In a move that could further undermine Wall Street’s grip on stock market flotations, Robinhood Markets Inc is building a platform to allow users of its trading app to snap up shares alongside Wall Street funds in initial public offerings, according to people familiar with the matter. The move would allow amateur traders to buy into the company’s IPO before it hits the stock market, which often trades higher when it does so.
This strategy could be especially beneficial for investors in the tech sector, where a slew of startups are attempting to break away from traditional IPOs and take their place among Silicon Valley’s new wave of IPOs. For example, Slack Technologies and Palantir Technologies Inc have already listed directly without using investment bankers.
As a result of their efforts, several other Silicon Valley companies have started to list directly as well, including Slack’s parent, Dropbox Inc, which filed for an IPO in November 2022 and was valued at about $1.3 billion. Similarly, Palantir is set to file for an IPO later this year, with a valuation that could be as high as $50 billion.
The SEC’s investigation of Robinhood focuses on its payment for order flow, or PFOF, practice, which allows the app to earn significant revenue by directing its customer orders to third-party market makers in exchange for a fee. This practice has led to a number of industry experts criticizing it, arguing that market makers may or may not improve the speed and price of a trade in order to earn their fees.
Despite its popularity, the SEC found that Robinhood’s payment for order flow rates were unreasonably high, and that its execution quality was inferior to that of its competitors. This deprived its customers of $34.1 million in savings from no commissions, and the SEC found that Robinhood had misled customers about its PFOF rates in its FAQs over an extended period of time.
These false claims constituted “a clear pattern of conduct that defrauded its customers,” the SEC found, and violated securities laws. As a result, Robinhood agreed to a cease-and-desist order from the SEC prohibiting it from engaging in misleading statements and omissions in its communications with customers about its largest revenue sources. In addition, it agreed to a $65 million civil penalty and to retain an independent consultant to review its policies and procedures relating to customer communications, payment for order flow, and best execution of customer orders.
In addition to its PFOF revenue, Robinhood also earns a percentage of brokerage commissions paid by its customers. This percentage is calculated based on the amount of money that its customers invest with Robinhood each month.
However, this percentage is not disclosed to investors and can be difficult to track. Generally, the higher the commission, the lower the percentage of Robinhood’s total revenue that comes from brokerage commissions.
As a result, Robinhood’s overall revenue growth has lagged in recent years. It had 12.2 million monthly active users in September, down from 15.4 million a year earlier, and the app is struggling to attract new customers and drive engagement. This decline has led Robinhood to introduce multiple new features, including a web3 wallet and extended trading hours.