Robinhood, a pioneer of commission-free investing which recently pulled out of its UK market entry, now faces a civil fraud investigation over its failure to fully disclose its practice of selling clients’ orders to high-speed trading firms.
As reported by the WSJ, the investigation is at an advanced stage and the company could have to pay a fine exceeding $10 million if it agrees to settle the Securities and Exchange Commission (SEC) probe A deal is unlikely to be announced this month, and the two sides haven’t formally negotiated a proposed fine
A Robinhood spokeswoman declined to comment on the investigation or any talks with regulators, but said: “We strive to maintain constructive relationships with our regulators and to cooperate fully with them.”
The probe is the latest headache for the brokerage firm that was founded in 2013 and has developed a hugely popular app that allows individuals to trade stocks, options and cryptocurrencies without paying any commissions.
While Robinhood has seen phenomenal growth this year, the firm has faced setbacks such as outages that prevented customers from trading, the cancellation of its plans to expand to the UK and fallout from the suicide of a 20-year-old Robinhood customer who thought he had lost money from a sophisticated options trade.
Companies that settle SEC investigations often pay fines without admitting or denying misconduct. Any settlement may not accuse Robinhood of intentionally violating the most serious anti-fraud laws, and instead allege the company should have known its statements were false or misleading.
The investigation examined Robinhood’s failure to fully disclose on its website—until 2018—that it took payments from high-speed trading firms for sending them customers’ orders to buy or sell stocks or options.
The practice, known as payment for order flow, is a common—if controversial—way for retail brokerages to execute client trades. Critics say payment for order flow creates a conflict of interest for the broker that sells the orders. The practice has raised suspicions that it could lead to sophisticated traders exploiting less sophisticated investors, although brokers and traders say such concerns are baseless.
Payment for order flow is legal. It often results in slightly better prices for individual investors, the SEC wrote in a report about algorithmic trading issued last month. The SEC’s report said high-speed trading firms pay for access to the orders because they “generally have more information and processing power than retail traders and brokers” and value the opportunity to trade with less informed traders.
Payment for order flow represented a significant portion of Robinhood’s revenue at the time. The privately owned startup earned under half of its revenue in 2017 from such payments, and roughly half in 2018, a person familiar with the matter said.
Robinhood collects payments from trading firms such as Citadel Securities and Virtu Financial for executing its customers’ orders. In 2019, the company paid $1.25 million to settle regulatory claims tied to that same practice.
The Financial Industry Regulatory Authority, a supervisor of brokerage firms that reports to the SEC, said Robinhood didn’t take sufficient steps from October 2016 to November 2017 to ensure it was getting the best prices for customer orders.
Robinhood said this year it has amassed more than 13 million customer accounts, and it was valued at $11.2 billion in a recent funding round.
Its trading app has boomed in popularity during the coronavirus pandemic, as more individual investors gamble with stocks and options. Its popularity has put its approach to attracting customers in the spotlight, with some critics saying Robinhood makes it too easy for novice traders to make risky bets.