A proposed solution to the "Robinhood Problem"

Updated: Jan 31, 2021

The biggest question of the last week is currently being asked around the world: Did Robinhood, a retail trading platform used by millions, make the right decision when they halted trading on various stocks that were clearly being pumped by retail traders (and certainly institutional investors, hedge funds, and high net worth individuals who saw a clear chance to make money) despite no actual increase in underlying value?

Robinhood, in a moment that will likely define the company for years to come, probably made the wrong choice.

In its discretion as a private company, when it limited and in some cases entirely halted trading on several stocks, Robinhood effectively chose winners and losers. The rest of the market that was still allowed to trade the stock did so to the detriment of those who could not buy or sell.

Some investors who held positions could only sell, basically forcing them to close their positions to avoid getting crushed. Those investors that held totally frozen stocks were left defenseless against the rest of the market.

It shouldn't be lost on anyone that the US Securities and Exchange Commission was notably silent when Robinhood made this decision.

Indeed, Robinhood is legally capable of halting and suspending trading on individual accounts. Those rights are clearly spelled out in Robinhood's terms and conditions and other disclosures. But disclosures don't matter when we view what Robinhood did in practical terms.

The difference between everyday retail investors and those who invest in and run hedge funds could not have been more stark. In fact, Robinhood basically said the quiet part out loud: "Rich people are allowed to manipulate the market. Normal people are not." There is actually very little difference between what Redditors did and what hedge funds do everyday.

Originally, Robinhood argued that it was protecting investors, but from what exactly? The individuals following Wall Street Bets over a cliff to almost certain profit did so willingly and in a way that, while wildly speculative, technically was not illegal.

Now, it tells the world that it had extreme capital requirements to meet with its clearinghouses to ensure ongoing securities law compliance. Robinhood claims,"It was not because we wanted to stop people from buying these stocks." But that's precisely what Robinhood wanted. It purposely interrupted trades to prevent the run-up in clearinghouse deposits from increasing further.

It doesn't get much more transparently dishonest than that.

A Proposed Solution to the "Robinhood Problem"

I would like to call the above situation the "Robinhood Problem."

Here is a proposed remedy to the Robinhood Problem: make it illegal to halt trading on publicly-traded securities without the explicit consent of or mandate from regulators, such as the Securities and Exchange Commission.

This rule should provide for very few exceptions, such as the case of the Twitters of the world that erroneously disclose earnings prior to the scheduled time of disclosure.

This solution is extreme and would likely be opposed by FinTech companies here in the US. They'll argue they should have unfettered control of their own platforms. But Robinhood demonstrated Thursday that it will cease trading, knowing without a doubt that such an act could vanquish investors' portfolios like Thanos snapping his fingers. Surely the general public would not be as outraged if the SEC had made this decision itself and required Robinhood to shut down unwanted activity.

Robinhood should have asked the Securities and Exchange Commission to step in and order a halt to trading certain securities. The unwritten rules of PR would have told Robinhood to try to shift the blame to someone who can serve as an appropriate shield to liability and criticism.

If the SEC chose not to stop trading, then Robinhood or the SEC should have published a statement telling the world of that decision. And Robinhood should have moved itself out of the way of investors.

While this type of regulation will slow down the process of halting unwanted trading behavior, the ultimate decision here should be vested in regulators, not in privately-held companies who have a demonstrated conflict of interest when making such decisions.

It's up to Congress to fix the Robinhood Problem.

164 views0 comments