Perhaps one of the most consequential innovations in modern finance has been the advent of an investing app known as Robinhood. Founded in 2013, Robinhood allows virtually anyone to invest in the stock market as well as cryptocurrencies without any transaction fees or commissions. There is no need to set up an account with a bank, call a broker, invest a minimum amount, or otherwise do anything besides downloading the app and inputting the required information. The result has been a more democratic, accessible, and personal stock market than ever before. According to CNBC, Robinhood and apps like it have been responsible for creating millions of new investors in 2020 alone. It writes,
“These first-time traders, many in their 20s and 30s, found the stock market accessible. High prices had kept many on the sidelines for years. As sports events were canceled, sports betting was replaced with stock trading.”
According to an article published by Marketwatch, Robinhood investors collectively outperformed many Wall Street professionals in part due to more aggressive investing combined with a sort of crowd knowledge. Over the course of its seven-year history, Robinhood has developed into a user-friendly investing tool serving a diverse range of customers, many of whom are young. It even launched its own podcast known as Robinhood Snacks which presents business news in an entertaining and youthful fashion.
Massachusetts Cracks down on Robinhood
The Wall Street Journal reported that
“Massachusetts securities regulators are expected to file a complaint Wednesday against the wildly popular trading platform operated by Robinhood Financial LLC, alleging the company aggressively marketed to inexperienced investors and failed to implement controls to protect them.”
It also reported that
“William Galvin, Secretary of the Commonwealth of Massachusetts, says Robinhood’s platform is ‘presented as some sort of game that you might be able to win.’”
The state took particular issue with Robinhood’s user-friendly setup
“Claiming that it “encourages customers to use the platform constantly” through what it calls “gamification.” The complaint alleges that, through the promise of free stocks, push notifications and its signature digital confetti, Robinhood encourages “continuous and repeated engagement with its application.” State regulators allege Robinhood allowed one customer with no investment experience to make more than 12,700 trades in just over six months.”
The problem with all this is that as mentioned before, Robinhood users are not pawns in the shark tank of professional Wall Street professionals. In some cases, they actually perform better. Although there are certainly some young investors who are lured into poor decisions, risk-taking is part of the financial profession. Like with any other activity such as drinking, smoking, rock climbing, physical fitness and so on people learn how to responsibly conduct themselves. Support resources such as online discussion forums, social media channels, peer to peer mentoring, and other private associations naturally arise to help investors improve. Furthermore, much like any profession, but especially in the financial market, nothing is a better teacher than failure.
I’m willing to admit that part of my education in monetary policy and financial markets was from my personal experience with Robinhood. Whether it’s learning about volatility induced by current events, the performance of diverse assets, or the influence of the Federal Reserve, these topics become very interesting when your money is on the line.
Massachusetts regulators are essentially acting as overly protective and intrusive parents who are not only too protective but stuck in the past. Robinhood has made investing attractive and interesting but it seems Massachusetts would like it to be unappealing and cumbersome.
The “Best Interest” of the Client
According to the Wall Street Journal, in February 2020 it reported that Massachusetts adopted a new fiduciary rule that required brokers to act in their client’s “best interest.” This law is the basis for the complaint against Robinhood.
Not only is that incredibly vague, but it opens up a disturbing reality where the state can decide what is and is not in one’s best interest. Furthermore, basic economics tells us that individual self-interest, not outward altruism drives the economy and prosperity. This is the lesson that Adam Smith gave us in The Wealth of Nations, which essentially outlined the basic foundations of modern capitalism.
Not only did Massachusetts enact this intrusive and cumbersome law, but it was done in response to a federal court striking down a similar rule created by the Department of Labor. The court found that the DOL’s rule was administrative overreach, so the state of Massachusetts decided to enact its own rule.
The Wall Street Journal reports that
“In an interview, Mr. Galvin said his office filed the complaint to protect young Massachusetts investors. The platform, he said, “is not presented as serious investing with substantial risk.”
