Suing Robinhood

What's up, you guys? It's Graham here. So as most of you know, I really like to keep this channel centered around personal finance and investing. But every now and then, something comes up that I think is worth talking about further, and today, it's important we talk about what's going on with Robinhood, so no one else makes the same mistake.

Now, just to give some background, I discovered Robinhood about four years ago, and what originally caught my attention was that they were one of the first brokerages to offer zero dollar stock trades. That made it extremely easy to buy and sell stocks on a whim without having to worry about eight to twelve dollar commissions eating into your profits. But even though they've now become wildly successful, the journey has not been smooth. They've had to shut down their original checking and savings account because it was never FDIC or SIPC insured. They experienced an outage that left people unable to sell their holdings during one of the most volatile times in the market. Users of Wall Street Bets were able to exploit an infinite money glitch that gave them unlimited leverage. And more recently, data was released in an effort to show how people were using public information on Robinhood to profit from enthusiastic traders before watching the stock come crashing back down.

Now, obviously, no one and no company is ever going to be perfect, and there are shortcomings that we could list for pretty much every single company in existence. But the allegations against Hood are starting to get more serious, and that is something worth diving into deeper because this has everything to do with your money, how you invest, and the accusation that if you lost money on Robinhood, then maybe it's not entirely your fault, and maybe Robinhood is actually the one to blame.

But before I explain why this is, if you wouldn't mind just gently annihilating the like button for the YouTube algorithm, it would help me out a lot. So thank you so much for doing that, and also, a big thank you to Morning Brew for sponsoring this video, but more on that later.

Alright, so here's where all of this begins. Last month, I covered a rather interesting article with the headline "Herding by Naive Robinhood Traders May Be a Good Signal to Short." The article went into detail about how Robinhood is designed as a platform, which I think we could all agree is a really good concept. Their user interface is incredibly simple, it's extremely easy to navigate, and by offering completely free stock trades to anybody, it's opened the door for pretty much everyone to invest with no prior experience whatsoever.

Normally, something like that should be celebrated. After all, I'm a firm believer that more people need to learn how to invest. It doesn't have to be overly complicated, it doesn't need to be confusing, it doesn't need to be expensive, and the more people that have access to financial literacy, the better. But some people argue legally, the ease at which you're able to invest your money in Robinhood might cause you to lose more money than you expect, and Robinhood might just be making investing a little bit too easy for people who really don't understand what they're doing.

For example, the biggest criticism was that Robinhood made investing feel more like a game. Like when you refer a friend, you could get a free stock that you scratch off like a lottery ticket and then confetti comes raining down on anything that you get. You swipe up to place a trade, you get DM-like notifications alerting you of account activity, and within a few clicks, you could have access to options trading.

And this is where things get interesting. Arguably, options trading is not for the squeamish because this could be a highly leveraged investment that could cause you to either make a lot of money or lose a lot of money. This is also nearly the entire premise of Reddit's Wall Street Bets, which is a community of 1.7 million users who post about how much money they've won and lost.

And that brings us to the lawsuits brought forth against Robinhood. The first was an SEC charge that fined Robinhood 65 million dollars for misleading investors as to how they made money and how they failed to get the best price for customer orders. See, when it comes to Robinhood and through zero dollar stock trades, you have to ask yourself if it's free to use, how do they go and make money?

Well, Robinhood has broken this down for you in a few main components. One, they make money from their Robinhood Gold service, which starts at five dollars a month and gives you additional features like margin trading, along with level two market data and research reports. The second, if you use margin, they're going to be charging you five dollars a month or five percent annually of your borrowed amount, whichever is more. Now third, they're going to be making money off the uninvested cash you have sitting on their platform. And fourth, the issue they're facing now is that Bloomberg says almost half of Robinhood's revenue came from their practice of routing order flow, which the SEC says is deceiving to you as the investor and exactly how much that's costing you.

