The US Securities and Exchange Commission has fined Robinhood $65 million over its failure to fully disclose its practice of selling clients’ orders to market makers.
The disciplinary case stems from an arrangement known in the brokerage industry as ‘payment for order flow’ between 2015 and late 2018. This controversial practice is a major part of Robinhood’s business and involves selling customer trades to certain trading firms. The popular millennial stock-trading app routed its customers’ orders to other broker-dealers, all of which paid Robinhood for that order flow.
“The settlement relates to historical practices that do not reflect Robinhood today. We recognize the responsibility that comes with having helped millions of investors make their first investments, and we’re committed to continuing to evolve Robinhood as we grow to meet our customers’ needs,” said Dan Gallagher, Chief Legal Officer at Robinhood.
In reality, Robinhood charges market makers and high-speed trading firms a percentage of the spread on each trade it sells, compared to a fixed commission, which some critics say creates a conflict of interest. A bigger difference between the bid and asked price means Robinhood customers do not get the best prices.
Although a major driver of revenue, Robinhood did not fully disclose these practices on its website until 2018. As a result, the SEC accused the discount brokerage of making misleading statements and omissions in customer communications, including in FAQ pages on its website.
The so-called ‘payment for order flow’ had reportedly deprived customers of $34.1 million even after taking into account the savings from not paying a commission.
As the SEC’s order finds, “one of Robinhood’s selling points to customers was that trading was ‘commission-free’, but due in large part to its unusually high payment for order flow rates, Robinhood customers’ orders were executed at prices that were inferior to other brokers’ prices.”
The industry rules require brokerages to use reasonable diligence to ensure that the transaction prices for customers’ trades are as favorable as possible amid the current market conditions. This duty of ‘best execution’ is incorporated in FINRA Rule 5310, which provides standards for firms with respect to best execution.
“Despite this, Robinhood falsely claimed in a website FAQ between October 2018 and June 2019 that its execution quality matched or beat that of its competitors,” the SEC further states.
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“We are fully transparent in our communications with customers about our current revenue streams, have significantly improved our best execution processes and have established relationships with additional market makers to improve execution quality.” added a Robinhood spokesperson.
The SEC penalty is the latest headache for the upstart brokerage firm which was hit yesterday with a complaint by Massachusetts regulators. One area of focus for the investigation is Robinhood’s aggressive tactics to attract inexperienced investors and “its use of gamification strategies to manipulate customers.”
A Wall Street regulator has previously fined the commission-free investing app $1.25 million in a civil action for not getting the best execution price for customer equity orders and failing to properly supervise the process.
Separately, Robinhood is facing multiple investigations into repeated outages of its trading platform, as well as failure to provide a swift resolution resulted in some investors losing money after being unable to access their accounts.