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‘You’re saving a penny to lose a nickel.’ Why Robinhood’s $65M fine is a cautionary tale for retail investors

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Robinhood, the stock trading app popular with young investors, wasn’t forthright with customers on how it makes money through its commission-free platform and didn’t live up to its duty to ensure users got the best terms on trades, the Securities and Exchange Commission said Thursday.

By going along with Robinhood’s tempting $0 commissions instead of brokerages with $5 trade-order commissions, investors missed out on $34 million over a roughly three-year span thanks to inferior trade prices, the SEC alleged. And that’s after factoring out the cost of five-dollar trade order commissions, the regulator added.

Now, Robinhood is paying a $65 million penalty to resolve the regulator’s charges and agreeing to pay for an independent compliance consultant that will review its approach when dealing with companies to execute user trades.

Robinhood — which isn’t admitting or denying the SEC findings — is paying the money and putting the matter behind it as it eyes an initial public offering. The fine relates to past practices that don’t reflect what the company is now, according to a Robinhood statement.

Yet Barbara Roper, director of investor protection at the Consumer Federation of America, said Robinhood seems “to be more focused on making a cool app than having a broker-dealer that complies with securities laws that investors get the best available price when they trade.”

She and other consumer advocates say the case contains cautionary tales that budding investors need to hold onto.

These are lessons like the potentially hidden cost of $0 commissions and unclear financial risks — all things worth remembering at a time when Robinhood isn’t the only place to trade without commissions and more people are trying to play the market with a couple of thumb swipes.

There’s no such thing as a free stock trade

When Robinhood users want to buy or sell a stock, the app, like other retail broker-dealers, isn’t carrying out the trade itself, the SEC order said. Robinhood routes orders to companies that pay to receive the order and carry out the trade.

But broker-dealers like Robinhood have what’s called a “a duty of best execution” where they have to seek the most favorable terms for a customer order, according to the SEC. (That could mean execution price, or other factors like execution speed, Roper noted.)

The problem when retail broker-dealers are paid to route orders is that it creates a potential conflict of interest, where the brokerage could put its own financial interests over a customer who just wants a quick trade, the SEC said.

Sometimes, laggy trades can tack on a mere penny or a half a penny as orders catch up to constantly moving markets, but it all adds up and never benefits investors, said Lev Bagramian, senior securities policy advisor at Better Markets, an investor protection watchdog organization.

Robinhood allegedly fell short of its duty, the SEC said. “Customers received inferior execution prices compared to what they would have received from Robinhood’s competitors. …These inferior prices were caused in large part by the unusually high amounts Robinhood charged the principal trading firms for the opportunity to obtain Robinhood’s customer order flow,” the order said.

See also: Is Robinhood making money off those day-trading millennials? Well, yes. That’s kind of the point.

For Roper, the case boils down to this: “You’re saving a penny to lose a nickel.”


‘You’re paying. You just don’t know how you’re a paying.’


— Barbara Roper, director of investor protection at the Consumer Federation of America

And it’s a reminder that $0 doesn’t mean no cost, she added. “You’re paying. You just don’t know how you’re a paying. This is not a charitable operation. It’s a money making business. If you’re not paying for something, you are going to pay for it in a way you can’t see.”

“The settlement relates to historical practices that do not reflect Robinhood today,” said Dan Gallagher, Robinhood’s chief legal officer and a former SEC commissioner. “We recognize the responsibility that comes with having helped millions of investors make their first investments, and we’re committed to continuing to evolve Robinhood as we grow to meet our customers’ needs.”

State regulators say Robinhood makes trading too fun and too easy

The SEC announced the $65 million penalty one day after Massachusetts state financial regulators filed their own administrative complaint against Robinhood. The company is turning investing into a game for young, neophyte investors who wind up exposed to unnecessary trading risks, the complaint alleged.


‘Millions of people have made their first investments through Robinhood, and we remain continuously focused on serving them.’


— Robinhood statement

A Robinhood spokeswoman said the company will “vigorously” dispute the matter. “Robinhood is a self-directed broker-dealer and we do not make investment recommendations. Over the past several months, we’ve worked diligently to ensure our systems scale and are available when people need them. We’ve also made significant improvements to our options offering, adding safeguards and enhanced educational materials. Millions of people have made their first investments through Robinhood, and we remain continuously focused on serving them.”

The SEC proceedings and the Massachusetts action are “different aspects of the same problem. The firm is putting its own interest ahead of the financial interest of its customers,” Roper said.

It’s also part of a larger issue as trading becomes super accessible and seemingly cost-free, Roper said. For the investor, “It’s sort of removing a disciplinary factor,” to think twice before making potentially weighty investment decisions, she said.

Some financial advisers have argued the same point about other companies. When Charles Schwab Corp.
SCHW,
+0.19%

 and TD Ameritrade dropped their commission fees (before Schwab acquired TD Ameritrade), advisers said the $0 commission would make it easier to trade impulsively, lose money and create market volatility.

