The Robinhood app was founded in 2013, promising no fee online stock trading to any consumer who downloads the mobile app. The company now boasts 13 million users in its most recent reports, primarily young millennials hoping to make quick money off commission free investing.
When COVID hit in March, many first time traders flocked to online brokerages, like Robinhood, TD Ameritrade, and E*Trade Financial. Facing financial hardship, people hoped to take advantage of stock market swings and the ease of trading from their very own smartphone. Robinhood’s order numbers far outpaced competitors in online brokerage in August at $180.1 million.
But consumers should beware. Robinhood’s business model pivots on selling consumer orders to High Frequency Traders (HFTs). This means that users trade against complex and sophisticated algorithms leveraged by HFTs. Robinhood’s business model also makes use of margin lending which is notoriously toxic for consumers, who are incentivized to borrow money to invest.
In September, the Securities and Exchange Commission opened a probe into Robinhood for failing to disclose its business model to consumers. This isn’t Robinhood’s first consumer protection circus. In December 2019, FINRA fined Robinhood $1.25 million for failing to ensure best prices for orders. In July 2019, two thousand Robinhood market accounts were hacked, followed by a system wide outage in March 2020. Robinhood’s failures to treat its users fairly have real consequences not only on wallets but on wellbeing. In June 2020, Alex Kearns, a university student in Nebraska, committed suicide after Robinhood showed a negative balance of $730,000.00 in his account. The negative balance later turned out to be a glitch in Robinhood’s system.
The SEC probe is a good first step to protecting consumers, because it would ensure that Robinhood and other e-trading companies become transparent in their business models. However, it is not a long term fix, and Robinhood could settle for $10 million and walk away without disclosing any of its business practices.
In addition to ensuring transparency, the issue demands concrete regulation of HFTs. Trading in milliseconds, the algorithms can analyze rival trades and use high trade speeds to undercut them. HFTs have also historically participated in fraudulent spoofing, which is highly illegal under Dodd-Frank but hard to prove with HFTs. Beyond that, unreliability of HFTs can lead to crashes, dislocations, and distortions in the market when something goes wrong with the algorithms. Potential regulations on HFTs that other countries have used and the U.S. should explore include circuit breakers and requiring firms to tag algorithms.
Sources:
Learn More