A Wall Street regulator today fined commission-free investing app Robinhood $1.25 million in a civil action for not getting the best execution price for customer equity orders and failing to properly supervise the process.
The Financial Industry Regulatory Authority (FINRA), the largest independent regulator for all securities firms doing business in the United States, said the disciplinary case stems from an arrangement known in the brokerage industry as ‘payment for order flow’ between October 2016 and November 2017.
This controversial practice is a major part of Robinhood’s business and involves selling customer trades to certain trading firms. The popular millennial stock-trading app routed its customers’ non-directed equity orders to four broker-dealers, all of which paid Robinhood for that order flow, said Finra.
The so-called “payment for order flow” had reportedly brought in $70 million in revenue for Robinhood last year.
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The industry rules require brokerages to use reasonable diligence to ensure that the transaction prices for customers’ trades are as favorable as possible amid the current market conditions. This duty of “best execution” is also incorporated FINRA Rule 5310, which provides standards for firms with respect to best execution.
No-fee model attracted 10 million users to Robinhood
The Financial Industry Regulatory Authority also said Robinhood did not perform systematic best execution reviews of several order types, such as nonmarketable limit orders, stop orders, and orders received outside of regular trading hours. As a result, hundreds of thousands of orders each month fell outside the firm’s “regular and rigorous” review process.
Commenting on the regulatory settlement, Robinhood said: “The facts on which the settlement is based do not reflect our practices or procedures today. The agreement relates to a historic issue during the 2016-2017 timeframe involving consideration of alternative markets for order routing, internal written procedures, and the need for additional review of certain order types. Over the last two years, we have significantly improved our execution monitoring tools and processes relating to best execution, and we have established relationships with additional market makers.
According to its recent metrics, Robinhood has ushered in ten million users, double than it was a year ago, and a $7.6 billion valuation in its six-year existence, up to $2 billion from its Series D valuation in 2018. Its free-commission model for stock trading has been successful in attracting millennials and put pressure on major brokerages that had to catch up with a wave of fee-eliminating announcements over the past two months.
For now, Robinhood can keep its free platform afloat through making compromises to some business aspects such as not having many physical locations, a small staff for client service, and not spending on massive promotional campaigns.