Robinhood Reportedly Hit By SEC Fraud Probe, Possible Fine Of Over $10 Million

TOPLINE

Millennial trading app Robinhood is under investigation by the Securities and Exchange Commission for failing to disclose that it was selling clients’ orders to high-speed trading firms, The Wall Street Journal first reported on Wednesday, the latest in a series of troubles for the online broker despite its unprecedented business growth.

Robinhood co-founders Baiju Bhatt and Vladimir Tenev.

BONNIE RAE MILLS PHOTOGRAPHY

KEY FACTS

Robinhood faces a civil fraud investigation from the SEC, which is reportedly at an advanced stage, over its deals with high-speed trading firms.

The online brokerage could be forced to pay a fine of more than $10 million if it decides to settle with the SEC, sources told the Journal.

The probe revolves around Robinhood’s early failure to fully disclose its practice of selling customers’ orders to trading titans like Citadel Securities and Two Sigma Securities.

According to a Forbes investigation earlier this month, despite its proclamations about democratizing finance, Robinhood’s entire business has been built since its inception on selling its customers’ orders—known as “payment for order flow”—to Wall Street’s most notorious sharks, accounting for 70% of its $130 million in revenue during the first quarter.

In the second quarter, Robinhood’s PFOF doubled to $180 million; At other brokerages like Schwab and ETrade, PFOF only accounts for around 3% and 17% of revenue, respectively.

While Robinhood didn’t pioneer the selling of customers’ orders, it differs from its competitors by charging market makers a percentage of the spread on each trade it sells, versus a fixed amount (the larger the gap between the bid and asked price, the more Robinhood and other big firms profit).

crucial quote

“We strive to maintain constructive relationships with our regulators and to cooperate fully with them,” A Robinhood spokeswoman told the Journal.

Tangent

A deal with the SEC is unlikely to be announced this month, sources told the Journal, and Robinhood hasn’t yet entered into formal negotiations over a proposed fine.

Key background

Despite unprecedented growth this year, Robinhood has come under fire during the pandemic, notably for its two-day outage during the market’s rebound in early March. The trading app is the subject of several lawsuits alleging gross negligence over the outage, and is also reportedly under investigation by both the SEC and Financial Industry Regulatory Authority (FINRA) for its March outage, according to Bloomberg. The company has also faced criticism for the way it markets trading to inexperienced retail investors. There have been rising concerns on Wall Street that the company caters too much to younger users who don’t necessarily understand the dangers of high-risk trading, especially around options. One of Robinhood’s inexperienced young options traders, a 20-year old college student from Illinois named Alex Kearns, died by suicide in June after he mistakenly thought he owed Robinhood more than $730,000 because his account hadn’t yet reflected the settled trades in his account. While it’s impossible to know all of the factors contributing to suicide—especially in young people, Kearns’ death prompted questions from several members of Congress about the platform’s safety. Two days later, Robinhood’s founders released a statement pledging to tighten eligibility criteria, educational resources and upgrades to its user interface for customers trading options.

What to watch for

Robinhood announced yet another new round of funding—its third major cash injection in the last four months—at a valuation of $11.2 billion earlier this month, amid record numbers of new customers and speculation that the company could IPO later this year.