Here’s What Happens if Robinhood Goes Bankrupt
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Robinhood promises “investing for all,” but what they deliver is a lot more gambling than investing. Robinhood pushes their customer base – most of whom are new investors – towards risky products like crypto and options contracts. That’s because they make most of their transaction revenue from these offerings. A respectable firm should act in the best interest of their customers. Robinhood, on the other hand, says one thing and does the other. That’s why we’d never invest in HOOD stock. But, is Robinhood safe? Let’s find out.
Anyone who worked on Wall Street during the 2008 financial crisis knows what real panic feels like. While I was there in London’s financial district in the city as they call it. We were all hunched around our desks watching our CEO John Mack of Morgan Stanley curse on live television. US household net worth dropped by $16 trillion and large firms like Bear Stearns and Lehman Brothers simply evaporated.
Today over 25 million people use Robinhood and there’s blood on the streets This had me thinking. That’s my thinking face. What happens if Robinhood goes bust? To answer that question, we need to determine what type of business Robinhood is. The last time we checked, Robinhood was a brokerage firm that pushed its largely newbie investors towards the worst possible investment options there are – crypto and options. In fact, they got in trouble for it by the SEC.
I think the nickname we gave them affectionately at the time was Robin the hood. That’s because when you don’t have many chips, you tend to look for cheap tables. Robinhood makes it no secret that they want you transacting as much as possible. Built for the future of trading, says their homepage.
And to the sorry saps that think they have a future in trading, think twice. When 95% of professional money managers can’t beat a benchmark over the long term, why would you think a few Saturday afternoons watching Tom Lee babble on about who knows what’s going to give you some sort of an edge? We’ll talk more about that later.
Is Your Money Safe at Robinhood?
But let’s get into talking about whether or not your money is safe with Robinhood. So in their six commitments to their customers, they define themselves as a safety-first company. And here you can see where they’re talking about extra protection.
So when we drill into that, there’s this big label here – your money is protected, your securities and cash are protected by SIPC. And they say Robinhood Financial and Robinhood Securities are members of SIPC. But then they go on to talk about this additional insurance. And I just found this really odd. So just reading it verbatim. It says, additional insurance becomes available to customers in the event that SIPC limits are exhausted. Those limits are $500,000. It says this additional insurance policy covers protection for securities and cash up to an aggregate of a billion dollars.
I mean that’s what it says. They have assets under custody of $193 billion. So this seems all rather token. Now when you start to dig into the various companies within the Robinhood umbrella, things become a bit more complicated. You see we’ve broken these different offerings out here. You have brokerage services. So they’re a member of SIPC. You have the portfolio management piece as an SEC-registered investment advisor.
But then you have these chunks here futures and cleared swaps trading. There is no good reason on this entire planet why retail investors should be involved in futures and swaps. Absolutely not. Then you have craptocurrency or crypto, as they like to call it. And, of course, we know that since that isn’t properly regulated, there’s no protection there whatsoever. It needs some time to mature. But when you look at things like the Robinhood spending account, well, what is that exactly? Cause you see here, it says not a member of FINRA, not subject to SIPC protection.
Well, that’s certainly something that I would be concerned about. And this spending account is offered through Robinhood money. And they talk about an account that lets you spend, pay and request money, get paid early.
Early paycheck companies are the bane of American culture. But anyways, they say that this particular entity is not a member of FINRA, not subject to SIPC protection but it’s maybe eligible for FDIC pass through insuranc., And then they have more links. And this whole “maybe” is concerning.
I personally would never use a firm like this. I don’t want to peruse 10 different accounts with different rules for each and try to navigate through this mess to figure out whether or not my money is protected. You shouldn’t need a secret decoder ring to figure out what’s covered or what’s not. I want all my accounts on any single platform to have the minimum basic protection across the board.
For example, compare our evaluation of Schwab to this exercise we’re going through today. You see two different pictures. But now there’s a much bigger reason why I would never use Robinhood. But I can hear you saying it already. Joe, your opinion and 50 bucks might get me a lap dance at Mustang Sally’s.
What Happens If Robinhood goes bust?
Answer the damn question: What happens if Robinhood goes bust? Fine. Let’s continue. So what happens when any brokerage firm goes bust? This piece here by Motley Fool asks the perfect question: What happens if my brokerage fails? And it correctly says, brokerage failures are rare but they do happen. SIPC insurance covers investments against brokerage failures.
