Robinhood, a trading platform that said it did not charge commissions, agreed to pay $65 million to settle the charges. The SEC said said it repeatedly offered misstatements. The firm paid the civil penalty without admitting or denying the SEC's findings. Regulators in Massachusetts have also made allegations about the firm.

The Securities and Exchange Commission has charged trading platform Robinhood Financial for “repeated misstatements,” which the SEC said failed to disclose the firm’s receipt of payments from trading firms for routing customer orders to them. 

It also charged the business with failing to satisfy its duty to seek the best reasonably available terms to execute customer orders. 

Robinhood agreed to pay $65 million to settle the charges, the SEC said in a statement yesterday. 

Separately, Massachusetts securities regulators on Wednesday filed a complaint against the platform, alleging the company aggressively sold its wares to inexperienced investors. 

The controversy comes at a time when the wealth management sector is adjusting to the Regulation Best Interest regime that kicked in earlier this year – to some controversy, prompted by concerns that it is actually a step backwards in terms of fiduciary duties (see commentaries here and here). 

Criticism from the sector
“We live in volatile times and that creates a lot of appetite for options,” Richard Smith, CEO of the Foundation for the Study of Cycles, told this publication. (Smith is a regular commentator in the media and elsewhere on these issues.)

Recent SEC regulations have required brokers and market makers to disclose options trading activity, and this has brought the data to light, he said. Smith said the idea of platforms such as Robin Hood offering “free trading” is “disaster for the public” because it encourages over-trading and this ultimately erodes returns, at the expense of the end-investor who does not appreciate what is going on.

“Robinhood is the Google of the retail industry; its customers are the market makers. There needs to be more transparency,” he said. As far as options in general are concerned, protecting downside risk by wealth managers can be sensible, Smith added.

What happened
The SEC said that 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 regulator noted that a Robinhood selling point 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. 

The SEC said that Robinhood “falsely claimed in a website FAQ between October 2018 and June 2019 that its execution quality matched or beat that of its competitors”. 

“The order finds 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. Robinhood made these false and misleading statements during the time in which it was growing rapidly,” the regulator said in its statement. 

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

Without admitting or denying the SEC’s findings, Robinhood agreed to a cease-and-desist order prohibiting it from violating the antifraud provisions of the Securities Act of 1933 and the recordkeeping provisions of the Securities Exchange Act of 1934, censuring it, and requiring it to pay a $65 million civil penalty. The firm also agreed to retain an independent consultant to review its policies and procedures relating to customer communications, payment for order flow, and best execution of customer orders, and to ensure that Robinhood is effectively following those policies and procedures.

Massachusetts 
The enforcement arm of the Massachusetts Securities Division has also said that the firm failed to protect its customers and their assets, violating state laws and regulations (source: Wall Street Journal).

Robinhood exposed Massachusetts investors to “unnecessary trading risks” by “falling far short of the fiduciary standard” adopted this year that requires broker-dealers to act in their clients’ best interest, the state body is quoted as having said.

The WSJ said Robinhood disagrees with the allegations, and that the company intends to defend itself vigorously.