Robinhood’s business of providing potentially risky loans for customers of its stock-trading app has grown rapidly in the lead-up to its initial public offering.
Popular but controversial online brokerage confirmed Tuesday that Robinhood shares have been sold to the public for first time. In a blog post, the company stated that it had submitted confidential paperwork to the Securities and Exchange Commission for the IPO and that the regulator was reviewing the registration. Robinhood didn’t disclose any timeframe for the public offering.
Robinhood also reported in a regulatory filing earlier this month that it increased its lending to customers to buy stock “on-margin” — where someone borrows money in order to purchase options, stock, or other securities with the hope of increasing their investment returns. This is when Robinhood’s total outstanding margin loans rose by more than 400% from the $650 million it had at the end of 2019. Robinhood’s outstanding margin loans totaled $3.4 billion at the close of 2019, up 400% over the $650m it had at the end.
Robinhood was launched in 2013 and has been a hit with young investors. It offers commission-free trading via an app that is geared towards millennial and Gen Z users who are raised on online games. According to a Global Wireless Solutions study, Robinhood was ranked second and Square Cash third in time spent by “power users” who use finance and trading apps more than the average customer.
Global Wireless Solutions reported that Gen Z “flocked to Robinhood and other trading apps throughout the pandemic”, citing a doubled time spent on such apps from March 2020 to February 2021.
Robinhood does not charge stock-trading charges, unlike other brokerages. It is required to find other ways of making money. This includes loaning money to customers so they can invest more in the stock exchange.
Robinhood charges $5 per month for a loan up to $1,000 to be used as an investment tool. Investors must pay an annual interest rate for loans above $1,000. Robinhood used to charge a 5% annual interest rate. But in December, just a month before GameStop’s success, Robinhood reduced that rate to 2.5%. This made it more affordable for customers to borrow money and place bets on stock picks.
Individual investors have been warned by financial advisors and financial planners to avoid buying stocks on margin. This is because borrowing money can quickly cause unexpected losses that exceed the original investment. Robinhood claims that customers can buy on margin because they have more flexibility, buying power, and are less likely to wait for access. It can also increase risk.
Robinhood spokesmen defended their investor-lending policies. The spokesperson said that the company’s margin lending rate was one of the lowest in the industry. He also stated that margin lending has increased as a result of millions of people entering the financial system.
Robinhood’s stock loan has not always been a success for its customers and the company. CBS MoneyWatch reported that Robinhood’s customers were 14 percent more likely than those who borrowed from other brokerages such as eTrade and TD Ameritrade to default on their stock loans.
Robinhood repaid $42 million in stock loans customers defaulted on by 2020. Another $41 million of loans were at risk of default, according to Robinhood.
Robinhood was sued last month by Alex Kearns’ parents. Alex Kearns was a 20-year old customer who committed suicide last year after mistakingly believing that he had lost $750,000 through Robinhood.
CBS MoneyWatch was told by experts that the company’s aggressive lending may also have contributed to the inflating of the GameStop stock market and other “meme” stocks. Robinhood’s app saw a surge in activity earlier this year, as investors bought up shares of downed companies to counter Wall Street’s short sellers (investors who bet on a stock’s price going down).
These stocks soared thousands of percentage points in a matter of days. Robinhood was also hit hard by the cash crunch. To meet its regulatory requirements, the company needed to obtain emergency funding from venture capitalists. This was due to the fact that so many of its clients were crowded into volatile stocks.
Robinhood had to also restrict trading in these stocks. Congress held two hearings about the matter, partly to determine if Robinhood and the hedge fund that pays Robinhood to process trades for its customers had acted correctly.
Joshua Mitts, a Columbia University professor of securities law, said last month that margin loans increased the purchasing power of GameStop and made it possible for them to increase its stock price. Robinhood’s risky lending practices, which limited customers’ trading ability and undermined investors confidence in the market’s fairness, is what people are most upset about.
This article was contributed by The Associated Press.
