Robinhood Settles S.E.C. Charges Over Misleading Customers

Robinhood, a fast-growing financial app, has attracted millions of young customers in recent years by making it fun and free to trade stocks, as well as riskier investments like options and Bitcoin.

Now the same practices that drove Robinhood’s success are increasingly leading to fines, complaints and scrutiny from state and federal regulators.

On Thursday, the Securities and Exchange Commission said that Robinhood had misled its customers about how it was paid by Wall Street firms for passing along customer trades and that the start-up had made money at the expense of its customers. Robinhood agreed to pay a $65 million fine to settle the charges, without admitting or denying guilt.

A day earlier, the top securities regulator in Massachusetts also filed a complaint against Robinhood, accusing the start-up of riding to success by “unscrupulously” pushing unsophisticated customers into risky investments.

The settlement and complaint add to the questions facing Robinhood, which has expanded rapidly over the last few years to become one of the biggest retail brokers in the country. Founded in 2013, it upended the brokerage industry with a sales pitch of no trading fees or account minimums. That has drawn in a younger generation of investors, turning the company into a Silicon Valley darling valued at nearly $12 billion.

But as people have flocked to Robinhood, some have said that the start-up’s lack of fees and account minimums have led to big losses for some customers. In June, a 20-year-old college student who traded on Robinhood committed suicide after placing trades that appeared to suddenly give him a negative balance of $730,000.

The legal actions against Robinhood show “that regulators don’t want this to be just a betting platform,” said Larry Tabb, an analyst who focuses on trading and brokers at Bloomberg Intelligence.

Nora Chan, a Robinhood spokeswoman, said the company “disagrees with the allegations” in the Massachusetts complaint and intends to vigorously defend itself. The company’s top lawyer, Dan Gallagher, said the S.E.C. fine, which was for activity between 2015 and 2018, “relates to historical practices that do not reflect Robinhood today.”

At the heart of the S.E.C.’s scrutiny of Robinhood was a business practice known as payment-for-order-flow. Under this practice, retail brokers allow Wall Street firms to trade against their customers in exchange for a fee.

That payment is Robinhood’s primary source of revenue. It has allowed the start-up to do away with the trading fees that retail brokerage firms historically charged people every time they bought or sold a stock. The S.E.C. said that Robinhood had misled customers by not telling them it was making money in this way.

Robinhood also chose to send its customer orders to whichever Wall Street firm paid it the biggest fees at the time, rather than the ones that offered customers the best trading prices, according to the S.E.C. complaint.

The complaint added that Robinhood employees raised concerns internally about how customers would have gotten better prices — or “price improvement” as it is known — if they had used other retail brokerage firms.

Over the period examined by the S.E.C., the agency said that customers lost more than $34 million by not taking their orders to other brokerage firms that would have offered them better prices.

The New York Times reported in July that Robinhood made significantly more than any other retail brokerage firm for each trade sold to Wall Street. Those fees have continued to rise as the year has gone on, according to public filings.

Many customers and investor advocates are also concerned that Robinhood has pushed even the least experienced investors into investments that can quickly lose money by sending phone notifications and emails recommending trades.

William F. Galvin, the Massachusetts securities regulator, said this week that Robinhood had used strategies that made trading feel like a game to encourage people to trade more. The app rains down confetti when customers place a trade, for example. It also offers people free shares of stock when they digitally scratch off what looks like a lottery ticket.

The Massachusetts complaint said Robinhood’s own policies prohibited the company from allowing customers with no experience to trade risky options products. But, the complaint said, Robinhood regularly approved customers for options trading even when they said they had no experience.

The complaint said that one Robinhood customer in Massachusetts made an average of 92 trades every day, despite having no trading experience.

The complaint also said that Robinhood had not invested enough in its technology, making the service vulnerable to outages at crucial moments. The company is currently fighting a lawsuit from investors who lost money when Robinhood went down for almost two days in early March, when the stock market was volatile.

The Massachusetts complaint said that Robinhood’s app had continued to face outages multiple times a month since then.

These issues have not scared away venture capital investors. Robinhood has closed two funding rounds this year. The company has recently begun planning for an initial public offering and has hired Goldman Sachs as an adviser, two people with knowledge of the matter, who were not authorized to speak publicly, have said.

Matt Phillips and Gregory Schmidt contributed reporting.

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