Just two days after Charlie Munger of Berkshire Hathaway called Robinhood “a gambling parlor,” the free-trading app said it derives a majority of its revenue from options trading.
The comments from Warren Buffett’s right-hand man came in an interview with CNBC on Tuesday night, in which the billionaire investor said, “it’s telling people they aren’t paying commissions when the commissions are simply disguised in the trading.”
On Thursday, Robinhood filed its S-1 with the SEC, a necessary step the company has to take prior to going public. The document revealed the underlying drivers of Robinhood’s business, from options, equities, and crypto trading, to securities lending and payment for order flow.
In 2020, Robinhood generated $720 million in revenue, of which 61%, or $440 million, was derived from options trading. Robinhood’s options trading revenue grew 298% in 2020, relative to 2019, as the pandemic and government stimulus checks led to a boom in stock market trading by retail investors.
Options trading is often viewed as a much riskier form of trading relative to stock trading, as it gives investors leverage to increase their exposure to short-term or long-term moves in the stock market.
While less risky option trading strategies exist, like selling covered calls on an underlying stock holding, a bulk of the options trading among Reddit “YOLO” investors tends to be buying directional put or call options with short-term expiration dates. Unless timed properly, these types of options trades can lead to a loss of nearly all invested capital.
“[Robinhood is] a gambling parlor masquerading as a respectable business,” Munger said.
Robinhood probably disagrees with Munger. In the company’s S-1 filing, it laid out how it’s democratized stock market investing for 18 million users through $0 trading commissions, an easy-to-use app, and education initiatives.
The company said more than 50% of its customers say they are first-time investors.
A customer named Angelina was quoted in Robinhood’s S-1 as saying, “The investor in my head was someone who wore a suit and a tie. Robinhood changed that for me.”
The online brokerage platform Robinhood launched nearly a decade ago but has gained popularity more recently. The app and web interface allow users to buy, sell, trade, and invest in stocks and other investments (like cryptocurrency) without paying commission fees.
According to Douglas Boneparth, certified financial planner and president of investment advising company Bone Fide Wealth, Robinhood is “geared toward the next generation of investors.”
Related Article Module: Robinhood review: Avoid trading commissions and purchase specialty investments such as cryptocurrencies
Robinhood’s rise has been rocky, leading many to wonder whether it’s safe to use.
The short answer? “Trade at your own risk,” Boneparth said.
Is Robinhood safe? Mostly
When setting up an account with Robinhood, users give their personal information, like their age, net worth, income, and social security number. According to Nickolas Sanchez, a certified financial planner at Financial Architects, this is an entirely normal process to trade stocks under SEC guidelines.
“This isn’t a Robinhood-specific requirement,” he said. “If you want to invest, even at the most reputable firms, you are going to have to give underlying personal information.”
The Securities and Exchange Commission requires these details to avoid fraud and especially risky investments. And just like any other brokerage firm, Robinhood must abide by the fair practice regulations set by the SEC, including providing proof of fair dealings. Otherwise, they face being hit with fines or civil lawsuits.
Additionally, Robinhood is a member of the Securities Investor Protection Corporation, which offers financial protection if a brokerage firm were to fail. The SIPC can replace up to $500,000 for both securities and cash, including a $250,000 limit for cash only, in missing customer property.
So if Robinhood went bankrupt, as an investor on that brokerage platform, your funds could be transferred to another brokerage firm or refunded to you. However, investments in cryptocurrency are not protected by either the SIPC or Robinhood.
Finally, Robinhood ensures its users that their passwords and “sensitive details” are encrypted. Once you verify your banking information, Robinhood states it will “never access them again.” The app also offers two-factor authentication via SMS text message and third-party authentication apps for additional security protection.
The risks of using Robinhood to buy, sell, and trade stocks
Anyone can sign up and create a trading account with Robinhood within minutes, without any real training on the stock market or educational resources on how investing works. That, according to Boneparth, may be a disservice to its users.
The financial expert pointed to the case of 20-year-old Alexander Kearns, who died by suicide after thinking he lost $730,000 on Robinhood.
“Sure, Robinhood will tell you if you go to their website they have blogs and articles about investing, but that’s no different than any other brokerage,” Boneparth said. “At the end of the day, Robinhood is a business. They don’t have a fiduciary obligation to their clients. They facilitate a service.”
