Robinhood Markets’ emergency ban to trade eight stocks this week caused anger across the political spectrum, quickly caught the attention of the state and federal government, and sent furious customers into the arms of competitors.
That was Thursday. Friday afternoon, it restricted stock purchases in 23 companies. Soon it was about 50.
A drama that started with an idiosyncratic leap into it The shares of GameStop Corp. This month has turned into an outright rebellion of private investors against the Wall Street status quo, leaving Robinhood, long their beloved brokerage, caught between clients and the cold demands of the gatekeepers of finance. Growing tensions on the company forced it into more than $ 1 billion in fresh capital and hundreds of millions more in loans.
The startup, which set out to “democratize finances for all,” is now in the awkward position of telling customers they can’t buy what they want. An online job posting provides some indication of the complexities facing the Silicon Valley company, with Robinhood looking for a federal lobbyist.
“Obviously, this is not a good position for a brokerage firm,” said James Angel, an associate professor at Georgetown University. “No company wants to reject customers who want to use their service. I would be shocked if that took a very long time. “
In a blog post Friday night, the company described the restrictions as necessary and temporary.
“It wasn’t because we wanted to prevent people from buying these stocks,” Robinhood said of his decision to impose limits. “Our goal is to enable purchase of all securities on our platform. This is a dynamic, volatile market and we have and will continue to take action to ensure that we meet our requirements as a broker so that we can continue to serve our clients over the long term. “
A company spokeswoman declined to comment outside of the blog post.
‘Trade and confetti’
At the heart of all the controversy is Robinhood’s highly polished app, which has lured millions of investors with an experience that seemed to defy the usual Wall Street physics. With a focus on immediacy, the company lets newbies start trading as soon as they set up a bank transfer. It gives them a free share for signing up. And then there is the smallest appeal of all: no transaction fees.
It’s no wonder Robinhood has created legions of fans who expect to buy stocks, options, and even cryptocurrencies with little sense of guardrails. But this week, that culture hit reality. Wall Street trading is a strictly regulated business that can require brokers to have mountains of cash available.
After Robinhood’s clients argued with hedge funds by sending shares of GameStop and other downed companies into the stratosphere, the market’s central clearing hub required the company to deposit much more collateral to mitigate the risk of such volatility to the system. In his blog post, Robinhood said that the deposits it had to make on stocks increased tenfold during the week.
Read a QuickTake: How a Collateral Call Brought a Break in the GameStop Mania
That meant Robinhood needed more money. And to keep its burden from growing, the company – like some others – began to restrict certain transactions. Initially, it prohibited purchases of some of the most volatile stocks. Although it allowed them in limited quantities later on, the list of tickers grew. Starting Friday evening, customers hoping to buy GameStop received one share.
“What Robinhood promised was free trade and confetti when you trade,” said Georgetown’s Angel, who specializes in market structure. But the rules of the financial system apply everywhere. Any investors considering leaving Robinhood to continue the crusade they started there, “will find at the end of the day that most other brokers are much the same.”
(Angel humbly noted that he posted a minor flaw on GameStop mid-week to see the price double.)
‘Growing pains’
Founded in 2013, Robinhood has courted long-ignored small and budding investors with innovations, including the promise of zero commission. For example, it offered fractional shares to people who cannot afford to pay about $ 800 for a share of Tesla Inc. buy just a piece of one instead. Those features became industry standard: free trading is the norm, and Charles Schwab Corp. and Fidelity Investments also allows customers to purchase “slices” in stock.
When the coronavirus pandemic broke out last year, private investors poured into the market, looking to spend extra money and time during lockdowns. Robinhood’s customer base grew to more than 13 million. Even during this week’s turbulence, the app has dominated the download rankings. But at times its popularity has surpassed the expansion of its business.
The company suffered repeated outages when the coronavirus pandemic erupted in the US last year, sending the markets into a tailspin. Later in the year, when hackers approached thousands of accounts, panicked users found the company didn’t have a customer service phone number.
