Course:MGMT405 2021W2/Case-2ii

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Robinhood Logotype green.png
Industry Stockbrocker and Crypto Currency
Founded April 18th, 2013
Founders Baiju Bhatt

Vlad Tenev

Website https://robinhood.com/us/en/
Stock Ticker HOOD

Introduction

Robinhood Markets Inc is an online trading platform that is known for allowing commission free trades and was founded in April of 2013. The company was founded by Vladimir Tenev and Baiju Bhatt who had previous experience building trading platforms for financial institutions.[1] The app officially launched in March 2015 under its mission which is reflected in the name Robinhood, they want to give everyone access to the financial markets not just the wealthy. They are a FINRA-regulated broker-dealer (Financial Industry Regulatory Authority), which means they have regulatory body assessing them to ensure that they are adequately protecting investors. The three main streams of revenue for Robinhood are interest earned on customer’s cash balances, selling information to high-frequency traders and margin lending. Robinhood currently has 31 million users and has a substantial waiting list for its cryptocurrency wallet. Robinhood found early success and was extremely popular with Millennials and younger customers due to its ease of use and access before going through a downturn due to system outages and poor customer service.[2]

What Happened

Robinhood went through a large scandal in March of 2020 and was officially fined $57 million in June of 2021 for failures that hurt Robinhood's customers and were also required to pay $13 million in restitution to clients affected.[3] The fine was due in large part to the system outages that occurred in March of 2020 and left their trading system offline. This incident left clients unable to trade equities, stock options, or cryptocurrency during some of the highest volume trading days in the fastest growing market in history. Misleading communication and trading practices were also cited in the fine. Robinhood lacked the proper due diligence when approving customers to place option trades and providing misleading information to customers about trading on the margin. FINRA was the governing body that gave Robinhood the fine as they are responsible for ensuring that the company has the proper regulations in place to adequately protect its investors. As it has become clear that Robinhood failed to follow the regulations, FINRA has fined them and ordered that Robinhood pay $1.3 million in restitution to its customers. FINRA cited a 20-year-old trader who killed himself after the huge losses he racked up on the app during the outages as an example of the damages done by Robinhood.[3]  The announcement of the fine came out just ahead of their IPO which was expected to be the highest profile of the year. The fine was the largest ever imposed by the FINRA. The company was repeatedly accused of operational and regulatory lapses that left customers exposed to huge losses.[3] Robinhood's IPO broke the record for worst-performing out of all 51 American companies that had raised the same amount of money. Due to all the negative publicity the company had received just prior to going public, their stock was set at a low opening price of $38 a share and still had a sharp decline of 8.4% on their opening day.[4]

Robinhood Timeline
April 2013 Robinhood was founded[5]
December 2014 Robinhood is published on the App Store[5]
March 2015 The Robinhood app is officially launched to the public[6]
May 2018 Robinhood has grown exponentially and is now valued at $5.6 Billion[7]
November 2019 Announces its global expansion into the United Kingdom[8]
March 2020 Robinhood experiences system outages that leave their trading system offline during some of the highest volume trading days in market history[3]
June 2021 FINRA hands Robinhood a $57 million fine and requires them to pay $13 million in restitution due to the March 2020 outages[3]

Key Players

The Robinhood trading scandal occurred because of the actions of several key players. However, the key players that team 2ii believes to be the most responsible for the scandal are Robinhood co-founders Baiju Bhatt and Vlad Tenev.

Robinhood Cofounders: Baiju Bhatt and Vlad Tenev

Baiju Bhatt (left), Robinhood cofounder and co-CEO (2013-2020). Now serves as Chief Creative Officer and on the Board of Directors of Robinhood.

Baiju Bhatt and Vlad Tenev co-founded Robinhood trading app in 2013, and were co-CEO’s from 2013-2020[5]. Bhatt and Tenev were co-CEOs at the time when Robinhood investing made the call to restrict individual investors from trading GameStop stock, while still allowing hedge funds to trade as normal.[9] Because of their role in the scandal, the founders were called to a hearing with the US House Financial Services Committee and questioned for over five hours with executives of other key players (such as Reddit and Melvin Capital).[9]

Vlad Tenev, Robinhood cofounder and CEO (2013-present).