He added that there are no risks specifically inherent to Robinhood’s platform, but advises his clients to bounce investment ideas off their personal investment advisor.
Sanchez agrees, telling Insider that the minimalistic design of the app, coupled with the commission-free trading feature, may “incentivize a lot of activity,” which could pose a potential risk to one’s portfolio.
“One school of thought is that the best approach to investing – and there’s really no right answer – is to buy and hold stocks in quality companies that you believe in, that you trust, and that you use.”
In short, don’t get caught up by the allure of free trading. Treat Robinhood like any other broker, and be careful with how you spend your money.
Trading app Robinhood said 9.5 million customers traded cryptocurrency during the first quarter of 2021, soaring from 1.7 million crypto traders on the platform in the last quarter of 2020.
Robinhood shared the figure in a blog post on Thursday in which it highlighted its Robinhood Crypto platform that it launched in 2018. “This year in particular has been a big one,” it said about activity in 2021.
There’s been a pickup this year in the number of financial institutions and other companies saying they will allow their customers to use or to gain access to cryptocurrencies and the blockchain technology that backs them. Investment bank Goldman Sachs is looking into ways to support their clients’ desire to own cryptocurrencies and other digital assets, CEO David Solomon said Tuesday in a CNBC “Squawk Box” interview. Tesla’s CEO Elon Musk last month said the electric vehicle maker will accept bitcoin as payment.
Robinhood said its customers have access to seven tradable coins including bitcoin, dogecoin and ethereum.
“The prospect of an open and decentralized global financial system, one where everyone can have access to financial services, strongly aligned with Robinhood’s mission–so democratizing cryptocurrency trading felt like a natural next step,” said Robinhood.
Robinhood Markets CEO Vlad Tenev defended the mission of his trading platform, which seeks to “democratize finance for all” amid backlash from lawmakers, regulators, and Wall Street firms blaming the mobile app for luring inexperienced investors and “gamifying” the stock market.
“Investing should be as ubiquitous as shopping online,” Tenev told Bloomberg. “It should just be something that people do.”
The Menlo Park, California-based company has faced scrutiny for its role at the center of the GameStop frenzy in January. This includes complaints that the mobile app used “aggressive” tactics to lure young and inexperienced investors with commission-free trades.
A five-hour congressional hearing in front of the House Financial Services Committee was held on February 18, scrutinizing the role the company played.
“This is what I signed up for,” Tenev said. “Any time you’re causing change in society and kind of upending the status quo, it’s probably not going to be the most comfortable process.”
The 34-year-old founder also rebuffed comments from various experts on the addictive nature of trading apps like Robinhood. The app has attracted over 13 million users since 2013, many of whom are younger retail traders.
“I reject the idea that investing in the US capital markets is gambling,” Tenev said. “We’d be happy to have the conversation, but of course we understand that investing is a serious thing.”
“The facts will come out and it will bear out that Robinhood is a customer-focused company that’s operating with the highest standards of integrity,” Tenev said.
In the February hearing, Tenev maintained that Robinhood has created opportunities for a new generation of investors. The CEO told lawmakers that the assets of his platform’s users have collectively grown by more than $35 billion, a claim challenged by some, including Rep. Jim Himes.
Robinhood is drawing down lines of credit to the tune of “at least several hundred million dollars,” Bloomberg reported Thursday.
The quick decision to seek additional funds from its lenders, which include JPMorgan Chase and Goldman Sachs, suggest that this week’s trading frenzy has put a strain on the company, according to Bloomberg’s Matthew Monks and Michelle Davis.
Robinhood did not respond to a request for comment on this story.
The trading app is popular among the online community r/WallStreetBets, a group of mostly retail investors who sparked massive market swings by targeting short sellers’ positions in companies including GameStop, AMC Theaters, and Nokia.
In an email to users, Robinhood attributed the company’s decision to restrict trading to having to comply with financial requirements including SEC net capital obligations and clearinghouse deposits, that it said protected investors and the stock market.
One Robinhood user in Massachusetts made an eye-popping 12,748 trades since February, according to the state’s complaint, which alleges the popular investing app encouraged inexperienced investors to execute trades frequently.
