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Robinhood agrees to $65 million civil penalty to resolve SEC charges

Federal regulators accused the trading app of misleading investors about how it makes money

(Gabby Jones/Bloomberg News)
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Robinhood has agreed to a $65 million civil penalty to resolve charges that the trading app misled clients about how it makes money, the Securities and Exchange Commission announced Thursday.

The federal regulator accused the company of misleading or omitting information about its largest revenue source — “namely, payments from trading firms in exchange for Robinhood sending its customer orders to those firms for execution” — in its communications with clients between 2015 and late 2018, and on its website. Such as system is known as “payment for order flow.”

Robinhood advertises its trading services to customers as “commission free,” but the SEC said that contradicted with “unusually high payment” it charges for order-flow rates, prices that deprived customers of $34.1 million.

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The company grew rapidly from October 2018 to June 2019, during which it claimed on its website FAQ that its execution quality matched or beat its competitors — statements that the SEC categorized as false and misleading.

“Robinhood failed to seek to obtain the best reasonably available terms when executing customers’ orders, causing customers to lose tens of millions of dollars,” Joseph Sansone, chief of the market-abuse unit in the SEC’s enforcement division, said in a news release. “Today’s action sends a clear message that the Commission will not allow brokers to ignore their obligations to customers.”

Robinhood agreed to pay the $65 million civil penalty without admitting or denying the allegations. It also said it will adhere to a cease-and-desist order to not violate federal anti-fraud and record-keeping provisions. The SEC said the company will also see that an independent consultant review its policies and procedures for customer communications, payment for order flow and best execution of customer orders.

“The settlement relates to historical practices that do not reflect Robinhood today,” Dan Gallagher, chief legal officer for Robinhood, said in an emailed 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.”

Robinhood said in a statement through a spokeswoman that it has been “fully transparent” in its communications with customers about current revenue streams and has “significantly improved” its execution processes and quality.

The SEC announcement came a day after Massachusetts regulators accused the trading app of predatory marketing “without regard for the best interest of its customers.” In the complaint, Massachusetts Secretary of the Commonwealth William Galvin (D) alleged that Robinhood uses “gamification strategies” — such as displaying confetti on screen whenever users make a trade — to lure young and inexperienced customers into risky stock trading. Regulators attribute the platform’s frequent outages to flawed infrastructure.

Kyshia Minor, 37, of Oakland, Calif., isn’t an experienced trader and decided in March to start using Robinhood. Last week, she said, she tried buy Airbnb when it opened for trading but the transaction was rejected because of a system error. The stock, which had been priced at $68 the night before its market debut, opened at $146 per share.

“This is my first time hearing about how they make money,” she said in an email. “I am curious to know more about it, and if I’m personally effected by it.”

The Menlo Park, Calif.-based broker-dealer was founded in 2012, according to company filings. Bloomberg reported in November that Robinhood Financial’s parent company, Robinhood Markets, is planning an initial public offering in 2021. A Robinhood spokeswoman declined to comment on the current status of a potential IPO.

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The company’s stated mission is to “democratize finance for all.” It has seen exponential growth in its customer base, with more than 13 million users who buy and trade individual stocks or partial shares — something that has resonated heavily with millennials who have less disposable income but want to take part in Wall Street’s rebound.

“Some of their common traits — such as a smaller-cap orientation, heavy exposure to economically sensitive sectors, and a contrarian bent — could pay off if there’s a strong economic recovery,” Morningstar portfolio strategist Amy C. Arnott wrote to investors November. “But the stocks on the list also court a fair amount of risk. They’re vulnerable to downturns both in the overall economy as well as company- and stock-specific factors.”

After a 20-year-old customer died by suicide in June after seeing a negative balance of $730,000 in his Robinhood account, SEC Chairman Jay Clayton said during Capitol Hill questioning that “we need to do something make sure that these kinds of things don’t happen.” At the time, Robinhood founders Vladimir Tenev and Baiju Bhatt outlined in a public letter ways the company would improve customer experience, including improvements to the user interface, educational resources and changes to user eligibility for more-sophisticated trading.

In July, congressional lawmakers sent a letter to Tenev and Bhatt, outlining their concerns and urging the company to do more to protect investors.

“Robinhood seems to be reaping outsized revenues by selling the trades of its users to third-party firms to execute the orders,” the letter reads. “By some metrics, this practice of ’payment for order flow’ generates between ten and almost one hundred times more earnings for Robinhood than for its three closest competitors.”

Robinhood has a market cap of $11.2 billion, CNN reported in August. The company received $180 million in payments for trades in the second quarter of 2020, according to public filings, and advertises that for every 100 shares trades, it saves customers $2.58, on average.