Robinhood/Finra: model is a tempting target for regulators

There are two ways to view Robinhood’s agreement to pay nearly $70m to settle regulatory allegations that it has misled customers. The first is that the US share trading app has ended its regulatory problems. The second is that a red flag has sprouted over Robinhood’s upcoming initial public offering.

The app is seeking to ride the twin waves of explosive growth in retail investing and a red-hot US IPO market to drum up demand for its own shares.

The Silicon Valley company confidentially filed to go public in March. Privately valued at $11bn less than a year ago, it is now reportedly eyeing a $40bn-$50bn valuation amid the trading frenzy fuelled by Reddit-driven retail investors this year.

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But IPO plans have faced delays amid regulatory scrutiny. Seen in this light, a $70m settlement is not much to pay to clear the path for a potentially big payday. The risk for investors is that the legal hits will keep on coming. 

Robinhood has been credited with helping to democratise stock trading for everyday investors with its zero-commission equity trading business model. But it has also become a target of regulators, lawmakers and its own users. 

Last year, the SEC fined Robinhood $65m over charges that it misled customers about its revenue sources. The regulator is also mulling changes to rules around payment-for-order flow, whereby brokers send retail customer trades to market-making companies such as Citadel Securities or Virtu Financial in return for a fee. 

Any changes could have serious implications for Robinhood’s business model. The company makes the bulk of its revenue from payment-for-order flows. These generated about $331m in revenue for Robinhood in the first quarter of 2021, more than triple the amount from the same period a year previously.

Robinhood can be credited with creating a popular and disruptive business model in retail financial services, a sector littered with flops. Unfortunately, that model depends on payment-for-order flow, where there are potential conflicts of interest. Would-be IPO investors should read the “risks” section of this prospectus closely.

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