You see this in many instances. There’s many examples of this out there. And this is the Securities Investor Protection Corporation and it protects client assets of up to $500,000, including $250,000 in cash. So a general rule would be that if you’re not overly certain about the integrity of whatever financial firm you’re using, you ought to keep your investments around those limits.
Now common causes of failures for brokerage firms. Excessive risktaking. So you have Lehman and Bear Stearns there. You have fraud (Madoff). These are more black swan outliers. Regulatory violations. So that’s something that is quite concerning, especially with what we’re going to talk about today.
So the bankruptcy of Lehman Brothers. That was the fourth largest US investment bank at the time and there were a certain number of retail accounts. Not many, but they were relatively large.
They had 110,000 retail accounts. And when that disaster took place, the SIPC transferred the funds from those accounts worth over $92 billion at the time within weeks. So retail investors were largely shielded from that disaster provided they didn’t have any of their investments tied to the bank itself or any of those risky products that the bank got in trouble for holding.
Our Problem with Robinhood
Now we’ve looked at Robinhood as an investment before and there’s a couple interesting takeaways right off the bat. And if you’re interested in the stability of whatever firm you’re investing with, you ought to understand how they do business. And I find the business that Robinhood does to be absolutely unacceptable, from where I sit. So for example, 29% of their net interest revenues are margin interest.
I’m sorry. Newbie investors have no business whatsoever using margin. They’re going to learn that the hard way. And if you trade a lot, you jump in and out of the market, you’re really going to have your ass handed to you. And when you look at how Robinhood makes money, 56% of their money comes from transaction-based revenues.
That’s retail investors transacting. And if equities are free to transact, then where’s all that money coming from? Well, 47% of their revenues come from options and cryptocurrencies. It’s just hard to fathom that. You as a retail investor, especially as a newbie retail investor, you have no business, whatsoever, dabbling in options. And you will learn that the hard way over time. Robinhood’s laughing all the way to the bank in the meantime. As for cryptocurrency, that’s not investing, that’s speculating.
So Robinhood started out quite good. They’re the ones that ushered in commission-free trading and that was awesome because what it let you do was dollar cost average with very small amounts and no commission. So it made dollar cost averaging very accessible for all investors. It was- it was perhaps one of the best things that happened in the investing world, honestly, and a lot of brokerage firms followed suit.
But how they ended up making money after they did that is somewhat controversial. We’re going to touch on that. But more recently, they came out with event contracts.
Event contracts are gambling. You’re not some big BSD money manager managing tail risk. And things like this, Robinhood halts roll out of Super Bowl betting contracts after CFTC request. Right there.
If I had children that were old enough to invest, I would warn them to avoid this institution like the plague, right? You don’t start combining betting with investing. And you see Robinhood doing the same thing across their entire platform. Again, going back to their six commitments. They talk about quality execution, commission-free stock trading. At quality execution point, there’s a reason that they say that.
That’s because they were in trouble before with misleading customers about how they made money. And, of course, they said, “Well, the settlement relates to- they settled with the SEC, right? – the settlement relates to historical practices that did not reflect Robinhood today. Sure. You still have the same founders in their key positions, don’t you? Yeah, not much has changed. You simply change to accommodate what was pointed out that you shouldn’t have been doing. They say, “We’re fully transparent in communication with customers about our current revenue streams. We’ve established additional relationships with market makers to improve execution quality.”
So what this is is called payment for order flow. They’re not the only ones that do it. Other firms do it as well. You could potentially look past this. But I just want to make a point about this. During the 2021 GameStop saga, Robinhood faced a lot of scrutiny for its reliance on market makers like Citadel.
And some of you out there will know what I’m talking about, I’m not going to go into that. But what they’re doing is sending all this order flow over to a hedge fund. And all you people out there that whine about the billionaires, the people at Robinhood that talk about democratizing access to finance. They’re democratizing? They’re essentially sending all this order flow over to Citadel where Citadel can make money off all these people making absolutely ridiculous trades. They’re getting themselves into options. They have no idea what they’re doing. And this kickback that Robinhood gets from market makers, that represents a conflict of interest.
