By Pam Martens and Russ Martens: August 5, 2021 ~

NY Stock Exchange Trading Floor-150pixRobinhood is the poster boy for the craziest, most unregulated stock market era since 1929. That one ended in tears. This one will also.

Robinhood is the trading app used by millions of young, inexperienced retail investors to trade stocks and options on their mobile phones. The company went public last Thursday on the Nasdaq stock market (the wonderful folks who brought us the dot.com crash in 2000). Robinhood closed the trading week last Friday with a share price of $35.15 – an embarrassing 7.5 percent below its IPO price of $38. Curiously, so far this week, through Wednesday’s closing price of $70.39, the stock has soared 100.256 percent from Friday’s closing price.

In an efficient, regulated stock market that is capable of engaging in its core function of price discovery, Robinhood would not have doubled in price in three trading sessions. The company lost $1.4 billion in the first quarter of this year and has yet to report its second quarter earnings or even announce the date that it will report those earnings – or lack thereof.

But in this crazy stock market era, earnings are just pesky details. The business media actually reports on how many times a company’s name is mentioned on Reddits’ Wall Street Bets forum. For example, Reuters – an international business wire – reported yesterday that Robinhood “was the most mentioned stock on WallStreetBets, the Reddit platform at the center of this year’s ‘meme stock’ rally, over the past 24 hours, according to sentiment tracker SwaggyStocks.”

After its big runup in price, Robinhood reported after the market closed yesterday that another 97.9 million Class A shares will be sold over time – meaning shareholders who bought in the IPO will be diluted. That sent the price of the stock down about 10 percent in pre-market trading this morning.

Big losses in the first quarter are far from the only negative about Robinhood. On December 17 of last year, the SEC brought charges against the company “for repeated misstatements that failed to disclose the firm’s receipt of payments from trading firms for routing customer orders to them, and with failing to satisfy its duty to seek the best reasonably available terms to execute customer orders.” The company paid a fine of $65 million to settle the SEC charges.

The day before the SEC’s action, the state of Massachusetts brought an enforcement action against Robinhood for “1) aggressive tactics to attract new, often inexperienced, investors; 2) failure to implement policies and procedures reasonably designed to prevent and respond to outages and disruptions on its trading platform; 3) use of strategies such as gamification to encourage and entice continuous and repetitive use of its trading applications; 4) failure to follow its own written supervisory procedures regarding the approval of options trading; and 5) breach of the fiduciary conduct standard required by the Act and Regulations.”

Six months later, Robinhood was back in the crosshairs of regulators. Wall Street’s self-regulator, FINRA, charged the company for causing “widespread and significant harm suffered by customers, including millions of customers who received false or misleading information from the firm, millions of customers affected by the firm’s systems outages in March 2020, and thousands of customers the firm approved to trade options even when it was not appropriate for the customers to do so.” FINRA fined the company $57 million and ordered it to pay $12.6 million in restitution, plus interest, to customers. FINRA previously fined Robinhood $1.25 million in 2019 for failing to provide “best execution” for its customers’ trades.

The negative news about this company does not stop there – by a long shot. On February 18 the House Financial Services Committee hauled Robinhood’s CEO, Vlad Tenev, before a hearing to answer questions about its dodgy business model.

The most revealing part of the hearing was this exchange between Congresswoman Cindy Axne of Iowa and Tenev:

Axne: “Right now, what I’m seeing is gambling in the stock market and that’s not a real solution to income inequality and I don’t think we should pretend that it is.

“Just last June when Hertz declared bankruptcy, after that Robinhood was actively pushing the stock on its site, it was trending on Robinhood, and the promotion of that worthless stock I don’t think is good for investors. That’s a gamble that they shouldn’t have taken. That’s just one example…

“Generally, 99 percent of short-term traders underperform the market. So, Mr. Tenev, you say Robinhood’s mission is to democratize finance. Is that correct?”

Tenev: “That’s correct Congresswoman, yes.”

Axne: “Okay. So I want to ask you then, you’ve invested significantly in behavioral research. And just so you know, I own a digital design firm with my husband so I’m familiar with what behavioral research can do for platforms and websites. That behavioral research has really shaped how your app is designed, is that correct?”

Tenev: “Congresswoman, like many technology companies we employ data scientists, user researchers, and designers to provide a better customer experience.”

Axne: “So on the specifics, when people sign up they get a scratch-off ticket to see what they get; confetti falls every time they place an order; they get push notifications; they’re encouraged to trade; if a friend signs up they get a free stock. On and on. Why have you added specific gaming design elements to look like gambling to your app that encourages more frequent trading?”

Tenev: “Congresswoman, as I mentioned earlier, we want to get people what they want in a responsible, accessible way. We don’t believe in gamification. We know investing is serious and that’s why most of our customers are buy and hold. A very small percentage of our customers utilize margin.”

Axne: “I appreciate that but you know, folks like my nephew actually aren’t your customer. They’re your product. Your customer is sitting right next to you, Mr. Griffin with Citadel.”

Billionaire Ken Griffin’s Citadel Securities is a so-called internalizer or market-maker. It pays Robinhood to send its retail orders to it to execute the trades, thus allowing Robinhood to offer commission-free trading on its trading app. While Robinhood has payment-for-order-flow agreements with other internalizers, the bulk of its trade orders are going to Citadel Securities. The vast majority of Robinhood’s revenue stream comes from this payment-for-order flow. Thus, its priority would appear to be to please its true customer, Citadel Securities.

The rationale behind the idea that the young people placing trades on Robinhood’s mobile phone app are “the product” that Robinhood is selling to Citadel Securities is that Wall Street has long viewed retail orders as the “dumb money” it wants to trade against. That’s because the retail investor is typically unaware that they are trading in the dark market offered by internalizers rather than on a lit market like the New York Stock Exchange, where bids and offers on stocks are publicly displayed.

CNBC has this statement appearing under a news article about Robinhood: “Robinhood is a five-time CNBC Disruptor 50 company and topped this year’s list.”

We agree that Robinhood is disrupting markets – but it certainly is not in a good way. A frequent commentator on CNBC, Steve Weiss, summed up his feelings about Robinhood on CNBC last Thursday:

“They’re not disruptors. They’re going into a business and they’re offering prices which are free, which many, many others are doing. So I don’t think they’re a disruptor. Number two – they haven’t democratized investing. That’s been democratized a long, long time ago. And they’re talking out of two sides of their mouth. Cause they are gonna own – I believe – about 16 percent of the company but control over 60 percent of the vote. So let’s go where their intentions are – which is not one shareholder, one vote. That’s really poor governance.”

Update: This article has been updated to add the word “Securities” after the word “Citadel” in the fifth paragraph from the bottom, second sentence.