“Acting on no discipline and no cost, it’s a recipe for disaster,” one adviser told MarketWatch at the time.

How can retail investors know they’re getting the best deal on $0 trades?

Roper is doubtful investors can fully understand the nitty-gritty on directives like “best execution” and then contrast and compare brokerage platforms. “It’s going to be industry-speak and nobody’s going to know what to do with that information,” she said.

That’s why it’s important to have strong regulators on guard, she said. Bagramian said the industry-wide issue of payment to route trade orders was “ripe for rulemaking” as a Biden administration comes in.

Read:From climate change to free-trading apps, brace for an aggressive SEC under Biden, experts say

“This is a tax on the investor. A penny here, half a penny there, it becomes billions of dollars that sustains this sick financial scheme,” he said.


‘This is a tax on the investor. A penny here, half a penny there, it becomes billions of dollars that sustains this sick financial scheme.’


— Lev Bagramian, senior securities policy advisor at Better Markets

In Robinhood’s case, at one point in 2015 through 2016, payment for order flow was 80% of company revenue, the SEC order said. But a frequently asked questions page on Robinhood’s website around that time said this revenue was “indirect” and “negligible,” according to the SEC.

Between 2015 and 2018, Robinhood customer service representatives fielded roughly 150 questions from customers on how it made money, but the reps didn’t mention payment for order flow, according to the SEC. Early 2018 training documents told Robinhood customer reps to “avoid” discussing the matter, the SEC order said.

Though Robinhood revealed some information in required SEC reporting, those details were tucked inside a “disclosure library” website page and not prominently displayed, the SEC said.

“We are fully transparent in our communications with customers about our current revenue streams, have significantly improved our best execution processes, and have established relationships with additional market makers to improve execution quality,” a Robinhood spokeswoman said.



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My brother owes $10K to our late father’s estate. There’s no loan agreement and I’m executor. How should I approach repayment?

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Dear Quentin,

My father passed and I am the executor of his will.

We sold the house and Dad’s assets with my brother’s help. Probate is done. We are ready to distribute the remainder of my father’s estate, but my brother owes the estate $10,000.

He feels that if he had paid this money back before Dad passed, he would still get half back, and therefore owes $5,000. (Dad also told me that he owed the money before he passed.)

My father’s will says his estate should be split 50/50. I feel my brother owes $10,000 to the estate. I do not want to rock the boat, and will do the right thing in order to keep peace.

What is the proper way to split $200,000 in cash when he owes the estate $10,000? For the record, my brother will abide by whatever I decide. Thank you in advance for your help.

Trying to Do the Right & Proper Thing

Dear Right & Proper,

You are right to not look for trouble where there is none.

Given that there is no notarized loan agreement between your brother and your late father and there is money to be distributed, it would seem simpler and faster to have him sign a note now saying he owes the estate $10,000 and deduct the $5,000 from his eventual inheritance. Done and done. He could, after all, say that the loan was only due to be repaid when your father was alive or, indeed, say the loan was a gift. (The subject of countless episodes of “Judge Judy.”)

Your story is a cautionary tale of what could go wrong. “A hug or a handshake is not sufficient to bind someone to loan repayment. Loans and repayment obligations should be spelled out in writing and include repayment terms upon the testator’s death,” according to the Absolute Trust Counsel, a California law firm. “It is the responsibility of the executor to collect the balance due. An estate cannot be settled until all loans are collected and all debts settled or paid.”

“When an estate is insolvent, the collection of outstanding loans becomes especially important. Creditors want to be paid and will pursue all available resources to accomplish that,” the firm adds. “Many times, unpaid loans create dissension among heirs. In some cases, heirs who owe money still expect to receive an equal share of an estate.”

There is a healthy cash sum from which to deduct your brother’s loan: $105,000 for you and $95,000 for him. It could get sticky otherwise.

Thankfully, your brother also wants to do what’s right and proper.

You can email The Moneyist with any financial and ethical questions related to coronavirus at qfottrell@marketwatch.com

The Moneyist: ‘Warren Buffett and Harry Potter couldn’t get those two retired early’: Our spendthrift neighbors said our adviser was ‘lousy.’ So how come WE retired early?

Hello there, MarketWatchers. Check out the Moneyist private Facebook
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 group where we look for answers to life’s thorniest money issues. Readers write in to me with all sorts of dilemmas. Post your questions, tell me what you want to know more about, or weigh in on the latest Moneyist columns.

By emailing your questions, you agree to having them published anonymously on MarketWatch. By submitting your story to Dow Jones & Company, the publisher of MarketWatch, you understand and agree that we may use your story, or versions of it, in all media and platforms, including via third parties.



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These money and investing tips can help you sail the stock market’s choppy seas

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Don’t miss these top money and investing features:

These money and investing stories, popular with MarketWatch readers over the past week, give you tips about how to navigate the financial markets after February’s bumpy second half and signs pointing to March blowing in with more unpredictable winds.