Bhatt and Tenev’s decision to freeze the trading of GameStop stock for individual investors, but continuing to allow hedge funds to trade[9], led their company to be accused of purposely manipulating the financial market for the benefit of financial institutions who were not Robinhood’s customers.[10] Under their leadership, the GameStop trading scandal resulted in Robinhood having over 50 lawsuits lodged against them in the 12 months following the scandal.[10] From a corporate governance standpoint, Bhatt and Tenev’s actions show the importance of the role that governing bodies play in ensuring that individual investors are protected. Because there are currently no direct securities regulations that govern the ability for a trading platform to halt trades,[9] Bhatt and Tenev did not face any federal charges for their role in the scandal. However, the fallout of their actions has damaged the trust that individual investors have in the Robinhood platform.

Targeted Hedge Fund: Melvin Capital

Melvin Capital Management LP is a registered investment advisor that was founded in 2014 and managed by the firm's Chief Investment Officer (CIO), Gabriel Plotkin[11]. Melvin Capital is well known in the industry for having a short-bias[12] which is an investment strategy that involves investors “borrowing” stocks, selling those stocks, and then buying them back at a lower price to return to the lender[13]. Running a short-bias strategy relies on the market for that particular stock declining, so that the investors are buying the shares back at a lower price than what they initially sold them for.[14]

Melvin Capital has been running a short-bias strategy against GameStop since 2014,[12] and up until 2020 the hedge fund had generated over 30% in returns by betting against GameStop.[12] In early 2021, a post calling for individual investors to buy stocks of GameStop in order to “bleed the short hedge funds dry”[15] went viral on popular investing subreddit “R/WallStreetBets”.[15] The coordinated actions of thousands of individual investors sent the GameStop stock soaring, and forced hedge funds such as Melvin Capital to continue to buy more shares in order to cover their short position.[15] Because of the short squeeze of the GameStop stock, Melvin Capital recorded losses of almost 55%[16] which amounted to nearly $7 billion dollars in one month.[17] As a result of the immense losses suffered by running their short-biased strategy against GameStop, Melvin Capital has now adjusted their overall strategy to focus on long-run funds only.[12]

Social Media Platform: Reddit

Reddit Inc. is a social media platform that is made up of over a million network communities called “subreddits”.[18] Each subreddit is specific to a certain topic (i.e. NBA, painting, etc.) and the content is moderated by volunteer moderators.[18] Among these subreddits are several related to investing, and have become increasingly popular forums that individuals use to get financial advice.[19]

Reddit played a key role in the Robinhood trading scandal as one of these financial subreddits, called “R/WallStreetBets”, was used by vigilante investors to rally together individual investors to drive up the stock price of GameStop.[20] Although Reddit cannot be faulted for individuals taking advice from their platform, the subreddit “R/WallStreetBets” played a key role in sensationalizing the buying/trading of GameStop stock. By making buying GameStop stock into a viral internet trend, Reddit was ultimately the catalyst that led novice investors to use Robinhood to access the stock market without the proper knowledge or training.

Key Stakeholders and Stakeholder Groups

Customers/Traders

Robinhood's scandal affected a lot of people, especially their small investors. The freeze harmed small traders and favoured the Wall Street establishment. Individual investors were stripped of their ability to trade within the app, while hedge funds and institutional investors could continue to trade as they normally would.[9]

The Financial Industrial Regulatory Authority (FINRA) accused Robinhood of systemic supervisory failures and giving customers false or misleading information. FINRA said that since late 2017, Robinhood failed to exercise due diligence before approving customers to trade options[21]. This false information encouraged traders to take risky options when they should not have, thus, losing their money. The inaccurate information cost customers more than $7 million, FINRA found, and Robinhood is required to pay restitution to affected users.[22]

Alex Kearns

One of multiple stakeholders was Alex Kearns. Alex Kearns died by suicide at 20-years old after seeing a negative account balance of $720,000. Kearns took his own life on June 12, 2020 after mistakenly believing he owed $720,000 and his desperate attempts to get in touch with Robinhood went unanswered, according to his family. The lawsuit accused Robinhood of wrongful death, negligent infliction of emotional stress and unfair business practices. Court filings indicate that a settlement was reached in late May 2021 and the case was permanently dismissed on June 21. [22]

Robinhood executives have previously said they were "devastated" by the tragedy and pointed to efforts made to improve the platform's options trading, educational efforts and customer service. [22]