Now, if you're confused, here's how this works: when you place a stock trade on Robinhood, Robinhood is not the one who actually executes those orders. Instead, they instantly outsource it to another company that pays Robinhood for the right to execute your trade. Those firms usually make a very, very small percentage off the total amount, and even though this is a very common practice for pretty much every brokerage out there, the 65 million dollar settlement came from accusations that Robinhood didn't necessarily get customers the most competitive pricing on a stock. Instead, they routed orders to the company that paid the highest commissions to Robinhood.

Now usually, this is an amount that's never really going to get noticed by you. In fact, Bloomberg estimated that this amounted to 0.0024 cents per share. But with hundreds of billions of trading volume, it adds up. This article says that Robinhood earned about 180 million dollars off of trades like this in their second quarter, and the SEC probe found that Robinhood's inferior prices cost their customers 34.1 million dollars, even after considering the savings from not paying a commission on stock trades.

Now, in defense of Robinhood, on this costing their users 34 million dollars off of what's probably hundreds of billions of dollars worth of total transaction volume is not that much money in the big picture. And probably most of us would just never even notice. But regardless, Robinhood did pay a 65 million dollar civil penalty without admitting to any wrongdoing, and Robinhood went on to say that this settlement is related to historical practices that do not reflect Robinhood today.

However, this doesn't just stop there because now there's a much more serious allegation on the table, and this is the entire reason I'm making this video. But before I get into that, I just want to say a huge thank you to the video sponsor today, Morning Brew. They're a totally free daily newsletter that gets sent to you every Monday through Saturday, and they bring you up to speed with the most important business and finance related news in under five minutes. After all, you don't want to be like me and have to read two to four hours of news every single day just to consistently come up with topics like this. Because no joke, that's how long I spend reading the news every single day.

But Morning Brew has a solution to this. Instead, they scour the internet on your behalf and they cherry pick the best, most interesting financial related news and they condense it down into exactly what you need to know in a way that's actually interesting to read about. For example, the other morning, they were giving details about the current status of the stimulus package that should be coming any day now. They were also covering details of my all-time favorite company that makes it all possible for you to watch this video in the first place: Google and the legal actions against anti-competitive practices. Finally, they covered the topic of this video, Robinhood and the complaints against them. It's just all really interesting content; it gets delivered to your email every single morning, and I read every single one of them and like it enough to recommend it to you.

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The most recent allegation against Robinhood is this: Robinhood accused of targeting novice investors with features that encourage excessive trading. This Massachusetts lawsuit, which I will attach down below in the description for anyone who wants some really good reading material, claims that Robinhood is using aggressive tactics to target inexperienced investors. They're failing to responsibly prevent and respond to system outages. They're gamifying investing to encourage repetitive trading. They aren't supervising who's trading options, and because of that, they have breached their fiduciary duty as a brokerage.

And now this is where it starts getting really interesting. They go on to say that 670 Robinhood users with limited or no investment experience averaged at least five trades a day, with two of those customers averaging close to 100 trades per day. And Robinhood even allowed one customer with no trading experience to make 1,200 trades in a six month time frame. I'm not even mad; like, I'm impressed!

Anyway, this lawsuit continues on to say that Robinhood would let 370 people with no experience that would ordinarily never have qualified for options trading access to options trading anyway. And in Massachusetts, they argue that Robinhood has a fiduciary duty towards their customers, meaning Robinhood needs to look out for their best interest, and most likely their best interest is not having access to unlimited margin trading that might cause them to trade more than they should.

Now, obviously, this is a bit of a touchy subject because on the one hand, investing should be accessible to everybody. But on the other hand, there should be safeguards put in place to make sure that people can't get in over their heads. A very, very unfortunate example of this was when one of their 20-year-old customers chose to end his life after seeing a negative 730,000 dollar balance in his account. He was one of the users that was approved to trade options, and because of how these options were exercised, a negative balance was temporarily shown in his account until the markets reopened on that Monday. This was considered to be a short-term glitch in the system, but this trader didn't know this and thought instead that he owed Robinhood 730 thousand dollars.

If Robinhood responded, they made changes to the app, and overall, the situation is something that maybe could have been prevented under different circumstances. But the whole thing is just really sad. Either way, the point of this lawsuit is that they say Robinhood is allowing people to gamble under the disguise of investing, and they make it far too easy for almost anyone to get approved for options trading without the proper safeguards in place.

