‘You’re saving a penny to lose a nickel.’ Why Robinhood’s $65M fine is a cautionary tale for retail investors

Robinhood, the stock trading app popular with young investors, wasn’t forthright with customers on how it makes money through its commission-free platform and didn’t live up to its duty to ensure users got the best terms on trades, the Securities and Exchange Commission said Thursday.

By going along with Robinhood’s tempting $0 commissions instead of brokerages with $5 trade-order commissions, investors missed out on $34 million over a roughly three-year span thanks to inferior trade prices, the SEC alleged. And that’s after factoring out the cost of five-dollar trade order commissions, the regulator added.

Now, Robinhood is paying a $65 million penalty to resolve the regulator’s charges and agreeing to pay for an independent compliance consultant that will review its approach when dealing with companies to execute user trades.

Robinhood — which isn’t admitting or denying the SEC findings — is paying the money and putting the matter behind it as it eyes an initial public offering. The fine relates to past practices that don’t reflect what the company is now, according to a Robinhood statement.

Yet Barbara Roper, director of investor protection at the Consumer Federation of America, said Robinhood seems “to be more focused on making a cool app than having a broker-dealer that complies with securities laws that investors get the best available price when they trade.”

She and other consumer advocates say the case contains cautionary tales that budding investors need to hold onto.

There’s no such thing as a free stock trade

When Robinhood users want to buy or sell a stock, the app, like other retail broker-dealers, isn’t carrying out the trade itself, the SEC order said. Robinhood routes orders to companies that pay to receive the order and carry out the trade.

But broker-dealers like Robinhood have what’s called a “a duty of best execution” where they have to seek the most favorable terms for a customer order, according to the SEC. (That could mean execution price, or other factors like execution speed, Roper noted.)

The problem when retail broker-dealers are paid to route orders is that it creates a potential conflict of interest, where the brokerage could put its own financial interests over a customer who just wants a quick trade, the SEC said.

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