Robinhood Markets, the startup broker-dealer that has been attracting multiple times as many new clients as its competitors, has an “unethical” business model, a congressman who has been questioning the company said on Thursday.
Robinhood has made waves this year after signing up more than 3 million new customers and attaining a private-market valuation of $8.6 billion. Robinhood pioneered commission-free trading and has become especially popular with young people. The median age of its more than 13 million users is 31.
Rep. Sean Casten, an Illinois Democrat, spoke to Barron’s about Robinhood after receiving answers to a letter he and five other members of Congress had sent to the company in July, following the suicide of a Robinhood client the previous month. Casten believes Robinhood has encouraged trading on its platform that is too risky for some clients in order to boost the company’s revenue.
In response, the company said it takes seriously its responsibility to help customers make thoughtful, responsible investment decisions.
Casten represents the town of Naperville, Ill., where a 20-year-old named Alex Kearns lived before committing suicide in June. (Another member, Rep. Lauren Underwood, who is also a Democrat, represents the part of Naperville that includes Kearns’s home. She wasn’t available to comment.)
Kearns, a Robinhood customer who had been trading options, wrote in a suicide note that he was distressed by what appeared to be a $730,000 negative balance in his account. He had “no idea what I was doing now in hindsight,” the note said.
The negative balance appears to have been a notification having to do with a portion of an options trade, and did not represent an actual liability, Kearns’s cousin Bill Brewster said in an interview with Barron’s. Robinhood declined to comment on the technical rationale for the notification to Kearns.
Robinhood founders Vladimir Tenev and Baiju Bhatt said in a letter on the Robinhood site that they were “personally devastated” by Kearns’s death and vowed to improve the platform.
In a July 13 letter, Casten and his colleagues asked Tenev and Bhatt about the account-approval process, raising the question “whether these proposed changes will have any meaningful impact on the ways your platform enables and encourages inexperienced investors to engage in high risk trading.”
David Dusseault, the president and COO of Robinhood Financial LLC, a unit of Robinhood Markets, responded to the letter on Aug. 7, explaining the steps the company is taking to improve education and permission levels on the platform. (See the full letter here.)
He also detailed Robinhood’s philosophy, saying the company is looking to expand access to trading in a world where the wealthy benefit disproportionately from stock-market gains. “For decades, by and large, only these wealthy few had access to stockbrokers, had the means to invest the required account minimums, and could afford to pay the high commissions,” he wrote.
Dusseault made a distinction between broker-dealers that offer advice and those such as Robinhood that offer access to trading without providing it.
“Robinhood’s platform allows customers to engage in self-directed investing. In other words, unlike many other broker-dealers, we do not make investment recommendations to our customers,” he wrote. “Certain SEC and FINRA rules, including the SEC’s Regulation Best Interest and FINRA’s suitability requirements, apply only to broker-dealers who make investment recommendations to retail customers.”
The company has already added customer-service representatives to respond to people by email. It is beefing up the eligibility criteria for more complex options trades, and is considering stiffening the financial requirements.
“We have already implemented clarifications to in-app messages and emails, including additional detail to the in-app history page, to help customers understand the mechanics of early assignments on multi-leg options spreads,” Dusseault wrote. “Over the long term, we will be continuously working on changes to our user interface, including enhancements to the way buying power is displayed.”
Users self-certify their experience levels on Robinhood when they apply to trade options, and can be approved in as little as 10 minutes. The self-certification process is not unusual to Robinhood, Micah Hauptman, an attorney at the Consumer Federation of America who does research and advocacy for investor protection, said in an interview.
The underlying rationale for who is approved and who is denied by different brokers can be opaque, Hauptman says. “I can’t gauge the decisions that the different firms are making to approve or deny,” he said.
Hauptman said he hopes that regulators are finding ways to gain more insight about these issues.
Casten said Robinhood’s response to the letter was inadequate and that the company is making money by pushing inexperienced investors into high-risk decisions. To Casten, Kearns’s death is a symptom of a larger problem at Robinhood. The company collects more than half its revenue from payments for order flow, or money that market-makers pay brokers for sending them client orders.
The market-makers profit from the spread between the bid and ask prices of assets. Options trades earn more for the market-makers than equities, because the options market is less liquid, so the bid-ask spread is wider. Robinhood makes more on average from each options trade than from each equities trade.
Robinhood brought in $180 million from payments for order flow from equities and options in the second quarter, double the amount in the first quarter. It was more than the comparable figures at
(ETFC), though less than at
Robinhood’s financial disclosures also don’t include how much it makes from cryptocurrency trading and from market-makers who process less than 5% of its orders, so its total revenue from payment for order flow is likely higher, Piper Sandler analyst Richard Repetto says.
Other brokers tend to get a smaller portion of their revenue from market-makers. Schwab brings in about 2% of its revenue from payment for order flow.
Because Robinhood receives such a large portion of its revenue from the practice, Casten said the company is incentivized to prompt its users to trade more. And because it makes more from options than equities or exchange-traded funds, he thinks the company has a financial incentive to make it easy for newbies—who shouldn’t be trading complex products—to get into options.
Robinhood says that its customers largely become “buy and hold” investors as they spend more time on the platform, as opposed to day-trading aggressively.
“Robinhood’s entire business model is driven by order flow,” Casten said. “They don’t make their money by making you wealthier, they just push the order flow. That’s not technically illegal, but it’s unethical. And the time has come for the SEC and Finra to protect investors like Alex.”
The Securities and Exchange Commission and Finra declined to comment.
“In general their argument is that they are compliant with existing laws and therefore that’s fine,” Casten said of the company. “I’m not going to take an opinion yet of whether they’re compliant with existing laws, but if you just had someone who killed themselves because of your platform and that’s your best answer then shame on you.”
Asked about Casten’s criticism and its claim that the platform is operating unethically, Robinhood said in a statement to Barron’s that it will continue to improve the platform.
“We have a responsibility to provide a reliable platform as well as informational and educational resources that can help our customers make thoughtful and responsible investment decisions,” a Robinhood spokesperson wrote. “We take our responsibilities seriously and continually strive to improve and enhance our customer experience. Over the past several weeks, we’ve implemented changes and enhancements to our options offering and we plan to keep making refinements in areas like eligibility, customer experience, and education. We will keep our customers informed of these changes as they become available on the platform.”
Write to Avi Salzman at [email protected]