Has Robinhood been gamifying the market and gaming its customers?

Robinhood has enjoyed significant growth in both clients numbers and trading activity during 2020 as millennials with time on their hands rushed to trade stocks and equity options on the platform.

Traders using Robinhood pursued unconventional strategies that saw bankrupt companies such as Hertz effectively rise from the dead. Whilst Kodak shares saw multi-digit gains as millennials pilled into the stock on the award of a dubious-looking government contract.

This kind of trading drew accusations that Robinhood traders and those using its platforms did not understand how the markets worked or the risk that they were taking when trading in so-called zombie stocks. Yet so influential where Robinhood’s traders en masse that hedge funds started to analyse the holdings and activity of Robinhood’s client base. Data which Robinhood made freely available in aggregate on a daily basis.

However, it is not the trading tactics of Robinhood clients that has led the state to take legal action against the broker.

Rather it is what the lawsuit describes as “aggressive tactics to attract inexperienced investors, its use of gamification strategies to manipulate customers, and its failure to prevent frequent outages and disruptions on its trading platform.”

Accusations that Robinhood has roundly rejected.

However, Massachusetts is not alone in calling Robinhood to account for its actions. The US securities regulator the SEC has today charged Robinhood with misleading customers about revenue sources and failing to satisfy the duty of best execution.

Those charges relate to the controversial practice of payment for order-flow under which a broker receives remuneration from a market maker or hedge fund for routing its orders through them, rather than directly onto an exchange. Those payments help to subsidise the broker’s cost and allow them to offer commission-free trading.

The question being asked now is whether brokers such as Robinhood are acting in their clients best interest in entering into such arrangements? After all the buyers of the order flow are not acting in an altruistic fashion and are prepared to pay for that flow because they believe they can make money out of it. Whether through individual orders or through the aggregated business as a whole.

The potential for conflicts of interest in these arrangements leaves a bad taste in the mouth and is reminiscent of the debate around how B-bookers in the leveraged FX market treat and view their clients. That is as a continuous stream of inexperienced traders who they can take advantage of and oppose through the execution of their trades.

Indeed the debates about the transparency of execution, order-routing, choice of counterparty and attainment of best execution that are so familiar to, and ongoing in, the London FX market are all applicable to the practice of payment for order flow. Which has proved so popular in the fragmented world of US equity trading and execution.

The potential for conflicts of interest and perceived lack of disclosure were at the heart of comments made by senior SEC members about the actions that the commission has taken against Robinhood.

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

Joseph Sansone, Chief of the SEC Enforcement Division’s Market Abuse Unit said: Robinhood failed to seek to obtain the best reasonably available terms when executing customers’ orders, causing customers to lose tens of millions of dollars,” and that “Today’s action sends a clear message that the Commission will not allow brokers to ignore their obligations to customers.”

In popular folklore, Robin Hood was able to get away from the Sheriff of Nottingham today’s namesake is unlikely to be so lucky.