The Financial Industry Regulatory Authority, or FINRA, has fined the world-famous commission-free investing platform, Robinhood, with $1.25 million. This fine is in accordance with a civil action laid against the company for not giving its customers the best execution price for equity orders and further failing in the proper supervision of the process.
The Importance of Payment Order Flow
FINRA serves as the largest independent regulator for the security industry within the US. The organization commented that the disciplinary case in question comes from a business arrangement known as “payment order flow” within the brokerage industry. Specifically, Robinhood was fined for events happening between October 2016 and November 2017.
The practice, while controversial, is a significant facet of Robinhood’s business model. The method entails selling the customer trades to specific trading firms, with said trading firms paying the brokerage for the order flows. Robinhood had made use of its stock-trading millennial app in order to route non-directed equity orders to four broker-dealers. These broker-dealers paid Robinhood for the order flow, in turn, according to FINRA. This “payment for order flow” practice raked in $70 million in revenue for Robinhood a year ago.
Robinhood’s Improper Order Flow Practices
The US industry mandates brokerages to make use of reasonable diligence in order to ensure that the transaction prices for customer trades are the most favorable they can be. This regulation is put into official legislation by way of FINRA Rule 5310, providing a standard for firms to adhere to and respect during best execution practices.
FINRA also stated that the Robinhood brokerage failed to do a systematic best execution review for several order types. Things like stop orders, nonmarketable limit orders, and orders received that were outside of regular trading hours were all done with lackluster best execution, according to FINRA. These “not-my-shift” style reviews caused hundreds of thousands of orders to happen every month that fell outside Robinhood’s “regular and rigorous” reviewing process.