Silicon Valley start-up, Robinhood fined $65M for misleading customers about how it makes money

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The U.S Securities and Exchange Commission on Thursday charged Robinhood Financial with deceiving its stock market customers about how it makes money.

The charge came barely a day after regulators in Massachusetts sued the company, accusing Robinhood of targeting young and inexperienced investors with flashy gimmicks on its trading app that treat stock investing like a game.

“Between 2015 and late 2018, Robinhood made misleading statements and omissions in customer communications, including in FAQ pages on its website, about its largest revenue source when describing how it made money — namely, payments from trading firms in exchange for Robinhood sending its customer orders to those firms for execution, also known as ‘payment for order flow,’” the SEC said.

SEC also charged the company for misleading customers that trading on its platform is commission free.

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“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,” according to a statement by SEC.

Without contest, Robinhood agreed to pay the $65 million fine. Dan Gallagher, the company’s chief legal officer said “The settlement relates to historical practices that do not reflect Robinhood today.

“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,” Gallagher said.

Robinhood makes millions through a process known as “payment for order flow”, whereby it takes a customer’s stock order and sells it to a much bigger trading firm that executes the trade.

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Most online brokers rely on this controversial, but legal practice as their primary method to make profits in lieu of commissions.

Robinhood received $180 million in payments for trades through the “payment for order flow” practice in the second quarter of 2020, according to CNBC, citing SEC filing.

SEC said Robinhood did not mention payment for order flow rates at a time when the company was rapidly growing, but it markets its services as “commission free,”

The Federal Regulator accused Robinhood of providing inferior trade prices that cost customers $34.1 million, even after considering the savings from not paying a commission.

“Robinhood provided misleading information to customers about the true costs of choosing to trade with the firm,” said Stephanie Avakian, director of the SEC’s Enforcement Division.  “Brokerage firms cannot mislead customers about order execution quality.”

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“Today’s action sends a clear message that the Commission will not allow brokers to ignore their obligations to customers,” said Joseph Sansone, chief of SEC Enforcement Division’s Market Abuse Unit.

In defense, a Robinhood spokesperson said; “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, the Silicon Valley start-up has achieved tremendous growth this year due to market volatility caused by the coronavirus pandemic. The company gained three million new customers in the first four months of 2020, according to reports