The sheriffs are coming for Robinhood and its army of new investors
The sheriffs have started targeting Robinhood, the sharemarket trading app that has revolutionised retail investing in the United States and in the process ignited a debate about its role in the surge in new investors in the market during the pandemic.
Robinhood, which pioneered “no commission” trading, has been credited with leading a retail investor boom that has seen a massive increase in retail participation in the US market.
The app has attracted novice investors with its slick presentation, its email updates and mobile phone alerts, the use of emojis and confetti blasts on completion of trades and the offer of free shares in popular companies for bringing new users to the platform.
While those investors are usually unsophisticated, the investments on offer aren’t. Investors can use leverage, trade derivatives such as call options and can buy fractions of high-denomination shares.
Not surprisingly, given the unfortunate history of “bellhops” – unsophisticated investors – in the market, the regulators in the highly-regulated financial markets are starting to pay close attention.
Last week the US Securities and Exchange Commission fined Robinhood $US65 million ($105 million) after claiming the company had failed to provide investors with the best prices for their trades.
Robinhood doesn’t charge commissions but it sells the trades – the “order flow” – to high-frequency traders. The SEC found it had sent its customers’ transactions to the firms that paid it the most rather than those offering the best prices, costing the customers more than $US34 million.
Robinhood made no admissions of fault and has said the practices the SEC highlighted no longer reflect the way it operates.
Also last week, the Massachusetts securities regulator filed its own complaint, alleging the company was “unscrupulously” pushing unsophisticated investors into risky investments and accusing the company of using “gamification” strategies to encourage traders to trade continuously.
It said two-thirds of the Massachusetts residents who used the app had little or no investment experience and said, despite a policy that prohibited it from allowing inexperienced customers to trade option products, one investor with no trading experience had averaged 92 option trades a day.
There is little dispute that Robinhood has been fulfilling its mission of democratising investment. It has introduced millions of new investors to the market.
The debate in the US is whether those customers are investors or gamers, bored during the pandemic and regarding trading on the stock market as akin to sports betting.
The Robinhood investors (and those using similar services) picked the turning of the market and the uptick in the “value” stocks most impacted by the pandemic earlier than institutional investors.
It is conceivable that they have just been lucky. From their nadir in March, equity markets have soared to record levels in the loosest financial conditions in history.
The absence of alternatives – globally interest rates are at or below zero – has provided a rising floor under an inflated market.
Are Robinhood and its army of new investors a force for good or a ticking time bomb? It’s possible to argue both sides of that debate.
There has been a boom in day-trading, in initial public offerings and in launches of a new generation of a familiar boom-time vehicle, the cash box – a listed vehicle with nothing but cash in it, awaiting an acquisition.
Some of these “special purchase acquisition companies” are trading above their net asset values – their cash holdings – a phenomenon last seen in the lead-up to the 1987 sharemarket crash.
It is, therefore, no wonder that regulators are becoming wary and scrutinising the new portals through which unsophisticated money is pouring into the riskier ends of a frothy market.
Are Robinhood and its army of new investors a force for good or a ticking time bomb? It’s possible to argue both sides of that debate. It has provided access to the market to first-time investors by providing them with a platform and tools that make it easy for novices to trade.
It has also, however, turned investing into something akin to a game, encouraging investors to take risks they probably don’t understand and which, if the market were to turn, could be very destructive.
Robinhood, which is considering an initial public offering of its own, appears aware that it will attract increasing regulatory scrutiny. It has been hiring compliance experts and beefing up the educational material on the app.
As it matures it might tone down some of the glitzier elements of the app and the regulators’ pressure might force it to become cautious about who has access to some of its riskier products.
There is nothing wrong with innovation in financial markets and Robinhood has attracted people who might otherwise have never seen themselves as investors.
Whether that’s an entirely good thing won’t be tested until there is a significant market shake-out which, given the monetary policy settings around the world, might yet be some distance away. In the meantime, closer regulatory scrutiny of these “new age” platforms is desirable.
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