On Thursday, the SEC accused flourishing online broker Robinhood of misleading customers about how it made money for several years, allowing trades to be executed so poorly that customers came out in a worse position even after taking into account the company’s free commissions. Privately held parent Robinhood Markets, which is looking forward to a 2021 IPO at a valuation of over $10 billion, will pay $65 million to settle the case.
Robinhood did not admit or deny wrongdoing, but agreed to a censure, and to hire an independent consultant to review its customer communications and trade execution. A company spokesperson said it is “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.”
The SEC’s order comes one day after the Secretary of the Commonwealth of Massachusetts declared even more wide-ranging claims that the company’s business model puts customers’ financial well-being in jeopardy. Robinhood’s convenient app and its early embrace of free commissions has bigly disrupted the brokerage industry. The company has cleaned up during the pandy, adding 3 million customers in the first five months of the year, far more than any of its competitors.
Its pledge of free trading was built on a business model that was not properly explained to customers from 2015 to 2018—and the company didn’t get the best execution on trades, according to the SEC. “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 SEC said in a statement.
Robinhood, meanwhile, claimed that its execution was as good or better than its competitors, the agency said. In fact, the execution on the trades was so bad that it outweighed the benefit that Robinhood customers received from free commissions. In total, the SEC found that the inferior trades cost customers $34.1 million even after taking free commissions into account.
Robinhood makes most of its dough via payment from order flow, a legal practice that involves skimming the profits that market-makers earn by executing client trades. Other brokers do this too, but tend to rely on it much less for their revenue. And the details of those orders are critical— brokers are supposed to route client trades so they get the best execution. The company highlighted that the issues in the SEC report are in the past. The company has since strengthened its legal, tech and customer service departments in the past year as it has drawn outside investigations. It hired Dan Gallagher, a former SEC commissioner, as its chief legal officer back in May.
“The settlement relates to historical practices that do not reflect Robinhood today,” Gallagher said in a statement. “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.” The SEC’s Decision on Kodak