Now from my own perspective, I do admit this is a very delicate situation, and I have a feeling that eventually there's gonna be strict regulation around who can and cannot get access to certain trading features on apps like this. For example, I've got over three million dollars in a Charles Schwab account, and I literally had to call someone up on the phone and talk to a live human being to be approved for options trading.

Now with Robinhood, on the other hand, I went on the app, I answered a few simple questions, and almost immediately was good to go. Sure, I certainly appreciate the convenience of Robinhood because that made my life very easy. But if I were somebody with an appetite for gambling or maybe I just want to throw my entire life savings into GameStop call options, then perhaps I had just opened Pandora's box.

Now some people could argue that it's not a broker's responsibility to protect people from themselves, just like we can't blame a casino for someone's gambling problem. But the real issue is whether or not Robinhood has a legal obligation to put proper safeguards in place to make sure people don't get carried away. And they also need to make sure that people are qualified for what they sign up for.

After all, the government has come to the conclusion that the average retail investor has absolutely no idea what they're doing, and therefore there are regulations that have to be put in place to prevent people from losing everything. Like the term accredited investor is one of them, and while some people argue that this just gives the rich an easier way of making more money, the reality is that so many startups fail, and the average person is not going to have the budget to withstand so many losses before eventually they maybe turn a profit.

Now, I'm definitely no lawyer, but I certainly believe these accusations are really just the tip of the iceberg of what's eventually going to be implemented throughout every brokerage. At some point, I believe they're all going to be held to a higher standard that places more barriers on how much money people could invest, who could invest, and how often they can invest. It really all just comes down to how much responsibility do brokers have to protect you from yourself, and how much responsibility do you have for your own actions.

In my opinion, maybe a good middle ground would be to have their users take a test or a quiz before they're able to trade a certain amount of times or before they have access to margin and option trading. Ask questions about how options trading actually works or what happens when one of those options expires. I guarantee that would cut down on a significant portion of the number of people trading options who have no idea how to trade options.

And I still think it's only a matter of time until there's a more clear distinction between what we call investing and gambling because the line is definitely blurred. But I do have to finish this off on a positive note about Robinhood because without them, we would likely not be seeing zero dollar stock trades like we do today. And undoubtedly, they've opened up the door for so many new investors to come into the space that ordinarily would never be investing.

There's inevitably going to be growing pains throughout the process, especially as a startup company that is now valued at an estimated 20 billion dollars. Overall, there's a lot of good to come out of the platform as well. Perhaps some changes will need to be made in terms of how Robinhood presents itself as a game when it comes to investing. Maybe that might be similar to how vapes were being advertised towards children, and maybe they will end up changing their layout a bit if more of these issues persist. But that was their competitive advantage from the very beginning, and that ended up getting so many new people into the investing space.

So it can be a double-edged sword, and it'll be interesting to see how this all plays out. But if I were to guess, this Massachusetts lawsuit is probably just going to be the tip of the iceberg until there's a more concise definition on what people consider investing and what people consider gambling.

And when it comes to all of this, I definitely want to hear what you think of this and whether or not it's reasonable or unreasonable. So if you want to comment down below and let me know your thoughts, I read like 95% of the comments at this point, and I do my best to respond to as many people as I can. So if you comment down below, most likely I will see it.

So with that said, you guys, thank you so much for watching. I really appreciate it. Make sure to destroy the like button, subscribe button, and notification bell. Also, feel free to add me on Instagram; I post it pretty much daily. So if you want to be a part of it there, feel free to add me there, as on my second channel, The Graham Stephan Show, I post there every single day I'm not posting here. So if you want to see a brand new video from me every single day, make sure to add yourself to that.

And lastly, speaking of stocks, if you want four free stocks, use the link down below in the description, and Webull is going to be giving you four free stocks when you deposit 100 dollars on the platform, with those stocks potentially worth all the way up to 1,600 dollars. So if you want those stocks, link is down below. Let me know which ones you get. Thank you so much for watching, and until next time!