SEC Charges Robinhood for its Misleading Statements, Omissions, and Inferior Order Execution Quality, Settles for $65M

On Thursday, the Securities and Exchange Commission (SEC) announced that Robinhood Financial LLC, which runs the popular Robinhood securities trading app, has agreed to pay $65 million to settle charges relating to its “repeated misstatements that failed to disclose the firm’s receipt of payments from trading firms for routing customer orders to them, and with failing to satisfy its duty to seek the best reasonable available terms to execute customer orders.”

“There are many new companies seeking to harness the power of technology to provide alternative ways for people to invest their money,” Erin E. Schneider, Director of the SEC’s San Francisco Regional Office, said.  “But innovation does not negate responsibility under the federal securities laws.”

Robinhood allegedly made misleading statements and omissions in customer communications between 2015 and 2018 by failing to disclose how it makes money in its business deals with various trading firms via a “payment for order flow,” which is payment from trading firms for when Robinhood sends its customer orders for the firms to execute; these firms pay for the right to execute. However, the payment for order flow practice can create a conflict of interest because of the incentive to send customer orders to the highest bidder.

According to the SEC order, despite Robinhood’s “commission free” trading, which was a selling point for consumers, Robinhood’s orders were executed at “inferior” prices in comparison to other brokers due to its unusually high rate for payment for order flow. The SEC stated that between October 2018 and June 2019 Robinhood falsely claimed in a FAQ on its website that it matched or beat its competitors’ execution quality. Nevertheless, the SEC found that Robinhood “provided inferior trade prices that in aggregate deprived customers of $34.1 million even after taking into account the savings from not paying a commission.” Moreover, the SEC proffered that these false and misleading statements were made when Robinhood was rapidly growing. The order noted that because Robinhood was “a broker-dealer that routed customer orders for execution, (it) had a duty to seek to obtain the best reasonably available terms for customers’ orders.”

“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, said.

Meanwhile, a lawyer for Robinhood stated that the aforementioned practices “do not reflect Robinhood today,” as reported by CNBC. A spokesperson for Robinhood added that “We are 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.”

Robinhood was accused of violating Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and Section 17(a) and Rule 17a-4 of the Securities Exchange Act of 1934. Robinhood did not admit or deny the allegations, but agreed to the SEC’s cease-and-desist order, which bars it from violating the Securities Act and the Exchange Act, in particular, the antifraud provisions and the recordkeeping provisions of the respective Acts. Additionally, Robinhood is censured and required to pay a $65 million civil penalty. Furthermore, Robinhood has agreed to have an independent consultant review its policies and procedures for customer communications, payment for order flow, and customer order execution, as well as to make sure that Robinhood is effectively following these policies and procedures; Robinhood is required to keep its compliance records for a period of time.

The SEC investigation was conducted and supervised by members of the SEC’s Market Abuse Unit and members of the San Francisco Regional Office. Members of the SEC’s Chicago Regional Office examined Robinhood and other members of the San Francisco Regional Office also contributed to the investigation. The Financial Industry Regulatory Authority (FINRA) also helped in the endeavor.

The charges and settlement come one day after the Wall Street Journal reported that a Massachusetts regulator filed a complaint against Robinhood for targeting novice investors and exposing them to “unnecessary trading risks. This also follows the SEC and FINRA’s September investigation into Robinhood for its March outage. Moreover, Robinhood faced several lawsuits for the same outage.