going to want to ban it.

Obviously, we are going to engage with the process and make sure our viewpoints and the viewpoints of our customers are heard and taken into account. I hope that that's where they end up, realizing the benefits of it and not trying to ban it.

What if they do ban payment for order flow? What would Robinhood do?

If that happens, we'll have to look obviously at the final rulemaking, the rationale, the analysis that underlie the decision. At that point, depending on how we feel about whether the decision was supported by the process, we would take whatever action is appropriate.

How do you respond to the main criticism of payment for order flow, that under this system, it is in Robinhood's interest to encourage clients to make as many trades as possible?

This is a statement about any agency business where it's transaction-related. If you think about the old system, where you had not only payment for order flow but commissions, if you earned $5 per trade, guess what? You wanted as many trades as possible. Any time you have transaction-based compensation, there is a potential conflict. Look back at the history of the SEC and all the churning cases that have been brought. Those are cases where brokers have traded actively in customer accounts simply to generate commissions, over time, that's something that needs to be looked at.

I will point out, though, that transaction-based compensation is probably the No. 1 [indicator] of what it means to be a broker under the securities laws. If you're collecting transaction-based compensation, especially in the context of a securities transaction, it's highly likely that you're going to be deemed to be a broker. And what comes with that is a ton of regulation. The FINRA rulebook is inches thick. You have the SEC rules. You have oversight by both FINRA and the SEC, and the states. If you're selling futures, you have the CFTC. There's so many layers of regulation to being a broker, and it's incumbent on the regulators to look for abuses of brokerage activity.

But the idea that payment for order flow is somehow novel in the world of transaction-related compensation is just silly. It's not novel at all.

It drew a lot of attention during the GameStop controversy in January which led to the view that investors who are new, young and inexperienced were getting swept up in a trading frenzy, and vulnerable to losing a lot.

I think it's a false narrative to say that payment for order flow or gamification or something else caused Jan. 28. If you take a step back and you look at it, social media created a phenomenon that resulted in a lot of market activity. If you're a policymaker, you're looking at it and saying, "Oh boy, I'm not gonna try to regulate social media. I'm not gonna try to regulate what people say consistent with their First Amendment rights."

I think this is a deflection, quite frankly, by folks to not let a good crisis go to waste. We have Jan. 28. We realize, "Oh gee, there was no collusion between retail firms like Robinhood and hedge funds. So let's move on to something else here." This is what the gadflies are saying: "What do we always want to take a look at? Payment for order flow and let's throw in gamification." It's a non sequitur to say it's tied to Jan. 28. I just don't agree with that.

Have there been efforts to have a dialogue with the SEC?

We're at the very beginning stages of conversations about payment for order flow, about gamification.

Have you had a conversation with Gensler about this, given that you know each other?

Not since he's been chairman, no.

Gallagher testifies at his 2011 confirmation hearing as an SEC commissioner nominee. Gallagher testifies at his 2011 confirmation hearing as an SEC commissioner nominee.Photo: Andrew Harrer/Bloomberg via Getty Images

You were a former SEC official. What lessons from that experience are most valuable for you in this role?

You know, being a commissioner, it's a crazy job. You sit atop an agency whose jurisdiction is incredibly broad. You have trading issues and asset management issues and corporate disclosure issues. There's just so many things that you're responsible for. As a commissioner, you're voting on the important issues. Unlike some in Washington, I like to know what I'm voting on before I vote on it. It was just a lot of hard work and a lot of reading and a real dependence on the quality staff that I have.

Being at Robinhood, being a chief legal officer, in some ways, is the same. There's just this incredible steady diet of things to deal with. It might be the Jan. 28 issue. It might be analyzing jurisdictions. There's so many things we're pulled into.

And I've been really proud to build an incredible team around me. I've gotten three new deputies who report to me on the legal side who are incredible. They've all been in place for almost a year. We've created a culture of excellence in our legal department. We have each other's backs and we demand from each other and from our department excellence in everything we do. It's been a thrill. I set out when I started in May of last year to build the best financial services legal department in the country. And I think we already have. We're still improving but I think it's a real quality team doing great work.

Are there strategies or tactics that some companies embraced when you were at the SEC which clearly were counterproductive that are top of mind for you today, that you stress to Vlad and Baijiu and your executive team, "We will not do this"?

Vlad [Tenev] and Baiju [Bhatt] have been very clear with me from Day One. Our first corporate value is called "Safety First." Safety First includes compliance. They have made it abundantly clear to me that compliance comes first. I've made it clear to my team and everyone cross-functionally that noncompliance is a non-starter with me.

