Ahead of IPO, Robinhood expands risky stock market lending

Robinhood has rapidly expanded its business of extending potentially risky loans to customers of the stock-trading app in the run-up to its initial public offering.

The popular but controversial online brokerage confirmed on Tuesday that it has begun the process of selling shares in Robinhood to the public for the first time. The company said in a blog post that it had filed confidential paperwork for the IPO with the Securities and Exchange Commission and that the regulator is reviewing its registration. Robinhood did not disclose a time frame for the public offering.

In a separate regulatory filing, Robinhood reported earlier this month that its lending to help customers buy stock “on margin” — in which someone borrows money to purchase stock, options or other securities in hopes of boosting their investment returns — rose by $2 billion in the second half of 2020. As of the end of the year, Robinhood had $3.4 billion in outstanding margin loans, up more than 400% from the $650 million it had outstanding at the end of 2019.

Robinhood, launched in 2013, has become particularly popular with young investors because it offers commission-free trading through an app geared to millennial and Gen Z consumers raised on video games and other online tools. Indeed, Robinhood and Square Cash were the top two sites in total time spent among so-called “power users” of finance and trading apps who clock more hours than the average customer does, according to a recent study of mobile app usage trends by Global Wireless Solutions.  

“Gen Z flocked to Robinhood [and other] trading apps throughout the pandemic,” Global Wireless Solutions reported, citing a doubling of time clocked on such apps by Gen Z users from March 2020 through February 2021.

Unlike other brokerages, Robinhood doesn’t charge stock-trading fees, requiring it to find other ways to make money. That includes lending money for a fee so customers can invest more money in the stock market.

Robinhood charges $5 a month to borrow up to $1,000 for investment purposes. For anything above $1,000, investors have to pay an annual interest rate on the loans. The company used to charge an annual interest rate of 5%, but in December —just a month before GameStop and other “meme” stocks took off — Robinhood cut that annual rate in half, to 2.5%, making it even cheaper for customers to borrow and bet on stock picks.

Many financial planners and advisers have long warned individual investors against buying stocks “on margin,” in large part because buying shares with borrowed money can quickly lead to unexpected losses that exceed what was originally invested. Nonetheless, Robinhood on its website says that buying on margin offers customers “more flexibility, extra buying power and less time waiting to access” their account. It also says it can add risk.

A Robinhood spokesperson defended the company’s investor-lending practices. “Our margin lending rate is one of the lowest and [most] competitive rates in the industry and we have seen margin lending increase alongside the rest of our business as we have welcomed millions of people into the financial system,” the spokeperson wrote in a statement. 

High rate of unpaid loans

Yet Robinhood’s stock loans have not always produced positive results for the company and its customers. CBS MoneyWatch reported in February that as of the middle of 2020, Robinhood’s customers were 14 times more likely to be unable to repay their stock loans than investors who borrowed from rival brokerages like eTrade, TD Ameritrade and others. 

In 2020, Robinhood wrote off $42 million worth of stock loans that customers failed to repay. The company said another $41 million in loans was at risk of ending up in default.

Last month, Robinhood was sued by the parents of of Alex Kearns, a 20-year-old customer who killed himself last year after mistakenly believing he’d lost nearly $750,000 in a risky trade through the app.

Some experts told CBS MoneyWatch they believed the company’s aggressive lending may have also helped inflate the market bubble in GameStop shares and other so-called “meme” stocks. Activity surged on Robinhood’s app earlier this year as online retail investors started buying up shares of beaten down companies in a collective move against Wall Street’s short sellers, or investors who try to make money by betting a stock will go down in price. 

That caused those stocks to soar thousands of percentage points in mere days. It also lead to a cash crunch at Robinhood. The company had to seek emergency funding from venture capitalists in order to meet its regulatory requirements, which rose because so many of its clients had crowded into a small number of volatile stocks. 

Robinhood also had to restrict trading in those stocks. Congress has since held two hearings on the affair, in part to question whether Robinhood and a hedge fund that pays the company to process its customers’ trades had acted properly.

“The margin loans amplified the purchasing power and the ability of those investors to drive up GameStop’s stock price,” Joshua Mitts, a professor of securities law at Columbia University, told CBS MoneyWatch last month. “What people are so upset about is that it was Robinhood’s own risky lending practices that limited its customers’ ability to trade and undermined investors’ confidence in the fairness of the market.”

The Associated Press contributed reporting to this article.