Robinhood's attempt to launch a disruptive, first-of-its-kind product offers some lessons for fintech companies trying to break the mold in a highly regulated industry.
On Thursday, the popular stock-trading start-up rolled out what executives said was the biggest announcement in the company's history: Checking and savings products with a 3 percent interest rate, and zero fees. But just a day later, the start-up un-winded its ambitious plan.
There were a number of questions about the product — but mostly on the regulatory side.
The accounts being offered by Robinhood were insured by the Securities Investor Protection Corporation, or SIPC. Those protections are a far cry from FDIC-checking and savings accounts, which have different capital requirements and are equipped to handle bank failures or a run on a bank.
President and CEO of SIPC Stephen Harbeck had "serious concerns" about Robinhood's product when the news hit Thursday. But said he didn't have a chance to air those to the company because Robinhood never called him, or the SEC, ahead of the launch.
Harbeck's key worry was that accounts Robinhood was touting as checking and savings were not insured the same way. SIPC protects brokerage accounts, which Harbeck explained are meant for the purpose of investing in securities. Cash in those accounts that isn't being used to invest in stocks, would likely not be protected, he said.
"I understand that people want to be innovative and things change, but I have to work within a certain statute," Harbeck told CNBC in a phone interview Monday. "The statutes we work with can only can protect certain funds."
Late on Friday evening, Robinhood's co-CEOs published a blog post amending their original plan and said they would re-brand and re-name the product, which "may have caused some confusion."
"They've done the responsible thing," SIPC's Harbeck said. "Next time they'll aim before they shoot."
UBS analyst Brennan Hawkins was the first and only major Wall Street analyst to call out major holes the Robinhood's plan. He said he was shocked by the speed at which SIPC responded, which is not a good sign for Robinhood.
"That shows that this was a really significant over-reach," Hawken told CNBC on Monday. "We shouldn't call it an about-face, but an epic fail."
The marketing material described this as a banking product. While they may have said otherwise in the fine print, Hawken said unsophisticated investors might not have gotten the message. There are guarantees and reassurances that come with FDIC-insured banking products that a first-time investor might not be aware of.
This was also a key worry for former Rep. Barney Frank, a key architect of the post-crisis financial reform that bears his name.
"If there's any uncertainty about regulatory protection, there is serious potential for people to be misled," Frank told CNBC on Friday. "There needs to be certainty — if there's stuff that isn't covered it needs to be in big bold [letters] on the top of the page."
Robinhood said it's investing customer deposits in government-grade securities like U.S. treasuries, which yield 2.8 percent. That model is strikingly similar to what's known as a money market fund. Those investment vehicles also put money in short-term debt securities like U.S. Treasury bills and are widely regarded as safe investments with a higher yield.
Hawken said by offering something like a money-market fund and calling it a checking account was misleading, and more of an "apples to oranges" comparison.
"The product is far less of an outlier in the money market world versus banking products," Hawken said. "You're not really comparing apples to apples with those interest rates."
Robinhood's 3 percent interest rate for checking and savings would have been roughly 30 times the national average. The average yield for checking accounts is 0.08 percent yield on U.S. checking accounts and the 0.1 percent average on savings accounts, according to the latest data from Bankrate.com. Goldman Sachs' consumer banking arm, Marcus, is one of the highest-yielding banks in the savings products category with a 2.05 percent annual percentage yield. But plenty of other money market funds are actually in the same range 3 percent interest as Robinhood.
Unlike a money market fund though, Robinhood planned to offer customers immediate access to their money, JMP Securities' Devin Ryan said Robinhood's structure is more of a "hybrid."
"The company is going back to the drawing board to put their own spin on some type of higher yielding instrument that passes along the benefit of a checking account," said Ryan, a managing director and analyst at JMP. "It's still something different than the incumbent firms."
The challenge for Robinhood, he said is playing the role of disruptor in an old school, highly regulated industry.
"When you're in that position, everything you create isn't going to succeed on the first pass and that's okay," Ryan said. "They're going to have to evolve this product to have to pass the test of regulators."
UBS's Hawken said Robinhood "stubbed their toe pretty badly," but it's "not a mortal blow, it's a step back."
"Clearly this is a company that's trying to apply the technology 'run fast and break things' approach to a highly structured and regulated industry," Hawken said. "Those two approaches are not necessarily congruent."
Robinhood certainly fits that mold for high-growth. The company's free stock-trading model has ushered in 6 million users and a $5.6 billion valuation in its five-year existence. The company's model took Wall Street brokerages by storm by offering stock trading for free and has put pressure on incumbents like Charles Schwab and TD Ameritrade, which charge $4.95 and $6.95, respectively, for equity trades. That price war is still intensifying. J.P. Morgan Chase unveiled its own free trading app in August.
Still, tech companies looking to disrupt banks and other areas of finance are dealing with an especially high bar.
While Robinhood may not have been legally required to check in with SIPC before launching the product, it's more "sound practice," and what regulators have come to expect.
"This isn't the way you're supposed to operate," Hawken said. "This is a cautionary tale for those that don't vet their new products with a regulator — you can hurt yourself from a perception standpoint, and you can end up with a little egg on your face."'
Karen Mills, a senior fellow at Harvard Business School and former head of the U.S. Small Business Administration during the Obama administration, said fintech companies have a complicated regulatory environment to weed through when launching new products.
"This situation with Robinhood is a flashing red light for fintechs and lawmakers — our current regulatory environment is not prepared for this rapid transformation," Mills told CNBC. "It's an example of the fact that we have entered un-chartered territory."
Mills said as fintech companies extend into banks' territory, Congress needs to start paying more attention. She calls the current fintech regulatory environment "spaghetti soup," fraught with dislocation and confusion.
"Fintechs right now are actively seeking clarity from regulators, but regulators have not yet responded," she said. "In the meantime, I would recommend that fintechs self-regulate, do all of the disclosures and make sure they are complying with the existing regulations."