Financial technology disruptors need to learn the intricacies of Wall Street’s mechanics and compliance systems faster, said Jim Toes, head of the Security Traders Association.
“We need to find a way to make those growing pains occur in a much shorter period of time,” Toes said in an interview Friday. “There are many fintech companies entering our market where the in-house expertise is more related to technology.”
Campaign of customers
In recent months, Robinhood has sought legal assistance by recruiting attorneys from Goldman Sachs Group Inc., Wells Fargo & Co., Schwab’s TD Ameritrade, and WilmerHale, a law firm known for its expertise in securities law.
But this week’s rush on cash contrasted with earlier snapshots of the company’s financial health.
Robinhood’s subsidiary that handles the trade reported adequate capital by mid-year Financial Statements. At the end of June, the broker-dealer unit had 14 times the minimum level required by the Securities and Exchange Commission rules for capital relative to what trading clients owe. That level surpassed that of larger competitors. For example, Charles Schwab’s TD Ameritrade trading unit had six times the SEC minimum on September 30.
A few months ago, groups of enthusiasts on Reddit began laying the groundwork for the frenzy that engulfed Robinhood this week. In online postings, they identified favorite hedge fund short positions, ultimately triggering a suppression by bidding on GameStop and AMC Entertainment Holdings Inc. to inflict billions of dollars in losses on money managers.
Read a QuickTake: How Flows Before Pros Distort Stock Markets
The extent to which traders relied on Robinhood to execute their strategy can be seen in data from Atom Finance, an investment researcher who connects to its users’ securities accounts.
Just over half of Atom’s users who traded with Robinhood on Wednesday were active in the volatile stocks that restricted the brokerage a day later. About 17% of users have adjusted bets on GameStop and 25% on AMC.
DTCCs requirements
But the stock movements had different consequences. Thursday around 10am Depository Trust & Clearing Corp. demanded significantly more collateral from affiliated brokers, prompting Robinhood and rivals to slow down certain transactions. At the end of the day, industry-wide collateral requirements have risen from $ 26 billion to $ 33.5 billion – an already elevated level.
Robinhood pulled at least several hundred million dollars from bank credit lines, a person with knowledge of the situation that day said. And several of its venture investors participated in a funding round. Robinhood has said it has raised more than $ 1 billion, which it called “a strong sign of investor confidence that will help us continue to serve our customers.”
The company plans to go public this year. This week’s fundraiser, structured as a convertible bond, was priced at a reduced percentage from the upcoming IPO, according to people familiar with the matter, who asked not to be identified because the information was private.
Index Ventures, Ribbit Capital and Sequoia Capital was among the venture investors involved in the effort, the people said. The final size of the funding is still being determined, one of the people said.
‘Rapidly changing priorities’
While Robinhood is trying to keep its finances up to scratch, customers are enraged.
At least There have been 18 lawsuits against the company in California, Connecticut, Florida, Illinois, New Jersey, Oregon, Pennsylvania, and Texas, most of which allege trade limits amounted to breach of contract.
Robinhood was also one of several entities that issued a civil investigation by Texas Attorney General Ken Paxton over this week’s investor restrictions. New York Attorney General Letitia James said she is reviewing the brokerage’s actions. The SEC said it is also investigating brokers’ decisions to limit buying.
“There is a lot of misinformation as to why Robinhood did this,” Vlad Tenev, Robinhood’s Chief Executive Officer, told Bloomberg Television in a statement. interview this week. “We did it primarily to protect the company and our customers.”
Robinhood’s vacancy for a lobbyist underscores the work involved in resolving cases with those customers and authorities.
“We are looking for a very flexible and collaborative person,” the ad read. Someone “who can deal flexibly and patiently with ambiguity and rapidly changing priorities.”
– With the help of Lananh Nguyen, Shahien Nasiripour and Katie Roof