Robinhood, an app that’s wildly popular with millennials, faces a civil fraud investigation over its failure to fully disclose to clients its practice of selling their orders to high-speed trading firms, the Wall Street Journal reported.
The app lets people trade stocks, options and cryptocurrencies without having to pay commissions.
On its website, Robinhood had a page until October 2018 called “How We Make Money” that listed two revenue sources: fees for its margin-trading service and interest collected on customer deposits. It didn’t mention payment for order flow — a common but controversial way for retail brokerages to execute client trades.
Robinhood makes money by taking a fraction of a cent per dollar from each trade order and collecting interest on customers’ deposits, CNBC reported.
Its no-fee model for stock trading has been successful in attracting millennials but it put pressure on incumbents like Charles Schwab and TD Ameritrade.
Order flow is legal. Robinhood took payments from high-speed trading firms for sending them its customers’ orders to buy or sell stocks or options, WSJ reported.
Robinhood has been criticized for relying on high-frequency traders, “especially considering a founding ethos that some have categorized as ‘anti-Wall Street,'” Kate Rooney reported for CNBC. “The company sends customers’ orders to high-frequency trading firms like Virtu or Citadel Securities instead of a stock exchange like the NYSE. These trades are executed in what’s known as a dark pool, which as the name suggests, lacks some transparency.”
Robinhood’s payments to high-speed traders were detailed in regulatory disclosures available elsewhere on Robinhood’s website but until 2018, not on the “How We Make Money” page. The SEC enforces laws that require brokerage firms, public companies and other Wall Street players to disclose all material facts that an investor would want to know to make a trading decision, WSJ reported.
As a private company, Robinhood is not required to disclose its income statements. As a registered broker-dealer it does have certain required disclosures.
Order flow often results in slightly better prices for individual investors, the SEC wrote in a report about algorithmic trading issued last month. 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, the SEC report said.
Robinhood earned about half its revenue in 2018 from order flow, and less than half in 2017 from such payments, a person familiar with the matter told WSJ.
Robinhood updated its webpage the second week of October 2018 to disclose that it “receives rebates from executing brokers.” Robinhood co-founder and co-CEO Vladimir Tenev also published a blog post about the getting paid by high-speed traders. “The revenue we receive from these rebates helps us cover the costs of operating our business and allows us to offer commission-free trading,” he wrote.
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In the first half of 2020, Robinhood made $271 million in revenue from electronic trading firms, according to new disclosure reports mandated by the SEC.
The company was valued at $11.2 billion in a recent funding round and claims to have more than 13 million customer accounts.
Robinhood could have to pay a fine of more that $10 million if it agrees to settle the SEC investigation, WSJ reported: “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.”