Robin Hood, the prince of thieves. He was supposed to be one of the good guys. As the story goes, he stole from the rich and gave to the poor. The tale was the obvious inspiration for the financial services company Robinhood, which has opened the world of financial investment to the masses.
If we're being honest, ethics are rarely the driver of financial services companies, where profits and dividends are king, but for Robinhood it was supposed to be different.
With its Investing for Everyone tagline and an app designed for quick and simple trading, Robinhood has quickly attracted millions of millennial investors that would otherwise be put off by red tape and jargon, with the promise of commission-free trading.
The application is presented as a 'pioneer of commission-free investing' that 'gives you more ways to make your money work harder'. It is well designed and easy to use. Its lack of fees, its mission and its presentation mean that even the most sceptical would be forgiven for thinking that the application was on their side, working with them to bring down Wall Street and avoid the traps of what is, in reality, a very technical and highly skilled industry.
Unfortunately, and perhaps unsurprisingly, this is not the case. It has instead come to light that the end users of Robinhood are not its customers, but its product. Market makers like Citadel Securities and Virtu Financial are not only performing trades for Robinhood, but working closely with the company to farm the data of its users. Of course, they are paying for the privilege.
This order flow payment model – whereby Robinhood sells the accumulated trading histories of retail clients to earn a substantial amount of its revenue in lieu of commissions – is key to the company's revenue. It goes without saying that these market makers can use and exploit this data to learn the buying patterns of a host of new investors. On top of that, the trades are executed in dark pools, which lack transparency and regulatory oversight.
If your business is data-farming, then people are your produce. Happily for Robinhood, the Covid-19 pandemic has caused a swell in the app's user base as employed millennials with more time and expendable income on their hands strive to become the next Warren Buffett, one TSLA at a time. During this period, Robinhood has comfortably overtaken its rivals in trading activity.
In August, the company released daily average revenue trades (DARTs) data for the first time. In June alone, the platform saw 4.31 million DARTs, and in Q2 registered more than twice the number of Q1. It has also surfaced that market makers are in fact prepared to pay more to Robinhood than other similar traders to service equity trades. Access to the unsophisticated millennial investor is obviously valuable.
In Q2, Robinhood made more than $180 million from order payments, of which $111 million were in options trades. In a highly publicised case in June, Alex Kearns, a 20-year-old Robinhood customer, died by suicide after incorrectly thinking he had lost $730,000 from trading options. Kearns reportedly left a note to blame the company for allowing him too much access to risk. After this, the company introduced new restrictions for options trading, but on the whole the application remains as user-friendly as ever.
A recent TV advert for Robinhood shows a young day trader on a bus performing a trade on the application. "Now is the time to stop waiting and start doing money – wherever you are. We're empowering the next generation of investors to take charge of their financial futures with an app that’s changing the way we do money," reads the copy. This is nothing short of gamification: the company has created an addictive experience for a practice that should be taken incredibly seriously.
It is not especially controversial to say that allowing unsophisticated retail investors 24/7 access to complex equity and option trading in a manner that simulates a computer game, while offering little in the way of education about the downsides, should be legally restricted.
Although the Securities and Exchange Commission (SEC), the regulator responsible for the majority of the capital markets in the US, has probed the company, it has not done enough. The Commission has a number of stringent rules and regulations in place specifically designed for ensuring that retail investors – who are largely unsophisticated – are not adversely affected by the products that multinational financial services companies offer. It appears that Robinhood has been largely unimpacted by these.
Considering the ease at which a 20-year old Alex Kearns was able to get into a position where he thought (albeitly incorrectly) that he was three quarters of a million dollars in the hole suggests that these rules do not go far enough. The SEC proposed improvements to the retail investor experience through modernised fund shareholder reports and disclosures in August, but it does not go far enough.
Gamification of equity and option trading that is designed to influence unsophisticated investors, where the data of these investors is subsequently sold to market makers at an inflated price, is essentially gambling, and should be prevented by regulators immediately.
In September, the SEC announced the launch of a civil fraud investigation into Robinhood's failure to fully disclose its practice of selling clients’ orders to high-speed trading firms. The punishment will likely be in the region of $10 million, but even if convicted, the company will be allowed to continue trading in much the same way.
Robinhood was recently valued at $11 billion. That money has, arguably, come at the expense of ordinary people – and that's not ok.