Lawsuits

Robinhood charged by the SEC for misleading customers

The Securities and Exchange Commission charged Robinhood Financial LLC for misleading statements and omissions in communications to the customer . As per the SEC order, between 2015 and 2018, Robinhood made multiple falsified statements to their customers regarding the information on their FAQ page and the true costs of trading with them[23]. Robinhood claimed that the trades made by customers through them were ‘commission free’. However, in their communications to the customers, they failed to disclose the receipt of payments received from the trading firms in exchange for sending Robinhood customers’ orders to these firms[23]. Due to the nature of the payments received by Robinhood from other trading firms, it set the payment for order flow rates [24] very high which meant that the prices at which the orders were being executed for Robinhood customers were higher than other brokers[23].

Not only did Robinhood fail to communicate this information to their customers they also falsely claimed on their website that their order executions were at a better rate than its direct competitors. This led the SEC to hold Robinhood in contempt for violating the antifraud provision in the Securities Act of 1993 and the recording-keeping provisions of the Securities Exchange Provision of 1934[23]. Without admitting any fault, Robinhood agreed to pay a $65 million civil penalty and contract an independent third party to look over its communication releases to the customers and payment for order flow to ensure that the organization is effectively following its policies[23].

Class-action lawsuit filed against Robinhood by its customer

The customer who filed the class-action lawsuit against Robinhood in New York claimed that the company rigged the market against its customers by barring them from buying shares of GameStop which was promoted by a Reddit group of investors[25]. The claims in lawsuits state that the actions undertaken by Robinhood restrained investors from making potential gains from trading the GameStop stock[25]. Further, the lawsuit also stated that despite the fact that Robinhood knew these actions would benefit financial institutions and investors who were not its customers, it knowingly undertook them which resulted in market manipulation from investors who were not trading through their platform[25].

Robinhood has a customer base of over 22 million verified users and holds over $98 billion in Assets under Custody (AUC)[26]. The lawsuit filed by the customer was not the first time Robinhood faced these accusations, Robinhood has come under scrutiny on multiple occasions where they have experienced a series of platform outages and failures during times of big market swings[10][27]. These instances have led Robinhood to be fined $70 million by the Financial Industry Regulator Author (FINRA) which is overseen by the SEC, and this is the largest fine they have handed out to any organization[3]. FINRA claimed that Robinhood did not meet its obligations and responsibilities to its customers by citing that it allowed 90,000 new accounts to be opened between 2016 and 2018 which signalled a red flag being raised for possible identity theft or fraud[28]. Moreover, another instance cited by FINRA included a Robinhood customer taking his own life due to the misinformation provided by the platform to him. The customer was falsely notified about a negative balance of $720,000 due to a system error that led him to take his life[10].

The fine imposed by FINRA includes a $57 million penalty for Robinhood’s negligence of its responsibilities to its customers and a $13 million compensation for the misled customers[27].

Where is The Company now

New product

Following their error, Robinhood began work on rebranding and reworking their new product.[29] Their new product promised to collaborate closely with regulators and improve marketing materials, including the product's name. Numerous investors, however, continue to criticize Robinhood for the massive losses suffered by investors.[3] Some users believe Robinhood is a "casino" rather than an investment platform. This continues to stain Robinhood's reputation and has made it difficult to re-establish themselves in their market, following their 2020 scandal.

Improvement

Due to public pressure, Robinhood has now added additional support features for its investors the biggest and most successful being a user hotline.[3] Additionally, Robinhood has upgraded its system to minimize future system outages. Robinhood has increased eligibility requirements and outlined additional criteria to ensure that their users understand the more sophisticated option trading and the risks that accompany it. These were implemented to better protect investors after the unfortunate events that lead to Alex Kearns death.[30] With these improvements coming only after this scandal it has some customers wondering what FINRAs requirements were prior to the outages, and how well they are being regulated not only for Robinhood but the entire industry.

