From the beginning, Robinhood has embraced the “move fast and break things” ethos of Silicon Valley startup culture, to the chagrin of the regulators who have struggled to keep abreast of the pioneering discount brokerage credited with inspiring a new retail-trading boom. A few years ago, Robinhood announced plans to launch a savings account, but quickly back-tracked amid a flurry of embarrassing reports about the company neglecting to seek a banking license. Now, as Robinhood reportedly prepares for its $30 billion IPO, Reuters has exposed another “slip up” by the company.
The retail brokerage apparently neglected to report OTC trades in fractional shares that it executed for customers over the last year, a mistake that could warrant another fine for the company. Robinhood first launched fractional-share trading in December 2019. Since then, fractional share trading offered via rivals like Schwab and the Cash App have made buying small slices of shares in Amazon and Tesla extremely popular among retail traders hoping to invest small dollar mounts – as little as $1 – at a time.
As Reuters explains, brokerages are required to report all their trades to trade execution facilities, according to rules laid out by the Financial Industry Regulatory Authority – better known as FINRA – as well as the SEC. FINRA, the industry’s self-regulator, has fined other brokerages, including Merrill Lynch and Deutsche Bank, for violations of its reporting and supervisory rules in the past.
When stocks trade on exchanges, everyone can see the activity. But when stocks trade over-the-counter, as is the case with Robinhood, investors rely on brokers to report the trades to the TRF. The information helps determine share prices. When certain trades are not publicly reported, it diminishes the amount of information available to market participants, and could create an unlevel playing field, FINRA says. Still, some experts said that while the omission was sufficiently serious to warrant fines to keep it from happening again, it was not a major lapse. That’s because the number of trades that went unreported would be a small fraction of the overall trading, these people said.
FINRA rules state that all trades have to be reported – including trades of less than a share – in the name of transparency, since market participants may base decisions on understanding not just prices but who is trading what and when. Unlike orders for full shares, which Robinhood sends en-masse to wholesale brokers to execute, Robinhood says its clearing broker arm, Robinhood Securities, executes fractional trades from its own account, which it is licensed to do by the FINRA.
Robinhood executed around 1.86 million tier-one shares during the week of March 15, and around 3.51 million tier-two shares the week of March 1, the latest FINRA data show. Tier-one securities include stocks in the S&P 500 Index, the Russell 1000 Index, and exchange-traded products, while tier-two includes smaller companies.
Reuters confirmed Robinhood’s lack of reporting with a company insider who was not named. Reuters could not determine how many trades Robinhood failed to report, although as of Dec. 31, Robinhood users held $802.5MM in shares bought through its fractional share program, the brokerage said in a regulatory filing. Many of those purchases may have been executed by wholesale brokers. A spokeswoman for Robinhood declined to comment on the reporting issue, but said the company, which had 13MM customers as of November, only executes a “very small percentage of its fractional orders from its own inventory.”
Still, at least one academic rent-a-quote included in the Reuters’ story said Robinhood deserved a firm slap on the wrist for the “mistake”. The penalty should be harsh enough to guarantee the company changes its reporting practices, but not stiff enough to derail the IPO.
“Should they deserve to get a parking ticket for it? Yes. Should it be painful enough that they don’t do it again? Yes,” said James Angel, finance professor at Georgetown University who specializes in market structure, when Reuters presented the data to him. “Should it be so overwhelming that it puts them out of business? Heck no.”
But news of this latest oversight isn’t the only new headline that might prompt some investors to rethink plans to buy the IPO. Bloomberg reports that Robinhood is seeking to boost its bank loans ahead of its IPO. Specifically, the company is negotiating with lenders to enhance its revolving credit lines, which would grant RH more access to liquidity that could be tapped when activity on its platform spirals out of control, like it did back in January during the first GME surge (which promoted a Congressional hearing). According to Bloomberg, the firm already has a $600MM revolver from JPM, Morgan Stanley and Goldman. BBG added that it’s not uncommon for companies to seek to bolster their credit lines before an IPO.
To be sure, the notion that this money will simply be kept in reserve is naive.
Actually you have raised $4 billion (including $600MM revolved) to fund capital shortfalls due to catastrophic risk management and disastrous back office operationshttps://t.co/Uxoi8xxn6v
— zerohedge (@zerohedge) February 1, 2021
While the Reuters story doesn’t delve into the implications of this reporting failure, Robinhood’s payment for order flow business model would suggest that these OTC trades were shared with Citadel, Robinhood’s biggest market-making client, long before they were shared with the public.
Remember the BATS IPO https://t.co/vgQwXC4ydo
— zerohedge (@zerohedge) April 8, 2021
So Robinhood needs more capital, and failed to report more trades, implicitly disadvantaging traders who use its platform in favor of “clients” like Citadel…but apart from all this, RH is totally trustworthy.