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This 57-year-old said ‘screw this’ to San Francisco — and retired to ‘delightful’ Albuquerque, where she slashed her expenses by 70%

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When Roberta Reinstein moved to the Bay Area roughly 30 years ago to go to law school, it felt to her like a different place than it does now.

“It was possible for a student to live there…it was filled with artists,” she says. But Reinstein, 57, watched as real-estate prices skyrocketed (in just the past decade or so, home values have nearly doubled, according to Zillow) and many artists and less wealthy people had to move out. Nowadays, “San Francisco is only for the wealthy — the super wealthy — unless you’re willing to live with five roommates,” she jokes.


Do you have an interesting retirement story? Email helpmeretire@marketwatch.com with your story.

As she was watching San Francisco become a hub for the rich, she had a financial setback of her own: a divorce, in which she and her spouse had to split up their assets. And the divorce necessitated she move out of the family home, so she was spending $4,000 a month on a tiny pad to share with her daughter, Eva, she says.

“When Eva was in high school I started to think, do I really need to be here? There are lots of other places I can go.” And the more she thought about it, the more she realized: “Screw this, I gotta get out of here,” Reinstein says with a laugh. “I was ready for a break from the high cost, crowds and Google-fueled insanity of the Bay Area.”

Plus, she loved to flip houses (she’d done a couple in California years ago, before the real-estate prices were so high) and knew that was out of the question for her to do in the Bay Area — so she and her new partner, Peter, considered where else they could live. “We thought for a microsecond that Arizona might be the place, but it was way too hot in the summer.”

Roberta Reinstein and her partner, Peter.


Roberta Reinstein

They settled on Albuquerque for a number of reasons, including the weather, affordability of real estate, access to outdoor activities and the fact that Reinstein’s best friend had recently moved there.

Here’s what life is like in ABQ.

The area: Though it’s perhaps best known for its annual hot-air balloon festival and being the setting for AMC’s hit show “Breaking Bad”, ABQ — which has a population of roughly 550,000 — has a lot more going for it than that. “Albuquerque is a delightful, quirky hidden gem,” says Reinstein.

The Albuquerque Skyline at dusk.


iStock

It’s an artsy spot — there are hundreds of galleries and art studios; monthly art crawls, and a robust performing-arts scene — and a city where outdoor enthusiasts flock to. That’s helped along by the miles of hiking and biking trails in the adjacent Sandia and Manzano Mountains, as well as the roughly 300 days of sunshine. (Though January average lows are in the mid-20s, and July highs hit the low 90s.) And Reinstein tells MarketWatch she loves that it’s a diverse city with its own unique cuisine and celebrations.

Of course, there are downsides: Overall crime is high, though Reinstein says that while there are some not-so-desirable neighborhoods, there are plenty of areas that are safe. She adds that she’s never been the victim of a crime other than someone stealing a hose from one of the homes she was flipping. And there is “a fair amount of poverty,” says Reinstein. Plus, she says, the city can feel like it has a lot of sprawl, and she misses great Asian food.

View of the mountains from Reinstein’s yard


Roberta Reinstein

Here’s what MarketWatch recently wrote about Albuquerque.

The cost: Though Reinstein doesn’t keep a strict budget, she estimates that she probably spends about $3,000 a month to live in Albuquerque — despite having pricey hobbies like owning two horses — it costs her $1,250 a month to board them, which is her most significant expense. She says that most things are cheaper in Albuquerque than they were in San Francisco, including energy and gas, and estimates that she spends roughly 70% less a month than she did in the Bay Area.

Reinstein at the nearby stables.

The biggest way she saves money is by not having a mortgage on her home: She bought the four-bedroom, three-bath home that sits on an acre of land for $240,000, using a combination of savings, her divorce settlement and proceeds from homes she bought and flipped in Arizona and New Mexico, she says. And she adds that you can get a “nice house in a decent neighborhood for under $200,000” with smaller homes to be had for $100,000 or so, and can rent a nice place for $700 to $800 a month. Plus, she drives an older car — “a ratty Toyota Tundra truck” — she explains, so she doesn’t have a car loan.

The sitting room in Reinstein’s home.


Roberta Reinstein

Indeed, the cost of living and property taxes in Albuquerque are slightly below average for the U.S., median homes cost under $200,000, according to Sperling’s Best Places — and you can read about New Mexico’s tax situation here.

The bottom line: Reinstein says she plans to stay. “People are super friendly,” she adds, noting that it’s easy to make friends and get involved in things here. She’s part of a ladies walking group in the neighborhood and has made friends from her barn. “I have like two people I still correspond with [from the Bay Area],” she jokes, adding that “I was so wrapped up in my own world there.” But in ABQ, she says: “I had to go back to managing my schedule because I can’t get stuff done. I have so much to do here.”



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