In the wake of Robinhood restrictions and outright bans on popular Reddit stocks like GameStop (NYSE:GME), conspiracy theories have been flying. However, a new conversation between CEO Vlad Tenev and Elon Musk revealed a much realer problem. The Robinhood risks may be, as commenters highlight, hiding in plain sight. Here is what you need to know following the Robinhood Clubhouse interview.
Last week, Robinhood made itself the enemy of an army of retail investors, including posters on r/WallStreetBets. After those investors took short-squeeze stocks like GME to new highs, Robinhood intervened. Citing market volatility and unprecedented customer demand, it outright halted trading on GME, AMC and other names. The Robinhood bans prompted a class-action lawsuit as customers, celebrities and lawmakers called out the platform. Then, the company placed restrictions on 50 equities, further angering customers.
Through it all, one of the primary theories has been that Robinhood is working on behalf of the hedge funds. The thinking there is that, in order to keep hedge funds like Melvin Capital from losing money on their short positions, Robinhood banned trading.
However, the Elon Musk interview with Vlad Tenev highlights that the Robinhood risks may be even more serious for the platform. On the invite-only Clubhouse app, Musk talked to Tenev about those conspiracy theories. Tenev denied that market-makers like Citadel (which gave Melvin an emergency cash infusion) were responsible for the bans. Citadel Securities has separately said that its goal is to provide liquidity to clients across all market conditions.
So if the Robinhood restrictions and bans were not in response to hedge funds, what is the real problem? Well, it looks like the trading platform may not have enough capital on hand…
Robinhood Restrictions and the Clearinghouse Risks
During the interview with Musk, Tenev highlighted the different components of Robinhood. Customers use Robinhood Financial, and Robinhood Securities clears and settles the customer trades. In the face of high customer demand and market volatility, the National Securities Clearing Corporation (NSCC) asked Robinhood to “put up” $3 billion. As Tenev explains, the $3 billion would serve as a sort of security deposit. The requested amount was apparently much higher than what the NSCC typically asks Robinhood for, causing a delay in the C-Suite.
Tenev told Musk that the team was able to work the deposit down from $3 billion to $1.4 billion and then ultimately $700 million. However, Robinhood placed trading limits to counter some of the volatility and lower the amount of capital it owed. Essentially, the company had to either anger its customers or anger the NSCC and other regulators.
So what are the real Robinhood risks? As Christina Qi, CEO of Databento, shared on social media, this means the danger with Robinhood was “hiding in plain sight.” Robinhood did not have enough cash on its balance sheet to allow its customers to trade the Reddit stocks freely. As a result, it had to place limits on GME and other equities. And it also had to raise emergency funds. At last count, it has raised $3.4 billion from investors and tapped its credit lines for $600 million. On top of that, it is also looking to raise another $1 billion in debt.
The Bottom Line: What Do Robinhood Restrictions Mean?
Looking to the future then, will investors trust Robinhood with these risks in the spotlight? And are these risks any different from those at other brokers like Charles Schwab (NYSE:SCHW)? Tenev says that with finite capital, there will always be theoretical limits. With this in mind, Robinhood restrictions on popular equities remain in effect on Monday.
Keep an eye on this story. With customers and industry insiders already losing trust in Robinhood, plans for a 2021 IPO are in question. Additionally, many are opting for Robinhood alternatives like SoFi.
On the date of publication, Sarah Smith did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Sarah Smith is a Web Content Producer with InvestorPlace.com.