Stock

In terms of the stock, the price of Robinhood's stock has fallen by more than 60% since its heyday in early August 2021. [31] Due to the recent governance scandals that Robinhood has been involved in their stock price has sharply declined. Customers have lost faith in the company and have thus taken their business elsewhere which is evidently reflected in Robinhoods stock performance. Robinhood has struggled since their initial public offering (IPO) in July of 2021 which was shortly after FINRA had handed out the fine and restitution rquirements to Robinhood

The public’s opinion

For a time, the review for Robinhood's trading app on the Google Play store was even reduced to one star.[32] System outages and false information were not the only reasons investors expressed dissatisfaction with Robinhood. Refusing to allow users to invest in GameStop without a valid reason enraged investors once more. Numerous users have abandoned Robinhood due to a lack of trust in the platform. Not only did those users abandon the app, but they also left a large amount of negative feedback on the Google Play store. Even after Google removed over 100,000 negative reviews for Robinhood for violating Google's policy, the app's rating remained at 1.1 stars. [33]

The general public is not the only customer base that is unhappy, several prominent figures have publicly criticized Robinhood.[32] For instance, United States Representative Alexandria Ocasio-Cortez believes that the direction in which Robinhood is currently heading is completely unacceptable. Mark Cuban, a billionaire, questioned Robinhood's market manipulation on Twitter. Dave Portnoy, the Barstool blog's founder, responded to one of Robinhood's announcements by claiming that Robinhood is misleading the public. Bill Pulte, a philanthropist, believed Robinhood was using jargon to confuse investors.

Where are The Key Players now

The Robinhood stock price had a significant effect on Vladimir Tenev and Baiju Bhatt.[34] They are no longer billionaires following the initial public offering (IPO), as a result of the stock price decline of Robinhood.

Vladimir Tenev

Mr. Tenev has now admitted that Robinhood is not perfect, but he remains committed to improving the platform in order to protect investors as the company's sole CEO. [3] Additionally, he is attempting to slow the rate at which Robinhood's stock price declines in order to maintain Robinhood as a long-term business.[35] In January 2022, his net worth was estimated to be approximately 850 million.[34] He has also earned money through his other business, Chronos Research.[36]

Baiju Bhatt

Baiju co-founded Robinhood with Vladimir and served as co-CEO until November 2020. He then resigned as chief creative officer and a member of the board.[5] Baiju was named to the Goldhouse 100 most influential Asians list in 2021.[37] Baiju Bhatt's net worth was over 900 million in January 2022.[34]

