Earlier this year, the Wall Street Journal reported that Robinhood was under investigation for not disclosing payments it received from market makers to execute the service’s trades. The allegations were yet another black eye for a company that had already found itself mired in controversy, but the case has finally come to a close. The Securities and Exchange Commission charged the makers of the popular stock trading app this morning with “misleading customers about revenue sources and failing to satisfy duty of best execution.” As part of its settlement, Robinhood is required to pay a $65 million civil penalty.
But what actually happened?
For years, Robinhood has positioned itself as a way for new and casual investors to get a feel for stock trading, and its early focus on commission-free transactions gave the company a consumer-friendly edge compared to more traditional brokers. Behind the scenes, though, the SEC alleges that the company engaged in a practice known as “payment for order flow,” in which market makers (like high-speed traders) essentially pay for the right to execute those transactions. And these payments aren’t handled in lump sums; instead, think of them a stream of micro-kickbacks delivered to the brokerage firm for each share sold.
The practice is not illegal, but it is controversial since it has the obvious potential to create conflicts of interest. (It’s also somewhat controversial by association, as infamous ponzi scheme peddler Bernard Madoff is widely considered to be the pioneer of payment for order flow.) Robinhood’s issues with it boil down to two things. First, the SEC found the company had published “misleading statements and omissions in customer communications” between 2015 and 2018 about how it made most of its money. It didn’t come from interest made by lending out investors’ cash, or the $5 monthly fee that comes with a Robinhood Gold membership — it was from those payments from market makers.
Second, and more damning, is the fact that people who bought into Robinhood’s vision of no-commission trades were worse off for it compared to people who traded with the company’s rivals. “Due in large part to its unusually high payment for order flow rates,” the SEC statement reads, “Robinhood customers’ orders were executed at prices that were inferior to other brokers’ prices.”
“The order finds that Robinhood provided inferior trade prices that in aggregate deprived customers of $34.1 million even after taking into account the savings from not paying a commission,” the SEC concludes.
As is often the case when the SEC goes after a company, Robinhood settled this investigation without actually admitting guilt. Today’s announcements notes the company agreed to the multi-million dollar penalty and a cease-and-desist order “prohibiting it from violating the antifraud provisions of the Securities Act of 1933 and the recordkeeping provisions of the Securities Exchange Act of 1934,” while neither “admitting or denying the SEC’s findings.”