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Robinhood IPO Pitch Unveils Order Flow Payment, Crypto Crackdown Risks

Robinhood's biggest revenue gainers -- payment for order flow and cryptocurrency trading -- could also face the biggest regulatory changes in the coming years.

Robinhood Markets unveiled plans Thursday for a Nasdaq listing that could value the online trading platform at more than $40 billion, but with regulators probing a key source of its revenues, investors may proceed with caution as the group brings its shares to the market later this summer.

In and S-1 filing with the Securities and Exchange Commission, Robinhood said it had “a market-leading financial technology platform with an intuitive customer interface that has changed the landscape of retail investing”, adding that it's “well-positioned to serve an increasing portion of the population and the broader financial services ecosystem.”

That's hard to argue when the group estimates it's captured more than half of all retail brokerage accounts that have been opened in the United States over the past five years. 

Robinhood said it generated $959 million in revenues last year, a 245% increase from 2019, and noted it has 17.7 million active users on the platform with aggregate assets of around $81 billion. 

However, more than three quarters of that revenue total -- as astonishing as it is on face -- came from larger brokerage firms in the form of so-called payment for order flows (PFOFs), a controversial practice that has caught the attention of the SEC. 

"Robinhood explicitly offered to accept less price improvement for its customers in exchange for receiving higher payment for order flow for itself," SEC Chairman Gary Gensler said last month in a speech during which he addressed by 'conflict of interest concerns' and the 'gamification' of stock trading on retail brokerage platforms

"As a result, many Robinhood customers shouldered the costs of inferior executions; these costs might have exceeded any savings they might have thought they’d gotten from zero commission trading."

Robinhood itself noted that new regulations on PFOFs could trigger "significant changes to our business model", while also detailing a series of regulatory and legal challenges linked to everything from anti-money laundering and cybersecurity to allegations of unethical conduct and lapses in transparency.

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Only this week, in fact, the Financial Industry Regulatory Authority (FINRA) fined Robinhood $57 million earlier this week, and ordered it to pay a further $12.6 million in damages, after it deemed the group caused "significant" harm to some its customers in showing them incorrect account balances.

Last year, Alexander Kearns committed suicide after he thought he'd run up massive losses in a Robinhood trading account.

Kearns, 20, was a student at the University of Nebraska. He thought he'd generated losses of more than $730,000. He had not.

Earlier this year, Robinhood raised $3.4 billion from its existing shareholders in a move aimed at allowing the group to meet margin requirements at the Depository Trust & Clearing Corporation (DTCC) clearing house while also expanding and fine-tuning its platform

Robinhood co-founder Vlad Tenev told the online audio meeting group Clubhouse at the time that the National Securities Clearing Corp., a DTCC subsidiary, asked for a deposit of $3 billion late Thursday -- a figure it ultimately reduced to $1.4 billion -- to support the surge in trading volume linked to the sudden surge in so-called 'meme stocks' that gripped Wall Street in January and February. 

Meme stocks, of course, represent an important component to the group's success, although its S-1 filing also revealed $11.6 billion in cryptocurrency assets, the majority of which were related to Dogecoin. 

Over the first three months of the year, in fact, 9.5 million Robinhood customers traded $88 billion worth of digital currencies, a massive increase from the same period last year.

"Regulation of the cryptocurrency industry continues to evolve and is subject to change. Moreover, securities and commodities laws and regulations and other bodies of laws can apply to certain cryptocurrency businesses,' Robinhood said in its S-1 filing. "These laws and regulations are complex and our interpretations of them may be subject to challenge by the relevant regulators. Future regulatory developments are impossible to predict with certainty."

"Changes in laws and regulations, or our failure to comply with them, may negatively impact our ability to allow customers to buy, hold and sell cryptocurrencies with us in the future and may significantly and adversely affect our business," the group added.