There is no such thing as a free trade.
Robinhood, the “Commission-free Stock Trading App” has agreed to a $65 million settlement to settle claims it 1) deceived customers about how it makes money and 2) failing to deliver the best trading execution for customers.
What’s The Beef?
In many respects, Robinhood is no different from any other brokerage. It makes money from interest on customers’ uninvested cash and through a practice known as “payment for order flow.”
You may have heard of payment-for-order-flow in Michael Lewis’ Flashboys. In essence, a brokerage firm will sell orders to third-party “market-makers” who then execute Robinhood customer’s trades.
- By quickly flipping the stock (in milliseconds), market-makers can capture the “spread,” or the difference between the price to buy and the price to sell.
On the surface, there is nothing illegal about payment for order flow (most brokerage firms do it). But (there’s always but) from 2015 to 2018, the SEC claims Robinhood did not accurately disclose this relationship to users.
The SEC said that Robinhood pressed high-speed traders for larger payments, which resulted in inferior trading executions for customers.
The Bottom Line: The SEC found that inferior execution cost Robinhood customers over $34 million, even when taking into account the amount saved from not paying a commission.
The Takeaway: The story broke just 24 hours after the Massachusetts Securities Division filed a complaint that Robinhood aggressively marketed to inexperienced investors and failed to implement controls to protect them.