Robinhood has revolutionized the way that younger generations, such as millennials, interact with the stock market. The initial appeal of Robinhood was its commission-free trades but the introduction of fractional share purchases has made the app even more attractive. Despite the app’s ability to reach demographics who would otherwise never consider trading on the stock market, they have experienced several setbacks this past year.
In March, Robinhood’s platform crashed creating a two-day outage in which could cost investors billions of dollars. Later in the year, they were subject to more public criticism after being identified as the cause for a 20-year old college student’s suicide. Despite emerging from those previous issues, Robinhood is currently facing a civil fraud investigation by the Securities and Exchange Commission (SEC).
The basis for the Robinhood SEC investigation relates to their use of payment for order flow. Simply put, payment for order flow is when a broker outsources the execution of a trade to a third party in exchange for compensation. The third-party, typically a high-frequency trading firm, benefits from the excess traffic so that they financially reward the broker for each trade. Although payment for order flow is not illegal, Robinhood failed to disclose that this was one of their primary sources of revenue which apparently warrants an SEC investigation.
According to The Wall Street Journal, The SEC’s probe into Robinhood is at an advanced stage and could result in a fine of more than $10 million. In 2019, the Financial Industry Regulatory Authority, overseen by the SEC, fined Robinhood $1.25 million for similar violations that took place between Oct. 2016 and Nov. 2017.
During the earlier stages of the pandemic, Robinhood gained 3 million new accounts during the first few months of 2020, with the total number of customer accounts increasing to 13 million, as of May. Robinhood made $180 million in payment from order flow revenue in the second quarter, roughly double from the prior quarter. Hopefully, the investigation will be settled within the next year so that Robinhood will be able to focus on providing more services to their customers.