The Securities and Exchange Commission on Thursday accused Robinhood of misleading clients about how the stock trading app makes money and failing to deliver the promised best execution of trades.
Robinhood agreed to pay a $ 65 million civil fine, without admitting or denying the SEC’s findings. A company attorney said the practices “do not reflect Robinhood today.”
The Silicon Valley start-up, which has final plans to go public, raised more than $ 1 billion in funding by 2020, bringing Robinhood’s valuation to $ 11.7 billion.
Between 2015 and the end of 2018, Robinhood made misleading statements and omissions in customer communications, including in FAQ pages on its website, about its main source of income in describing how it made money – namely, payments from trading firms in exchange for sending Robinhood to are customer orders to those firms for execution, also known as ‘payment for order flow,’ ”said the SEC.
“One of Robinhood’s selling points to clients was that the trade was ‘commission free,’ but largely because of the unusually high payment for order flows, Robinhood clients ‘orders were executed at prices lower than other brokers’ prices,” statement added.
Loved by millennials, the trading app is best known as a pioneer in “commission-free trading”. Robinhood, and the rest of the online brokerage industry, rely on what is known as payment for order flow as their profit engine rather than commissions.
Taking payments for order flow from Wall Street companies is a controversial but legal practice used by most electronic brokers. It is the largest source of income for Robinhood. Robinhood received $ 180 million in payments for transactions in the second quarter, according to an SEC filing.
The SEC order found Robinhood was offering inferior trading prices that cost customers $ 34.1 million even after considering the savings from not paying a commission.
“Robinhood has provided customers with misleading information about the true cost of dealing with the company,” said Stephanie Avakian, director of the SEC’s Enforcement Division. “Brokerage firms cannot mislead customers about the quality of order execution.”
Market makers such as Citadel Securities or Virtu pay e-brokers such as Robinhood for the right to execute client transactions. The broker is then paid a small fee for the shares being routed, which can add up to millions when clients trade as actively as they did this year.
Robinhood experienced record growth in 2020 as a result of the unprecedented market volatility of the Covid-19 pandemic. Robinhood has reached a record 3 million new customers in the first four months of 2020.
“The settlement pertains to historical practices that do not reflect current Robinhood,” said Dan Gallagher, Robinhood’s Chief Legal Officer. “We recognize the responsibility that comes with helping millions of investors make their first investments, and we are committed to continuing to develop Robinhood as we grow to meet the needs of our customers.”
A Robinhood spokesperson added: “We are fully transparent in our communications with clients about our current revenue streams, have significantly improved our best execution processes and have built relationships with other market makers to improve the quality of execution. “
The SEC’s indictment came a day after Massachusetts regulators filed a complaint accusing the trading app of predatory marketing on inexperienced investors.
The complaint refers to Robinhood’s “aggressive tactics to attract inexperienced investors, using gamification strategies to manipulate clients, and not avoiding frequent outages and disruptions on its trading platform.”
– with reporting from CNBC’s Kate Rooney.
Subscribe to CNBC PRO for exclusive insights and analysis, and live programming of working days from around the world.