The Trading App Robinhood Takes From You and Gives to the Rich
The start-up trading app Robinhood invoked Occupy as it promised to fix a "rigged" financial system. But the firm now faces class action lawsuits for scamming its millions of novice customers — showing that "democratizing" finance is just a way of finding more people to prey on.
Market researchers estimate that over 10 million Americans became first-time investors in 2020, amid record volatility. A staggering 6 million chose to invest through Robinhood, the Silicon Valley start-up that pioneered commission-free trading back in 2013. The app has been lauded by commentators for its mission to democratize finance — but as the New Year approached, the company found itself in hot water three times in just two weeks.
Most recent is the class action lawsuit, filed on December 24, that claims Robinhood offsets the costs of its commission-free calling card by reselling stock orders for backdoor fees. A similar charge was settled with the Securities and Exchange Commission (SEC) on December 17, with Robinhood forced to pay out $65 million for misleading customers about its revenue sources and failing to execute trades at quality prices. The SEC found that this latter fault cost users over $34 million — far exceeding any short-change savings they would have made on commissions costs.
The heist would have been a scandal even if it had hit America’s more capitalized investing class, but Robinhood’s clientele is different: the average account holder has a few thousand dollars at hand, is around thirty years old, and is more likely than not to be a first-time investor. The app that built its brand around sticking up for the entry-level investor, it turns out, has been picking their pockets in the shadows.
But possibly the most concerning part of the recent flurry came from Massachusetts regulators on December 16, alleging that Robinhood systematically preys on novice investors. The lawsuit claims the app deploys a gamified interface that pushes users to engage in advanced derivatives trading, short sales, and options calls. Trading in the options market, for instance, is typically considered out of bounds for incoming investors, not out of paternalism but protectionism. But, in the name of individual empowerment, Robinhood has removed almost all barriers to this risky, often leveraged, form of derivatives trading — and its customer base is hooked. In the first three months of 2020, Robinhood traders bought and sold options contracts at eighty-eight times the rate of those at Charles Schwab.
This frequency could be attributed to many factors. But Robinhood has undeniably created an ecosystem that rewards frequent and risky trading. It has brought on board young, undercapitalized investors through a social media strategy of variable reward systems, dopamine dependency, and click-notification behavioral directives. Virtual confetti, for instance, falls over the users’ screen at first trade — despite the fact that trade frequency is negatively correlated with trade success.
But the problem also runs deeper. Robinhood proclaims that “democratizing finance” constitutes a social good. Its argument is dependent on a neutral view of markets as a place where the average American can go to turn one dollar into two. In reality, markets are more akin to a NASCAR race: cheating is common, and, over time, the ones who win are those with institutional backing, high-speed technology, and experience. Still, the average millennial is being told they should enter the track on a bicycle with no helmet.
As far as the fight against capitalism is concerned, democratizing finance is supplying temporary oxygen to a terminally ill patient. And, ultimately, that has been one of the primary functions of Robinhood, intended or otherwise. It is directly feeding a sputtering, inflated Frankenstein market with a new cast of investors to push it forward just a few more staggering steps. By any measure (price to earnings ratios, price to sales, price to book value, market cap to GDP), the market is inexplicably overpriced and has been so even before the emergence of COVID-19. In a century’s worth of data on the market, one of the few known facts is that it will periodically crash. And it will inevitably be the small-account, novice investors who will be the first and the most violently wiped out.
But even in our current bull market, stockbrokers are always looking for a loser. Incoming retail traders have historically played that part. In the SEC lawsuit presented against Robinhood, one of the issues at hand is a practice called “payment for order flow.” It means that Robinhood is selling your trade to a third-party company for execution. Those secondary brokers will then, commonly, “take the other side.” They are betting that you are wrong — and make double when you are. But even if you win, the brokerage will have made spread and commission charges from you. It’s a zero-stakes game for them and a rigged one for users. One of the more sinister aspects, here, is that secondary brokers are lining up — specifically — for Robinhood’s trade orders. They are paying a huge premium for the right to exploit the app’s newcomers by taking the other side of their bets.
Increased scrutiny on social media platforms has popularized a phrase that rings true for Robinhood — if you aren’t paying for the service, then you are likely the product. It was the tech giants like Facebook and Twitter who first revolutionized the neurological genius of the casino: they took the slot machine and made it into a social network. Our own evolutionary desire for community and closeness had been flipped against us. Now, there is Robinhood — fusing the most addictive elements of both the casino and the social media apps.
“One of our core values,” Robinhood cofounder Baiju Bhatt said in an interview, “is that participation is power.” For decades, millions of working-class Americans were told a similar fable about homeownership. That story ended in one of the largest upward transfers of wealth from working-class Americans in the nation’s history. And homeownership, like the stock market, works differently depending on the participant. As Keeanga-Yamahtta Taylor has made clear, homeownership was a value-accruing asset for middle- and upper-income white families, while, at the same time, it has served overwhelmingly as a debt burden for a great many black families and families living at the margins.
Taylor’s work built a theory of “predatory inclusion” to explain how real estate markets function across lines of race and class. Clearly, this theory can be applied to the stock market. It is being opened up to many millions of Americans who feel as though they are being let in on the wealth-building strategies of the upper classes. As they say on Wall Street, keep dancing — so long as the music is playing. No one cut the track in 2020 — the music played despite untold human suffering and the real economy collapsing in on us. A reckoning will come, be it this year or another, the music will stop, and lower-income, noninstitutional investors will be left to clean up the mess.
Bhatt and his partner Vlad Tenev have both cited the mortgage crisis and its ensuing Occupy Wall Street movement as a primary inspiration for Robinhood. The irony is almost impressive, but the stakes are grave. What Robinhood has accomplished thus far is not the democratization of finance, but an extreme redistribution of risk. The working class of this country will not be bailed out when the market, inevitably, crashes again. In the meantime, this Robinhood shouldn’t be confused with the one who robbed the rich to serve the poor.