We are all about compliance with the rules and laws. Where we see noncompliance, we fix it. We don't tolerate lingering noncompliance. You've seen us settle some regulatory matters that, in my view, reflect the old Robinhood because they weren't properly fairly ferreting out regulatory issues as they arose. That is not going to happen on my watch and I've gotten the full support of the founders and the rest of the C-team. If you talk to regulators, they'll tell you that they've seen a pretty noticeable difference at Robinhood. We're just working hard every day to earn their respect.

Let's go to the flip side of that question: Are there examples of companies that had productive and constructive relationships with the SEC when you were there that you think is sort of an example for you?

When I look back, there's companies that just represent in some ways the best of a given industry. I think of Vanguard, for example. I think of the seniormost leadership of Vanguard and how I enjoyed a relationship with them, exchanging information and ideas and getting color on the markets that they operate in, and getting a strong sense from them that compliance and regulatory relationships were key and critical. That was a big part of the trust they had with their customers.

For Robinhood, that would be a goal for me, to your point, to be the sort of standard-bearer, or at least a go-to firm that has the lens into the retail brokerage world, to be a trusted partner with the regulators for information, for color about market practices and things like that.

You joined Robinhood as the pandemic was escalating. That was also the time when retail investing was taking off, which led to the Jan. 28 controversy. How do you look back on the factors that led to that — social media, the pandemic, the pivot to remote work?

I don't think too many people could have predicted the confluence of events like we had on Jan. 28, the idea of a band of retail traders getting together to short squeeze a hedge fund by buying the stock of companies who are suffering greatly because of the pandemic given their business models.

It obviously started to get more and more in focus throughout the days of January. But I can't tell you anybody who saw this coming in 2020.

Clearly, many investors today are processing different types of information. They may not be reading financial filings or press releases. They're reacting to what they're reading or seeing on social media. Given your background, how do you reflect on that trend?

How would I view it if I was back in my old job?

Yeah, in a way.

To me, it's an age-old issue. I mean it certainly is as old as the internet. When I was an intern at the SEC, I worked on the Systems of Excellence case which was a pump-and-dump on the internet. I had to read the Yahoo Finance chat board, trying to figure out who people were and all that. It was-mind numbing, some of it. But it's the same thing. It was people getting in a chat room, talking about stocks, sharing ideas and doing other things to drive activity.

That was the goal. What do we have here with Reddit and WallStreetBets? I mean, very similar stuff. I think what's changed, obviously, is just how much more pervasive it is. It used to be that I had to go to the SEC and there was one computer terminal in the middle of our floor that had the internet. You went down and you would dial into it. Now you have it sitting on your phone. It's just so much more accessible and I think that's why there's so much more activity.

But the principles are the same. If you're on a chat board, if you're talking about a stock, if you're lying and misrepresenting in connection with the purchase or sale of a security, you're breaking the law. If you're not, you're fine. You're just exercising your First Amendment right.

You've got to go in there, figure out who's saying what, who they are. You've got to find trading records, and see if they were lying or not. It's just a grind. It's not an exciting thing for a young enforcement lawyer to be sitting there. I did it as an intern grinding through all this stuff.

Let's go to another issue: crypto. What is it that you're most worried about or watching more closely in this space?

Crypto, it's another vexing area in the sense that there's no existing legislative framework to regulate it. Crypto without any sort of organic legislation is hard to regulate. You have various regulators who are set up to do different things clawing away various pieces of jurisdiction. You have Chairman Gensler and the SEC bringing cases where they're saying that things that are otherwise crypto might be securities like in a lending capacity. That's sort of a developing area.

What is your own opinion of the issue related to Coinbase?

Oh, boy. Yeah, I'm loath to weigh in on someone else's public fight. I'm just happy it's not my public fight. I have enough of my own.

I'm fascinated by it. I can clearly see the frustration from the Coinbase side. On the flip side of it, based on what's publicly available — I know nothing other than what's publicly available — the SEC seems to have kind of operated in its traditional fashion and met with them and gave them an answer. Sometimes you get a lot of frustration when you're at the SEC, you meet with folks and you just don't give them an answer and the issue hangs out there. Kind of like the bitcoin ETFs. You have massive frustrations because they just don't have an answer.

Here they got an answer. So I don't know what else really the SEC owes them besides the answers. I see both sides of it.

I do think it's emblematic of the larger frustration related to the lack of clarity on regulation of crypto assets. I quite frankly think Congress owes everyone some clarity. I don't think the regulators sort of scratching and clawing away at jurisdiction is the best way to bring surety to the markets.

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