The New Yorker May 17, 2021 pp30-41|A Reporter At Large| “The Big Gamble” “Is Robinhood democratizing finance or encouraging risk?” By Sheelah Kolhatkar
Image from Robinhood.com
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Summary provided by 2244
Robinhood (RH) launched in December 2014 essentially with an APP gamifying equity investing. In doing so RH brought many new investors into the market and with fee-less trades, making small purchase possible and offering fractional-share buying eventually led traditional industry providers like Fidelity, Schwab, E-Trade and TD Ameritrade to follow. Now in Q1 2021, valued at $12B, RH had raked in $331,000,000 in PFOF (Payment for order flow) fees alone. During its brief tenure RH has experienced a number of high-profile controversies but is still “adding millions of new users.” One stated goal of RH founders, Vlad Tenev and Baiju Bhatt, was “putting the investing tools used by the wealthy into the hands of nonprofessionals” as a way to “help reduce inequality.”
The biggest and most public RH controversies stem from key root causes.
Customer service-RH customer service initially was solely by email and later when phone-based support was instituted phones were not staffed by certified investment professionals.
Infrastructure-when there was unusual market volume the RH systems couldn’t handle the volume.
Services offered-to what are predominately neophyte investors, includes risky options trading and margin accounts.
PFOF-although used by traditional firms PFOF became a point of controversy for RH. The SEC requires that firms notify traders of the practice and require proof that trades are filled in the most economical way.
Customer service. Regarding customer service one highly reported case involved a 20 year old male trader who in the process of investing $16,000 received a read-out from the APP showing “a negative cash balance of more than” $730,000. Unlike traditional companies, like TD Ameritrade as an example which offer voice customer support with certified investment professionals, the investor seeking to understand the -$730,000 couldn’t reach RH using their customer support option of EMAIL. Instead, he received an EMAIL from RH that “instructed him to deposit $173,612.73 in to his account…” He made two more EMAIL inquiries “begging for clarification.” Getting only “autogenerated responses” he “left the house, biked to a local train crossing, and jumped in front of an oncoming train.” “Later that day, his parents found a note from him: ‘If you’re reading this, I am dead. How was a 20 year old with no income able to get assigned almost a million dollars worth of leverage?’” “He added, ‘The amount of guilt I feel as I commit this is unbearable-I did not want to die.’” Sadly had he successfully reached RH there was a simple explanation. He needed to execute another piece of his option transaction to nearly offset all of the apparent loss.
Infrastructure. Another case, affecting many traders, happened when trading volume of the GameStop stock soared and RH suspended trading in the stock after which many traders experienced substantial loses. In this case blame falls on infrastructure-the inability to manage the trading volume, SEC regulations and insufficient customer support.
Services offered. Trading options have long been the purvey of institutional investors and retail investors supported by certified financial professionals. In its purest use institutional investors, like those supporting large pension funds, work knowledgeably to insure a targeted return for these funds needing to last into perpetuity. They do so by forming a portfolio consisting of a variety of investment positions some of which include holding a stock, holding options to buy more stock for a predetermined return if the stock rises (Call Options) and options to profit even if the stock falls in value (Put Options). Constructing portfolios correctly requires expertise and complex calculations to limit risk of underperforming expectations. In the wrong hands or in market anomalies large losses can be incurred. For this reason, most experts would agree that these option tools don’t really belong in the hands unsupported neophyte investors. The potential of making matters worse, is that RH essentially extends credit to investors making it easy to potentially lose money they don’t have while affording the opportunity to leverage the lent money for large gains as well.
PFOF. PFOF fees could be shared as a line item cost but they are not. So, behind the curtain, these small fees captured by the submitting and processing firms are hidden from view. The upside to trading firms is based on receiving these small transaction fees on a huge volume of trades. Processing firms receive fees from the investment bank selling the security. All the SEC requires is that traders are notified that PFOFs are being used and that customers are “getting the best prices for their trades.” RH and others argue that receiving these fees are offset by investors having transaction-free trades. At least one study disputes this claim, and other feel that RH benefits and the investors benefits are not aligned. The SEC reported that “Robinhood provided inferior trade prices that in aggregate deprived customers of $34.1 million…” RH disputes the claim but paid a fine of $65M for this and other findings in the SEC investigation.
How does the RH APP function?
“The app asks for your name, your phone number, and your level of investment experience….then it directs you to log into your bank account in order to link it. Finally, it asks how much you would like to transfer to Robinhood: a hundred dollars, five hundred dollars, five thousand dollars or a ‘custom amount’. A green bar glows at the bottom, inviting you to click and submit.”