The management at Robinhood learned a significant lesson last week: Be careful what you promise.

On Thursday, December 13, Robinhood announced jubilantly that customers can sign up for a Checking & Savings product, which would also be free of charge while paying 3% interest on cash balances. Celebrities, many of whom are investors in the firm, made pronouncements on social media that this was the only place to get a 3% return on cash. If it sounded too good to be true, that’s because it was.

The very next day, all references to the product had disappeared from the website following a blog post from the co-founders, soberly and meekly saying, “We realize the announcement may have caused some confusion.” (You can, however, still find mention of Checking & Savings on the mobile app if you signed up prior to the Friday re-branding.)

The main issue, which we (among others) called out in our initial reviews of the Checking & Savings product, is that Robinhood claimed the cash in your account would be insured by the Securities Investor Protection Corporation (SIPC), rather than the Federal Deposit Insurance Corporation (FDIC). But Robinhood was playing a little loose with the regulations, as SIPC insurance only covers cash that is intended to be invested, and thus is treated as a security—similar to a stock or a mutual fund that you might hold in an investment account. 

However, the CEO of SIPC, Stephen Harbeck, said that money deposited for any purpose other than investing is not protected by their insurance. 

So why would Robinhood claim SIPC coverage for their customer’s checking and savings accounts? The firm prides itself on keeping its own costs cut to the bone, and it appears that SIPC coverage for securities is considerably less expensive than the fees charged by the FDIC for bank accounts. The fee structures of the FDIC and SIPC do not line up side by side, and it’s not immediately obvious how the FDIC would categorize Robinhood if it was to become a Real Bank. The FDIC charges a higher rate to newly insured institutions, which drops after five years of coverage.

SIPC assessments, however, are calculated as a percentage of the brokerage’s net revenue rather than of the cash deposits held by a bank. SIPC’s Board of Directors has determined the assessment rate is .0015 of net operating revenues through the 2019 calendar year. Most observers of Robinhood’s operations are fairly certain that they are not yet running a profit, which means that if their definition of a bank account had been accepted by SIPC, their insurance would, in essence, be free to them.

When I checked on my application for Robinhood Checking & Savings on late Sunday night, I was still logged in to the app and was informed that I had slipped a bit to #103,399 line, with a total of about 729,056 others.

The app let me send an invitation to a friend, who was able to sign up for a spot in line for the newly labeled Cash Management and was assigned #753,143, so apparently, Robinhood is still accepting new customers even though they are completely reworking the product. Thanks to my friend’s sign-up, my initial spot in line got bumped forward by 10,000 spots.

According to the blog posted on December 14 by co-founders and co-CEOs Baiju Bhatt and Vlad Tenev, “We plan to work closely with regulators as we prepare to launch our cash management program, and we’re revamping our marketing materials, including the name.”

Franklin Gold, a digital transformation and financial services expert who was the leader of Fidelity Investments’ online research and education, says, in response to Robinhood claiming SIPC insurance for cash balances, “The problem now is they've been yellow-carded. Any move to launch a ‘deposit’ account in the future is going to get extra scrutiny. In case of a failure, it may be up to customers to prove that the money in their account was meant to be reinvested in eligible securities.”

With any luck and some critical analysis of this failure, the next version will at least be legal. My advice: Less hype, more reality.