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Robinhood is under investigation

Image source: Sabelskaya - Shutterstock

What's going on?

Robinhood is facing a probe from US regulators concerned that the upstart trading app hasn’t been clear enough about how it makes its money.

What does this mean?

The majority of stock trading involves huge “market makers” that use lightning-fast computers to profit from tiny price discrepancies within a fraction of a second. Pretty much all US brokers sell their customers’ orders to them, but the practice – known as “payment for order flow” – accounts for a higher proportion of revenue at Robinhood, which doesn’t make much from trading fees.

The Securities and Exchange Commission (SEC) is now reportedly looking into whether Robinhood did enough to let its customers know. And if it has to settle the case, the $11 billion company – which has attracted more than 13 million clients since 2013 – might have to pay more than $10 million in fines.

Why should I care?

For markets: Small is beautiful. 
The plumbing that connects modern financial markets is complicated. When you hit buy on a stock in your Robinhood app, it’s unlikely your order will ever actually reach a stock exchange. That’s because market makers get in there first: small investors’ orders – unlike those of big banks and hedge funds – don’t have the clout to influence share prices, which means those prices are never going to move in a way that hurts market makers. And since market makers give small traders a better price than if the order had gone to the exchange itself, it’s a win-win.

For you personally: Careful what you wish for. 
Robinhood made $180 million from payments for order flow in the second quarter, and while the company’s total revenue is generally kept under wraps, we know those payments have accounted for about half in previous years. So if the SEC gets too tough, there’s always a risk Robinhood might think about making money in new ways – like, say, suddenly imposing more fees on its users…

Originally posted as part of the Finimize daily email.

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