On Thursday, Robinhood Financial LLC, the company behind the popular investment app, was charged by the Securities and Exchange Commission with misleading customers about its revenue and failing to execute customer orders on the best available terms.
According to an SEC press release, Robinhood’s practices are responsible for customers losing tens of millions of dollars. Robinhood has already agreed to settle and pay the SEC $65 million.
The SEC found that Robinhood made "misleading statements and omissions in customer communications'' about its revenue and how it made money, specifically surrounding how trading firms paid Robinhood to send customer orders for execution. The payment for order flow process (created by Bernie Madoff) is simple: investment firms receive payment for directing orders to "market makers,” which are high-frequency traders that ensure whenever a customer wants to buy or sell some asset, a merchant can always fill the order.
On paper, this incentivizes companies to send orders to market makers with the lowest prices. In reality, it seems to have incentivized Robinhood to send orders to market makers that offered it the best rebates for consistently sending over customer orders.
“Robinhood provided misleading information to customers about the true costs of choosing to trade with the firm,” said Stephanie Avakian, Director of the SEC’s Enforcement Division in the SEC’s statement. “Brokerage firms cannot mislead customers about order execution quality.”
Robinhood became popular largely due to having no commission fees, but the SEC found that "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." In other words, Robinhood customers were effectively paying a premium because Robinhood chose trading firms that would provide it with higher revenues, as opposed to lower prices for its customers.
Even after the SEC took into account savings from trades not having an explicit commission fee, the regulatory agency found Robinhood had "deprived" customers of a cumulative $34.1 million.
“Robinhood failed to seek to obtain the best reasonably available terms when executing customers’ orders, causing customers to lose tens of millions of dollars,” said Joseph Sansone, Chief of the SEC Enforcement Division’s Market Abuse Unit. “Today’s action sends a clear message that the Commission will not allow brokers to ignore their obligations to customers.”
“There are many new companies seeking to harness the power of technology to provide alternative ways for people to invest their money,” added Erin E. Schneider, Director of the SEC’s San Francisco Regional Office. “But innovation does not negate responsibility under the federal securities laws.”
Robinhood did not immediately respond to Motherboard's request for comment.