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Explainer-How Robinhood's public listing ups the regulatory stakes

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FILE PHOTO: The seal of the U.S. Securities and Exchange Commission (SEC) is seen at their headquarters in Washington, D.C.
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By Katanga Johnson

WASHINGTON (Reuters) -Robinhood Markets Inc's highly anticipated public listing will subject the company to onerous new regulatory demands - a weak spot for the fast-growing online broker.

Those new obligations, which are enforced by the U.S. Securities and Exchange Commission (SEC), comprise disclosure, governance and internal controls, legal experts said.

"What changes now is that its relationships with its shareholders and other investors are subject to much closer supervision by the SEC," said John Coffee, a law professor at Columbia University.

DISCLOSURE

As a public company, Robinhood will be required to release quarterly financial results, including previously nonpublic information such as how certain businesses, like cryptocurrency trading or options trading, contribute to its overall revenues.

It will also have to announce in a timely manner information that could have a material effect on its stock price, such as a government probe, cyber breach or a major operational issue.

These disclosures expose the company's top executives to increased personal liability, said lawyers. Robinhood's chief executive officer and its chief financial officer, for example, must certify the accuracy of its annual Form 10-K report, which is a comprehensive overview of a company's business and financial condition that includes audited financial statements.

In addition, Robinhood corporate insiders - officers, directors and any beneficial owners who hold more than 10% of the company's stock - must promptly file disclosures of their dealings in the company's shares to help prevent insider trading.

"Being a public company will either impose significant discipline over Robinhood's operations or, failing that, substantial pain," said Howard Fischer, a partner with law firm Moses & Singer and former SEC attorney.

GOVERNANCE

Under the 2002 Sarbanes-Oxley Act and stock exchange listing requirements, Robinhood will have to comply with additional governance requirements.

It must have a majority of independent board directors who will play an active role in overseeing management of the organization's risks and create an audit committee.

That audit committee selects an independent, external auditor and reviews the company's internal and external audit results. Financial reporting controls, cyber security and operational issues are also within its purview.

The rules aim to reduce financial fraud by ensuring company principals are aware of all of the organization's risks.

For brokerages, lawyers say the key type of risk is counterparty risk: the probability that the other party in a transaction may default on the contractual obligations.

Robinhood will also have to create an independent compensation committee to assess and report on reasonable and sustainable pay, especially for senior executives, lawyers said.

INTERNAL CONTROLS

These include a slew of mechanisms, rules and processes to ensure the integrity of accounting information and prevent internal employee fraud or embezzlement, in addition to ensuring a company complies with laws and regulations.

Boards must assess and respond to potential financial or accounting threats in the first instance before investors and regulators are informed, said lawyers.

"As its financial businesses grow in complexity, it gets harder and harder for investors to understand what the risks are," said Ridgway Barker, partner at law firm Withersworldwide.

"Internal controls and disclosure requirements will force a better assessment for the specific and general types of risks Robinhood might face."

A Robinhood spokesperson declined to comment.

(Reporting by Katanga Johnson in WashingtonEditing by Michelle Price, Steve Orlofsky and Jonathan Oatis)