Robinhood paid $70 million to the Financial Industry Regulatory Authority on Wednesday. Robinhood filed for public placement on Thursday. This will bring in billions of dollars, and it will make its founders and the inner circle extremely rich.Both events are connected. The two events are related. Robinhood has seen enough growth to be eligible for a major initial public offering. This will result in a large cash pool.AdvertisementAdvertisementAdvertisementRobinhood is a pioneer in this space. Robinhood is a significant player in retail investing, perhaps the most important player at this moment. However, it's not a bank nor a financial advisory firm. It is very different from the legacy financial institutions that have shaped the markets for decades. Robinhood is positioned as a foil to those big financial institutions that have done a lot wrong. It's in the name! Robinhood gives to the poor and takes from the wealthy! Robinhood's marketing message is simple: Big firms have practiced cronyism and made finance work for a few elite while leaving the rest of us out in the cold. Robinhood's story is that it is resetting the scales. Its stated mission, it says, is to democratize financing for all.AdvertisementRobinhood doesn't deny that big banks and large firms have caused a lot of harm. Robinhood has not denied Blacks home loans. It also helped facilitate the foreclosure of millions upon millions of homes. The app also made investments in fossil fuel firms (I don't think), charged overdraft fees for poor people during a pandemic, manipulated currencies and advised people to trade stock stocks against their best interests.AdvertisementRobinhood isn't like other financial industry peers. It has not served an elite few. It caters to everyone. The mass. This has been a trade-off that turned out to be quite different. Robinhood made a lot of money by treating its product as a drug, and its users as addicts. This is the reason Robinhood was fined $70 million and will be able to float a lot more.AdvertisementRobinhood's success or failure is largely due to the fact that its users are different from its customers. Robinhood has many users. According to its big IPO filing with Securities and Exchange Commission, it claims that it has approximately 18 million users per month, up from 4.3 million at end 2019. It also boasts $81 billion in assets, which includes equities and options as well as cash. Robinhood does not have as many customers as it used to, since a customer is someone who purchases something from a company. Robinhood users pay no fees. Robinhood Gold, a subscription product that offers premium features at a $5 per month price, has 1.4 million customers. Robinhood doesn't have to worry about these customers, as they are not the ones funding the company's operations.AdvertisementAdvertisementRobinhood earned 75 percent of its revenue in 2020 from transaction rebates, and 81 percent in 2021's first three months. Market makers are companies that pay Robinhood for stock. They route trades from Robinhood users to market makers. Robinhood taps them millions of times each day to execute trades. The market makers make their money by selling the security at a fraction of what they paid. Bernie Madoff, the idea pioneer, was there to ensure that consumer interests were always at the forefront of his mind.This system demonstrates that Robinhood's customers are not its customers but its product. Robinhood sells them (or their trades) directly to market makers. The New York Times reported last summer that Robinhood makes a lot of money on these transactions, compared to other trading platforms. Robinhood did not answer the Times' questions about the matter. I have yet to see a full explanation. Robinhood may simply have a lot of traders who are willing to pay market makers a favorable price. Robinhood claims that four market makers accounted for 59 percent of its total revenue over the first three months in 2021.AdvertisementRobinhood does not need to have a lot of users. Robinhood relies on its users to trade and trade some more in order to make money. Robinhood finds it easy because there are many users who trade a lot. The company's transaction-based revenue reached $720 million in 2020. Financial regulators have found that Robinhood has done some nefarious things to encourage its users to do what they need.FINRA's report highlights how Robinhood made options trading laughable for novice traders.FINRAs report reveals that Robinhood made it easy for novice traders to trade options trading. This is a risky investment in which someone can lose their entire premium and sometimes even more if a stock does not move in a certain direction. Options trading can be attractive because it allows for fast profits, if done correctly. Imagine buying a stock for $80 and it trading at $120. Robinhood was required by regulation to verify that investors were authorized to trade options. This included customers younger than 21 who claimed to have more than three years of experience.AdvertisementAdvertisementAdvertisementOther transgressions are also highlighted in the FINRA report, which is 73 pages long. Robinhood misled users by stating that some account types wouldn't allow them to trade on borrowed money. However, certain trades automatically enabled it. According to the report, approximately 818,000 Robinhood customers were approved for options trading. They found themselves in situations where borrowing money was possible and sometimes did. This was possible because Robinhood customers entered into certain types of options spreads. Robinhood's app informed a 20-year old Robinhood user that he owed $750,000. This despite the fact that his app had margin trading disabled. The actual amount owed by him was half of the total. However, the FINRA report details that Robinhood reported incorrect cash balances to over 135,000 customers. According to the report, Robinhood either doubled or increased these customers' actual negative cash balances. FINRA states that Robinhood led some customers to believe they lost more than what they actually lost. It also led others to believe they had more money than they did. Both are dangerous in different ways. According to FINRA, the inaccuracies in balance displays were present from December 2019 through June 2020. This means that Robinhood had not fixed the problem during a period of significant growth at the beginning of the pandemic.AdvertisementAdvertisementRobinhood is also being criticized by regulators for not adequately supervising its technology in order to ensure it could process orders from its growing userbase. FINRA claims that the outages caused five-figure losses to individual investors. It ordered over $5 million in restitution. This is separate from Robinhood's January trading halt on certain meme stocks, due to insufficient collateral to satisfy regulators during volatile trading periods. Robinhood was not prepared for its large user base to enter into an admittedly unusual trading pattern.Robinhood is not the first to be fined by FINRA. In 2019, FINRA stated that the company had not ensured its order routing was in the best interests of users. It also paid a smaller fine. Robinhood paid a $65million SEC fine last December to settle claims that it had misled customers. The Massachusetts state securities regulator also filed a complaint against Robinhood last week. It claimed that Robinhood tried to exploit customers by making investments seem like games. Robinhood stopped showing confetti to users who executed trades through its app. Massachusetts tried to ban the app from the Bay State in April.AdvertisementAdvertisementPerhaps each of these regulators has a personal vendetta against Robinhood. Maybe Robinhood treats its users like pawns and the new record fine is simply a cost of doing business as Robinhood wants.Robinhood is a great example of this concept. Everyone should have the opportunity to invest. It might even be revolutionary in the relative world of tech and financial companies. It is possible that Vlad Tenev (Robinhoods CEO) is committed to this idea. It is admirable to democrastrate finance. It isn't as glamorous as trying to encourage user growth, no matter how many rules you break, but it will be more profitable if Robinhood does that.