And they’re saying “Well the market maker’s always going to give you best execution.” Well, the fact that that, potentially, the market maker might not is where that conflict of interest resides. Anyone who works in finance understands just how bad the situation could potentially be. Now if you’re a long-term investor, you’re not jumping in and out of the market, you’re not writing options, and probably don’t have much to worry about here if your order gets filled for a few pennies less than it should. So I don’t think that’s a showstopper.
What is a showstopper’s if you think you’re going to go over and make a whole bunch of money on options and you’re simply taking that money and filling Citadel’s coffers with it. I like this point here. They say, “We were founded on the idea that the rich shouldn’t get a better deal.” Really? Well, the rich are getting a better deal. I’ll tell you that.
The Gamification of Investing
And then you look at this piece here from Vinson and Elkins. It talks about some gamification features that Robinhood had employed. And I just wanted to point to these as sort of this idea of mixing gambling and betting and investing all together, right?
So confetti for your first stock trade. You have these free stock rewards with a low probability where you scratch a lot ticket. These are things they used to do. List of stocks based on popularity on Robinhood’s platform prominently placed on the homepage, pushing people towards particular names, push notifications to customers to invest in said stocks.
The accusations say they were not tailored to consider, much less, promote the individual needs, goals, or risk profile of the customer. Exactly. That’s the problem that I have with Robinhood. Investing is not a game. That’s what casinos are for. If you want to be an investor, invest with a platform that doesn’t try to pull you in any number of directions that aren’t good for you, like options, cryptocurrency, and event betting.
So I worked as a hiring manager on Wall Street for over a decade. We always looked for red flags. So it’s a given that you went to an Ivy League school, you helped starving orphans in Africa. What we’re looking for are indications that you’re a bad apple. And the same holds true when we look at any investment or platform that we’re going to put money on. If you’ve tangled with regulators before, does that increase the odds that you will in the future? Yeah, kind of. What’s the upside of using Robinhood, exactly? I guess I’ve never really understood that.
Would We Buy HOOD Stock?
As for holding the company, we would never hold a company that says one thing and does another. So I understand that these guys are building a business. They’re not running a charity. But anyone who ever says they’re democratizing access to something, no good has ever come of that, honestly.
Robinhood and Wall Street are not in the business of making you money. They are in the business of generating transactions. What happens if Robinhood’s clients just bought not traded low-fee Vanguard ETFs?
They would be very wealthy, the vast majority of them over many decades of investing like that. But Robinhood would not be clearing near the revenues that they are today. It’s a conflict of interest. How could we reach the conclusion that we have today and then still hold this stock? No. And, you know, back in 2021, half of their client base identified as first-time investors. You look at the profile here.
You have lots of millennials. These are people that have never experienced true fear. They’ve never seen Lehman Brothers crash. They’ve never seen the market have real turmoil. And they’re going to have their asses handed to them over time if they continue to dabble in options and use margin. Now Robinhood’s going to launch a banking product that should come with FDIC insurance. That’s great. And I’m sure there’s lots of features that will come with that.
Conclusion
But getting back to that original question: what happens if Robinhood goes bust? Well, they say your cash and securities are SIPC protected. There’s no reason to doubt that statement. This would, of course, involve transferring those assets to another institution. Keep your documentation. And you need to evaluate each product line you’re using at Robinhood on its own merits.
For example, your crypto isn’t protected by any broad government programs. It’s not regulated. We would never use the Robinhood platform or own Robinhood stock because they don’t act in the best interest of investors and that’s been proven over time. Look, our mission is to make people better investors. If we do that, inevitably, they’re going to become loyal customers and we see that every day. We invest in our audience and we’re very protective of them. This is why we police comments and respond to everyone. We’ve blocked hundreds of people trying to scam you.
If a firm, noticeably, does not act in the best interest of their clients, we will not invest in it. We do not condone gambling disguised as investing. I personally utilize more than a dozen firms across three continents to reduce systemic risk. You ought to consider doing that if you have a lot of money. I have favorable things to say about Interactive Brokers, Schwab, Vanguard – big household names with a reputation to maintain that have been around for a long time.
Now you still have to be careful there because as Lehman showed us, no firm is too big to fail. So why take any risk at all? Why mess around with a firm that says one thing and does another.
So for those of you that are invested in Schwab and asking the same sort of questions, we did an excellent piece that sort of digs into the risks surrounding different brokerage firms, in this case, Schwab. Make sure to give that a watch. Thanks so much for taking the time to watch this today.
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