Inexperienced Robinhood Traders Charged Backdoor Fees in Undisclosed ‘Payment for Order Flow’ Scheme, Class Action Says

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Robinhood has capitalized on a surge of first-time, inexperienced investors by “misleading and luring” unsuspecting users into executing inferior market trades under the guise of “commission-free” trading, a proposed class action alleges.

Through what the lawsuit calls a “process of deceit and omission,” Robinhood has misled traders by failing to disclose that its business operations—and revenue—rely extensively on “payment for order flow,” which refers to the payment defendants Robinhood Financial and Robinhood Securities receive from market makers in exchange for executing the service’s trades, the complaint claims. 

In all, the 30-page lawsuit charges that Robinhood, while touting its product as an “easy-to-use commission-free” stock trading platform, has “profited extensively” from inexperienced users who’ve made trades at inferior execution prices—the price at which a stock trade is actually made or executed—compared to what they would have received from the defendants’ competitors. For larger-value orders, the price differential between Robinhood and its competitors is often in excess of what those competitors would have charged in commission, the case additionally claims. 

According to the lawsuit, the inferior execution prices received by Robinhood users stem in large part from the “unusually high” charges sought by the defendants from principal trading firms in exchange for the opportunity to obtain Robinhood’s customer order flow. These principal trading firms and electronic market makers in turn passed their costs along to Robinhood’s users on each trade through “inferior execution quality,” the price at which the requested market orders were executed. 

“Effectively, Robinhood charged backdoor commission fees to each of its clients’ orders, while concealing and denying the payment for order flow scheme,” the plaintiff, a New Hampshire Robinhood trader, claims. 

To make the aforementioned scheme happen, Robinhood published “misleading statements and omissions” in communications with customers with relation to the execution of trades and the sources of the company’s revenue, the lawsuit alleges. Further, Robinhood failed to disclose and omitted information regarding the payment for order flow process, the defendants’ largest revenue source, by instructing customer services reps to avoid mentioning payment for order flow in response to questions about how Robinhood makes its money and keeping this information off the company’s website, according to the case. 

As a broker-dealer that handles customer orders for execution, Robinhood had a duty of best execution to its client and a duty to seek and obtain the best reasonably available terms for customer orders, the suit relays. Nevertheless, the defendants “knowingly violated” these obligations by charging unusually high payment for order flow rates to vendors and failing to conduct adequate regular and rigorous reviews of the execution quality it was providing on customer orders, the lawsuit alleges. 

“Defendants have quietly sought to force its customers to execute trades on Defendants’ platform at inferior prices compared to what consumers would have received from Robinhood’s competitors, while profiting on the back end of those trades,” the suit says, alleging violations of California consumer protection statutes and the federal Securities Exchange Act of 1934. 

The lawsuit’s December 23 filing brought to a close Robinhood’s bumpy 2020, a year in which the stock trading app faced proposed class action litigation over everything from the game-like nature of its platform to widespread March outages to problems allegedly experienced by options contract holders to an apparent swing and miss on a T1 halt on the trading of Hertz Corp. stock. 

The case looks to represent a class consisting of all individuals in the United States or its territories who were Robinhood users between September 1, 2016 and June 30, 2019 and who placed orders in connection with which Robinhood received payment for order flow. The plaintiff looks for the court to require Robinhood to pay damages and restitution to proposed class members and enjoin the defendants from any further legal violations through the alleged payment for order flow scheme, as well as “publicly correct the false and misleading statements and omissions” alleged in the lawsuit.

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