He seems to hold Massachusetts residents in such low regard that they are unable to decide for themselves what they should do with their money. That young investors are so ignorant that they forget that they can lose money while investing in the stock market. Regardless, it shouldn’t be the role of the state to tell adults what they can and cannot do with their money.
However, it seems that Massachusetts regulators are not only overprotective, but they fail to even understand what they are regulating. According to a paper produced by the National Bureau of Economic Research, Robinhood investors are a breed of their own with seemingly unorthodox tactics that go against traditional thinking but are nonetheless successful. The study outlines this idea when it states
“Robinhood (RH) investors collectively increased their holdings in the March 2020 COVID bear market, indicating an absence of panic and margin calls. Their steadfastness was rewarded in the subsequent bull market. Despite unusual interest in some “experience” stocks, their aggregated consensus portfolio (likely mimicking the household-equal-weighted portfolio) primarily tilted towards stocks with high past share volume and dollar-trading volume. These were mostly big stocks. Both their timing and their consensus portfolio performed well from mid-2018 to mid-2020.”
Although there are certainly plenty of reckless and irrational Robinhood users, collectively users tend to be much smarter than even professional investors counted on them being. If anything this is but another example of how the seemingly uncoordinated actions in the marketplace produce optimal results without central planning.
The State vs the Market
Although it is frustrating to see Massachusetts attempting to attack an innovative company for its success, this is yet another instance of many in the battle between the state and the market. AIER recently published a book on this topic where economists Deirdre McCloskey and Alberto Mingardi outline how counterproductive the state can be for innovation. When the market comes out with something innovative and exciting the state tends to pass policies that seem well-intentioned but in the end slow progress. Just look at the ongoing efforts to regulate ride-hailing apps such as Uber, which is another disruptive company that has changed the world. Many of the regulations proposed threaten to completely eliminate the company as it exists, taking us back to the days of taxi cabs.
Even the federal rule that serves as the model for the fiduciary law that Massachusetts is using to regulate Robinhood has negative unintended consequences. The US Chamber of Commerce explains,
“Investors have unfortunately already felt the impact of the DOL rule being in effect. Many retail investors, especially working-class Americans, have been priced out of quality retirement advice, don’t have access to certain types of products and accounts, and don’t have a clear understanding of their financial adviser’s role and responsibilities. These limitations and uncertainty have hampered the ability of advisers to provide the critical retirement advice needed by millions of workers.”
Such contempt for Robinhood’s accessibility and attractiveness to young investors will have a similar effect. Financially disenfranchising and disempowering millions of people in the name of the state’s idea of safety.
Furthermore, government intervention in the financial sector in the name of public safety has less than a stellar record. Let us not forget the role government sponsorship of Fannie Mae and Freddie Mac played in the 2008 Financial Crisis. Although its intention was to support homeowners and the mortgage market, it only created a massive moral hazard while incentivizing an unsustainable level of debt accumulation.
Finally, Massachusetts’ attempts to regulate Robinhood is representative of the ongoing regulatory onslaught that is slowly draining life from the financial sector. This is part of the growing popularity of private equity, which carries less regulatory burdens than the public equity markets, making it an attractive option for many. However, private equity is less accessible and most people do not have access to such investment opportunities. A lighter regulatory presence in the public equity markets would allow more dynamism and growth that the average investor can participate in.
Supreme Court Justice Neil Gorsuch gives another example of the negative side effects of excessive government regulation when he describes the legal profession in his book. He notes that the soaring cost of lawyers and strict restrictions on who can give legal services has led to the growing popularity of private arbitration. This has created concerns on the legitimacy of the US legal system and the fairness of proceedings conducted under private arbitration.
All these examples should go to show the less than stellar record of seemingly well-intentioned government programs that have not only slowed progress but set society back. Massachusetts’ regulatory intentions for Robinhood not only demonstrate a high level of disregard for the decision-making abilities of its citizens, but also a failure to understand the entity it seeks to regulate. The ongoing attempts to place onerous regulations on innovative companies like Robinhood in the name of the public interest are not only misinformed but they will likely leave us worse off.