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Robinhood: The $30 Billion Cockroach Of Fintech

OBSERVATIONS FROM THE FINTECH SNARK TANK

On successive days last week, digital brokerage Robinhood: 1) was hit with a $70 million fine by FINRA for outages and misleading customers, and 2) announced it was going public.

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This led many people to wonder why the company would announce its IPO the day after it was fined. The answer is simple:

On any day that Robinhood chooses to announce an IPO, there is a probability far greater than zero that it will be fined.

Robinhood is on track to get fined more times than Major League Baseball manager Bobby Cox was ejected from a baseball game.1

Fining Robinhood has about as much impact on the company as spraying pesticides has on cockroaches (that is, it has no effect at all).

The FINRA Fine

FINRA (the Financial Industry Regulatory Authority) charged Robinhood with “systemic supervisory failures and significant harm suffered by millions of customers.” The brokerage is alleged to have:

  • Displayed “significantly” inaccurate cash balances. For example, Robinhood displayed negative cash balances that were twice as large as they actually were.
  • Provided false information to customers about the risks associated with options trading. Robinhood told customers they would “never lose more than the premium paid to enter a debit spread” when in reality many customers did lose much more than that.
  • Issued erroneous margin calls and warnings. Robinhood told customers they were in danger of a margin call when in reality they weren’t.

Legal Issues From The GameStop Debacle

The FINRA fine isn’t Robinhood’s only legal trouble. Since the GameStop debacle earlier this year, nearly 90 lawsuits have been filed against the brokerage.

The most high-profile case, Nelson v. Robinhood Financial, LLC, alleges breach of contract and breach of fiduciary duty for halting trading unfairly and causing massive losses for users.

Useless pesticide. According to an article in the Minnesota Law Review:

“Robinhood will not be held accountable because the lawsuits are almost certain to fail as a matter of law. Robinhood’s fiduciary duties to its customers are highly limited; courts have determined that stockbrokers generally do not owe a fiduciary duty unless a customer has delegated discretionary trading authority to them. Moreover, Robinhood requires users to sign a user agreement that (1) requires users to go to arbitration before instituting a lawsuit; and (2) provides that Robinhood may, in its sole discretion, prohibit or restrict trades without prior notice.”

Cockroaches Are Indestructible—And So Is Robinhood

Fines and legal action won’t slow Robinhood down for two reasons: 1) the big money behind Robinhood, and 2) the willingly-clueless customers doing business with the brokerage.

Robinhood has raised a total of $5.6B over 23 funding rounds. The most recent round was a $2.4 billion injection from Ribbit Capital, which should cover the penalties Robinhood will likely have to pay over the next few years (if history is any guide).

In addition to Ribbit, other well-known investors in the brokerage include ICONIQ Capital, Sequoia Capital, Andreesen Horowitz, and New Enterprise Associates.

With that kind of money invested, by these high-powered venture capital firms, there’s no way a few nuisance fines and lawsuits is going to slow this cockroach down.

Do Robinhood’s Customers Understand Its Business Model?

The other reason Robinhood’s train isn’t slowing down is because many of its customers don’t know—or don’t care—about the company’s fines and business model.

A sample of one is not a great sample size to draw conclusions from, but a conversation between a leading VC and a Robinhood customer raises questions about how well the brokerage’s customers are informed about how the company operates.

Frank Rotman, co-founder of QED Investors shared on Twitter a conversation he had with a friend who used Robinhood as his on-ramp into the trading world. Here’s a snippet of the thread:

Frank: What do you like about Robinhood?

Friend: It’s free and super easy. They don’t make any money on my trades so I can move my money around a lot. I like trying a little of this and a little of that and it works because its free.

Frank: Do you realize they make money by selling your order flow to electronic trading firms? They make a little on stock trades, more on crypto and even more on options.

Friend: First I’ve heard of it. They don’t charge me anything so to me its free.

A recent report from BestEx Research titled The Good, The Bad, And The Ugly About Payment For Order Flow suggests that there is some benefit—in terms of lower order price—from payment from order flow (PFOF) to retail customers.

But the report goes on to demonstrate that the downsides—the bad and the ugly—of PFOF far outweigh the benefit to the average retail investor.

Are Robinhood Users Hypocrites?

Personally, I couldn’t care less how Robinhood makes its money. I’m truly happy for its founders who will become billionaires when the stock goes public at its anticipated $30 billion valuation.

What burns me up, however, is the hypocrisy of its users, predominantly Millennials and Gen Zers. Supposedly, these generations want “authenticity” from the companies they do business with:

Really? Is there any fintech company less “authentic” than Robinhood? Its claim to “democratize finance for all” is total nonsense. As Scott Galloway tweeted:

A recent consumer survey from Cornerstone Advisors asked Robinhood users what impact trading with the brokerage firm had on their financial lives. No surprise, nearly nine in 10 customers said Robinhood made it easier for them to buy and sell stocks.

But only a little more than half (54%) said the digital brokerage helped them become more educated about investing, and just 37% credited the firm with helping them improve the overall return on their investments.

The latter shouldn’t come as a surprise.

Because Robinhood makes money by selling order flow, it will always place the needs and priorities of the companies that pay for that order flow over the needs and wants of its users.

Addressing this problem will be firms I call the “Anti-Robinhoods”—companies like Invstr, Public, and Wizest who may never be valued at $30 billion, but are far more “authentic” than Robinhood will ever be.

The (Near) Downfall of Robinhood

As long as Robinhood remains the “cool” brokerage to trade on, it will continue to attract young investors. But just as social media platforms go in and out of style with young consumers, so will Robinhood.

With $80 billion in assets and 18 million funded accounts, the average account size is roughly $4,444. Not exactly huge accounts.

In fact, according to Cornerstone Advisors’ research, 54% of Robinhood’s Gen Z and Millennial investors keep less than 20% of their total investable assets with the discount brokerage.

As these investors move into their 30s and 40s, will Robinhood still be the cool place to have a brokerage account? Doubtful.

Will increased negative press brought on by “systemic supervisory failures” keep current account holders from putting more of their money with the firm? Possibly.

But with the big money behind the firm, neither factor is likely to kill this cockroach.

1Bobby Cox was ejected 161 times, by the way.



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