Though the class action names many other financial businesses, like Citadel Securities, Charles Schwab, Melvin Capital Management and SoFi Securities, Robinhood is the main antagonist. It is a defendant in nearly all of the dozens of original actions, is facing almost all the claims and appears on nearly every page of the filings. The complaint calls Robinhood “a true amateur among institutional brokers.”
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Investors taking part in the class action argue that Robinhood’s business model has a built-in conflict of interest. The company generates about 80 percent of its revenue from payment for order flow, which allows it to offer commission-free trading to users. In this arrangement, the broker sells customer orders to market-making firms (primarily Citadel Securities in Robinhood’s case) that execute the trades. Robinhood makes more from this practice than other brokers because its traders are more active.
Critics of payment for order flow, who include some lawmakers and regulators, say it presents a conflict for brokers who are paid by market makers but owe a fiduciary duty to customers. And because brokers make more money if customers trade more, the incentive is to “gamify” trading, which could be against the investors’ interests. (In March, Robinhood removed the digital confetti that celebrated trades in the app.)
There is “no question” the decision to limit trading during the January chaos harmed retail traders and cast doubt on Robinhood’s claims of leveling the playing field for the small investor against big institutions, said Marc Steinberg of Southern Methodist University’s law school, the author of “Rethinking Securities Law.” “The question is to what degree we are going to hold parties liable.”
These sorts of lawsuits are an important enforcement mechanism, forcing more transparency from companies, Mr. Steinberg said. The class action will take at least 18 months to resolve if it goes to trial, said Maurice Pessah, one of the lead lawyers for the plaintiffs. Robinhood has told the court that it will seek a dismissal.
The plaintiffs have not yet determined how much they are seeking in damages if they succeed. Regardless, Robinhood is accustomed to paying up and moving on.
In July, it was hit with the Financial Industry Regulatory Authority’s largest-ever penalty, $70 million, for service outages and the misleading of customers. Late last year, the Securities and Exchange Commission imposed a $65 million fine on the company for its failure to disclose “true costs” to customers. The S.E.C. has promised a report on January’s trading frenzy this summer, and warned that changes to how brokerage apps operate might follow.