References

  1. ↑ Touryalai, Halah. "Forget $10 Trades, Meet Robinhood: New Brokerage Targets Millennials With Little Cash". Forbes. Retrieved March 19, 2022.
  2. ↑ "Robinhood Markets". Wikipedia. Retrieved March 18, 2022.
  3. ↑ 3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 Fitzgerald, Maggie. "Robinhood to pay $70 million for outages and misleading customers, the largest-ever FINRA penalty". CNBC. Retrieved March 20, 2022. Cite error: Invalid <ref> tag; name ":0" defined multiple times with different content
  4. ↑ Robitzski, Dan. "SCANDAL-PLAGUED ROBINHOOD SUFFERS WORST IPO IN HISTORY". The Byte. Retrieved March 20, 2022.
  5. ↑ 5.0 5.1 5.2 5.3 Constine, Josh. "Robinhood Raises $13M To Democratize Stock Market With Zero-Commission Trading App". Tech Crunch. Retrieved March 21, 2022. Cite error: Invalid <ref> tag; name ":11" defined multiple times with different content
  6. ↑ Long, Heather. "New app offers free trading. Millennials jump in". CNN Business. Retrieved March 21, 2022.
  7. ↑ Lynley, Matthew. "Free stock trading app Robinhood rockets to a $5.6B valuation with new funding round". Tech Crunch. Retrieved March 21, 2022.
  8. ↑ O'Hear, Steve. "Robinhood launches… UK waiting list". Tech Crunch. Retrieved March 21, 2022.
  9. ↑ 9.0 9.1 9.2 9.3 9.4 Gonzalez, Oscar; Priest, David (March 17, 2021). "Robinhood backlash: What you should know about the GameStop stock controversy". Cnet. Retrieved March 17, 2022.
  10. ↑ 10.0 10.1 10.2 10.3 Leonhardt, Megan (February 17, 2021). "Robinhood now faces roughly 50 lawsuits after GameStop trading halt—here's how customers might actually get their day in court". CNBC. Cite error: Invalid <ref> tag; name ":7" defined multiple times with different content
  11. ↑ "Melvin Capital". Melvin Capital. Retrieved March 21, 2022.
  12. ↑ 12.0 12.1 12.2 12.3 Zambonin, Bernard (February 4, 2022). "Betting Against GameStop Stock Ended Terribly Bad For Melvin Capital". TheStreet. Retrieved March 23, 2022.
  13. ↑ Beers, Brian (March 13, 2022). "How an Investor Can Make Money Short Selling Stocks". Investopedia. Retrieved March 23, 2022.
  14. ↑ Downey, Lucas (October 1, 2019). "Dedicated Short Bias". Investopedia. Retrieved March 23, 2022.
  15. ↑ 15.0 15.1 15.2 Adamczyk, Alicia (January 27, 2021). "'You will lose your money very, very quickly': What investors need to know about GameStop's stock surge". CNBC. Retrieved March 24, 2022.
  16. ↑ Porzecanski, Katia; Parmar, Hema; Burton, Katherine (July 8, 2021). "Melvin Struggles to Shake Reddit Attack With 46% Loss So Far". Bloomberg. Retrieved March 24, 2022.
  17. ↑ Chung, Juliet (January 28, 2022). "Hedge Fund Melvin Lost $6.8 Billion in a Month. Winning It Back Is Taking a Lot Longer". The Wall Street Journal. Retrieved March 24, 2022.
  18. ↑ 18.0 18.1 Widman, Jake (July 5, 2021). "What is Reddit?". digitaltrends. Retrieved March 20, 2022.
  19. ↑ Nova, Annie (February 1, 2021). "Getting your financial advice from TikTok and Reddit? That could backfire". CNBC. Retrieved March 20, 2022.
  20. ↑ Stewart, Emily (January 29, 2021). "The GameStop stock frenzy, explained". Vox. Retrieved March 20, 2022.
  21. ↑ Egan, Matt (July, 2021). "Robinhood settles lawsuit over 20-year-old trader who died by suicide". abc7news. Check date values in: |date= (help)
  22. ↑ 22.0 22.1 22.2 Adamczyk, Alicia (June, 2021). "Robinhood to pay $70 million fine after causing 'widespread and significant harm' to customers". CNBC. Check date values in: |date= (help)
  23. ↑ 23.0 23.1 23.2 23.3 23.4 "SEC Charges Robinhood Financial With Misleading Customers About Revenue Sources and Failing to Satisfy Duty of Best Execution". U.S. Securities and Exchange Commission.
  24. ↑ Carey, Theresa. "Payment for Order Flow (PFOF)". Investopedia.
  25. ↑ 25.0 25.1 25.2 Alonso III, Fernando. "Class-action lawsuit filed against Robinhood following outrage over GameStop stock restriction". CNN Business.
  26. ↑ "Robinhood Reports Fourth Quarter and Full Year 2021 Results". Robinhood.
  27. ↑ 27.0 27.1 Michaels, Dave. "Robinhood Agrees to Pay $70 Million to Settle Regulatory Investigation". The Wall Street Journal.
  28. ↑ Merced, Michael; Griffith, Erin. "Robinhood is fined $70 million over misleading customers and system outages". The New York Times.
  29. ↑ Maclay, Kyle (December 1, 2021). "Is Robinhood Safe?". Wall Street Survivor.
  30. ↑ Rooney, Kate. "Robinhood increases guardrails on options trading in the wake of a customer suicide". CNBC. Retrieved March 21, 2022.
  31. ↑ "Robinhood Markets Inc". Google Finance.
  32. ↑ 32.0 32.1 Gilbert, Ben; Akhtar, Allana (January 28, 2021). "Robinhood users are revolting against the trading app after it stopped trades of GameStop". Business Insider.
  33. ↑ Klar, Rebecca (January 29, 2021). "Google deletes negative reviews of Robinhood app". The Hill.
  34. ↑ 34.0 34.1 34.2 Klebnikov, Sergei (January 29, 2022). "Robinhood's Struggles Continue: Its Cofounders Are No Longer Billionaires, Shares Down 60% Since IPO". Forbes.
  35. ↑ Clifford, Tyler (July 29, 2021). "Robinhood CEO Vlad Tenev on stock's first-day decline: 'I'm used to being doubted'". CNBC.
  36. ↑ "Vladimir Tenev". Popular bio. January 12, 2022.
  37. ↑ Tangcay, Jazz (May 3, 2021). "Kamala Harris, Chloé Zhao, Blackpink Among Gold House's 100 Most Impactful Asians". Variety.
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