The complaint against Robinhood was filed on Wednesday and also detailed how the brokerage firm popular among younger investors failed to supervise the review and approval of options tradings, leading to many inexperienced traders dabbling in more complex investments.
In an e-mailed statement, Robinhood said, “We disagree with the allegations in the complaint by the Massachusetts Securities Division and intend to defend the company vigorously.”
Robinhood’s rapid growth and lack of internal controls facilitated an environment where inexperienced investors would trade stocks and options incessantly, nearly 100 times per day on average in one case, the state of Massachusetts said in a complaint filed on Wednesday.
The complaint is separate from a settlement with the Securities and Exchange Commission announced on Thursday that resulted in Robinhood paying $65 million to settle charges of misleading clients on the quality of its trading service.
According to Massachusetts, Robinhood successfully encouraged inexperienced investors to execute trades frequently on its platform by utilizing gamification techniques.
“During the relevant time period, at least 241 Robinhood customers with no investment experience averaged at least 5 trades per day on Robinhood’s platform,” the complaint said.
An average of five trades per day is peanuts relative to 25 Massachusetts Robinhood customers detailed in the complaint.
“Robinhood experienced as many as seventy outages or disruptions on its trading platform from January 1, 2020 through November 30, 2020 as a result of its failures,” the complaint said. At least seven of those disruptions impacted the ability of Robinhood customers to access their accounts to buy or sell securities.
Four more allegations against Robinhood listed in the complaint include: advertising to younger individuals with little to no investment experience, providing lists to encourage customers to purchase securities without consideration for suitability, employing a number of strategies to encourage customers to continuously engage with its application, and failing to meet the fiduciary duty it owes its customers.
In an e-mailed statement, Robinhood said:
“We disagree with the allegations in the complaint by the Massachusetts Securities Division and intend to defend the company vigorously. Robinhood is a self-directed broker-dealer and we do not make investment recommendations. Over the past several months, we’ve worked diligently to ensure our systems scale and are available when people need them. We’ve also made significant improvements to our options offering, adding safeguards and enhanced educational materials. Millions of people have made their first investments through Robinhood, and we remain continuously focused on serving them.”
Robinhood is likely hoping for a swift resolution to the complaint as it plans to go public next year at a valuation of more than $20 billion, according to reports.
Robinhood agreed to pay $65 million to settle with the Securities and Exchange Commission over charges that the brokerage misled clients on its revenue from trades and the quality of its service.
The SEC alleged Robinhood made “misleading statements and omissions” about how it made money with market-makers. Robinhood, like other brokerages, sells its orders to high-speed trading firms for execution.
While Robinhood marketed its trades as commission-free and matching or exceeding its peers in quality, the brokerage provided inferior trade prices that cost clients tens of millions of dollars, according to a Thursday SEC press release.
The settlement relates to practices “that do not reflect Robinhood today,” Dan Gallagher, the brokerage’s chief legal officer, said in an emailed statement.
Robinhood agreed to pay $65 million to settle Securities and Exchange Commission charges that allege the discount brokerage misled customers on the quality of its trading service.
The regulator argued Robinhood made “misleading statements and omissions” about how it made money with high-speed trading companies, according to a Thursday press release. Like other brokerages, Robinhood sells its orders to trading firms for execution in a process known as “payment for order flow”.
The SEC’s order alleges the brokerage routinely provided inferior trade prices, even as Robinhood marketed its trades as commission-free and executed with quality that matched or beat peers. The second-rate prices have cost clients a total of $34.1 million even after accounting for the lack of commission fees, according to the SEC.
“Robinhood provided misleading information to customers about the true costs of choosing to trade with the firm,” Stephanie Avakian, director of the SEC’s Enforcement Division, said in a statement. “Brokerage firms cannot mislead customers about order execution quality.”
The settlement ends a probe that examined Robinhood’s omission of order-flow revenue on its website from 2015 to 2018. Robinhood resolved the probe without admitting or denying the SEC’s charges.
The settlement relates to practices “that do not reflect Robinhood today,” Dan Gallagher, the brokerage’s chief legal officer, said in an emailed statement.
“We recognize the responsibility that comes with having helped millions of investors make their first investments, and we’re committed to continuing to evolve Robinhood as we grow to meet our customers’ needs,” he added.
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