Robinhood coughs up

Many assumptions were wrong. Robinhood did not escape from the clutches of the Sherrif of Nottingham, which in this case is the US Securities and Exchange Commission, more commonly known as the SEC.

In fact, only a few hours after Robinhood’s transgressions came to light, the SEC levied charges of making misleading statements and omissions about its sources of revenues from its client-facing websites and by extension of failing to obtain the best reasonably available terms when executing customers orders against the broker.

Robinhood settled those charges with a payment of $65.0 million dollars. Lawyers for the company said that the behaviour characterised by the SEC did not reflect the Robinhood of today.

The brokerage which has helped to transform the US equity trading landscape has raised $1.0 billion during 2020 and has been valued at $11.70 billion so the $65.0 million settlement was probably the best option with Robinhood following the old trading adage that the first cut is the cheapest.

Robinhood would no doubt have been concerned about additional reputational damage it may have incurred had it contested the SEC allegations. Allegations that might have persuaded some of the 3 million new customers it’s believed to have acquired in 2020 to look elsewhere for the brokerage services.

The SEC alleged that the prices that Robinhood achieved for customers in the period between 2015 and late 2018 were inferior to those of other electronic brokers and that because of this clients missed out on more than $34.0 million dollars even after allowing for the fact that they weren’t paying for execution.

The SEC filings were said to reveal that Robinhood received $180.00 million in payment for order flow revenues in Q2 2020 alone.

The rules around best execution for retail business often involve a degree of latitude beyond just achieving the highest or lowest price available and can include factors such as the ability to trade and settle on a venue, order sizes, aggregation and other factors which can influence the choice of trading venues and the price attained.

It’s not clear if that $180.0 million dollar payment was from one or more execution venues but one can imagine how an income of that size could influence the choice of execution venues and order routing to it.

There has been no mention yet on Robinhood’s website about the SEC action and its prompt settlement nor is there any mention the separate legal action taken against the company by the State of Massachusetts or if The company plans to defend and dispute those claims.

However, Robinhood’s website does contain a graphical explanation of where and how the businesses revenues are generated. Although when I clicked through for a fuller description of what the company calls rebates from market makers and trading venues and for details order routing and execution quality I was taken to a page with a 404 error notice on it.

It’s not clear if the money paid to the SEC or a portion of it will be made available to compensate Robinhood clients who may have been disadvantaged. If not could that perhaps lead to a separate class action against the company? Robinhood settled the SEC charges with admitting any guilt or liability but it didn’t deny the allegations either.

We are often told there is no such thing as a free lunch and this episode just serves to reinforce that message.