Robinhood Financial LLC Charged By The Securities & Exchange Commission
While the S&P 500 (SPY), Nasdaq (QQQ), and even the Russell 2000 (IWM) rise to new highs this week, there’s something else that some traders may be focusing on. This week we reported on regulators in the state of Massachusetts alleging that Robinhood Financial made aggressive moves to attract unwitting users to its platform. See: Robinhood Catches Heat From Massachusetts Regulators. While some pushed the news to the back burner, unbeknownst to some, the Securities & Exchange Commission was mounting a case. This is the second major SEC headline coming out against the broker within the last 4 months.
Earlier this year, the Wall Street Journal reported that the platform was under SEC investigation. Specifically, it was for disclosures around the company’s practice of selling clients’ orders to high frequency traders. The result could be a more than $10 million fine if the company settles. The practice of selling order flow isn’t illegal as many brokers do the same thing. However, due to the revenue generated by the practice with Robinhood specifically, questions began arising.
Robinhood VS The SEC: New Details Come To Light
We’re not talking about just trading penny stocks on Robinhood. Nor are we talking about Robinhood being down as is usually the case when the app makes negative headlines. This could be something much bigger. According to documents from the U.S. Securities and Exchange Commission, Robinhood is being charged with misleading its customers about things like revenue sources. Furthermore, the Commission alleges that Robinhood failed to “satisfy the duty of best execution.”
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In the document, Robinhood Financial is cited for repeated misstatements that they didn’t disclose the firm’s own receipt of payment from trading firms. These payments were for moving customer order to these trading firms.
According to the SEC, this isn’t a short time frame of instances either. From as early as 2015 through late 2018, the Commission says that Robinhood made “misleading statements and omissions in customer communications.”
Furthermore, when describing how Robinhood made money, the sites own FAQ page, the SEC said the firm mislead its clients. As discussed above, the firm focused mostly on sending its customer orders to trading firms for execution. This is a practice known as “payment for order flow”. In the order from the SEC, the Commission found that Robinhood sold clients on “commission-free” trading. Yet since there was such a high payment for order flow rates, customer orders were executed at inferior prices to other brokers.
How bad were these “inferior prices”? The SEC alleges that trade prices through Robinhood “deprived customers of $34.1 million even after taking into account the savings from not paying a commission.”
Robinhood Misleads Customers
According to the Directo of the SEC’s Enforcement Division, Stephanie Avakian, “Robinhood provided misleading information to customers about the true costs of choosing to trade with the firm.”
“Robinhood failed to seek to obtain the best reasonably available terms when executing customers’ orders, causing customers to lose tens of millions of dollars. Today’s action sends a clear message that the Commission will not allow brokers to ignore their obligations to customers.”
Joseph Sansone, Chief of the SEC Enforcement Division’s Market Abuse Unit
These claims are obviously concerning to the millions of users on the app itself. If you remember from an article published earlier this year, Robinhood is one of the largest platforms utilized by the new generation of traders. Millennial traders, no matter the platform, have even been dubbed “Robinhood Traders”. Thanks in part to the “wild west” treatment of stock trading, these “Yolo-ing” risk-takers have turned Reddit into the new CNBC. Even Jim Cramer has made mention of the site’s impact on the market as a whole.
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Is The Robinhood IPO On Hold?
Robinhood has reportedly brought on Goldman Sachs to lead an IPO. This could value the app at more than $20 billion according to Reuters. The current private valuation is somewhere around $11.7 billion following the last round of financing in September.
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While the Massachusetts case didn’t necessarily raddle things, another SEC case could. Obviously, when going public, being on the bad side of regulators can make things difficult. But herein lies the argument. It’s not only Massachusetts regulators saying the platform used shady tactics to attract users. Now, it’s the Securities & Exchange Commission.
It would seem, according to the SEC’s statement, that the issues are relating more to how the platform makes money. Furthermore, the fact that it gave its users inferior access to markets could bring a lot of things into question. Sure, the application is easy to handle and makes placing trades relatively simple. But at what cost? Well, again according to the charge, it imposed a cost to traders over $34 million in optimal trade prices.
What Was Robinhood’s Response?
In the formal statement, Robinhood neither admitted nor denied the SEC’s findings. Furthermore, it agreed to a cease-and-desist order. This prohibits the firm from violating antifraud provisions of the 1933 Act as well as the record-keeping provision of the ’34 act. This resulted in requiring Robinhood to pay a $65 million civil penalty. The firm also retained an independent consultant to review its policies and procedures relating to customer engagement.
How do you think this works out for Robinhood and will it impact the pending plan to IPO? Leave a comment below and let us know your thoughts.
End Notes:
SEC Charge: https://www.sec.gov/news/press-release/2020-321
