Robinhood IPO filing reveals new info on the GameStop frenzy and regulatory response

Robinhood’s prospectus, filed Thursday with the SEC, shed more light on what took place behind the scenes at Robinhood when Reddit users rushed to buy up GameStop shares and forced hedge funds out of short positions. The filing also offers a look at how regulators honed in on Robinhood when responding to the chaos.

After the meme stock mania at the end of January—which led to Robinhood raising billions in funding, suspending some trades, and struggling to maintain its for-the-people reputation—the company has moved forward with its anticipated plans to go public.

Robinhood’s business and revenue lines had already been under the microscope since January’s volatility fiasco. CEO Vladimir Tenev has been asked on multiple occasions to explain the company’s decision to restrict trading on meme stocks (which the company has repeatedly attributed to soaring deposit requirements from clearinghouses).

Testimony from officials with the Securities and Exchange Commission and the Financial Industry Regulatory Authority earlier this year showcased that regulators were taking a look at the GameStop frenzy, as well as brokerage marketing, the gamification of trading, and payment for order flow—a practice in which brokerages sell the execution of investor trades. 

As Robinhood seeks an IPO, the risks of this regulatory attention are being laid open. Robinhood mentioned its “early 2021 trading restrictions” 45 times in the 400-page IPO filing and laid out the full extent of regulatory and legal fallout it has been up against.

Robinhood’s actions during the GameStop frenzy sparked 49 putative class action lawsuits and three individual action suits against the company or its affiliated entities. It also sparked a series of inquiries from the U.S. Department of Justice, the Securities and Exchange Commission, the New York Attorney General’s Office as well as other state attorneys general offices and state securities regulators.

The U.S. Attorney’s Office for the Northern District of California even executed a search warrant to obtain CEO Vladimir Tenev’s cellphone, according to the documents. In addition to requesting information about the company’s trading restrictions, the regulatory agencies and offices have also made requests over specific consumer complaints and Robinhood employee trading, the filing says.

“We are cooperating with these investigations and examinations,” the company said in its filing, noting that the inquiries may trigger fines, penalties, or settlements — or alter the way the company has to do business. 

A key item under inspection: Robinhood’s payment for order flow practices. 

While the practice of payment for order flow has been a hot button topic on Wall Street for decades, the meme stock volatility at the end of January drew fresh attention.

In February, the Committee on Financial Services of the U.S. House of Representatives held hearings over the GameStop frenzy, grilling Tenev over Robinhood’s order flow practices and options trading. In June, the SEC said it would consider new rulemaking on payment for order flow.

Robinhood’s newly released business data showcases how sensitive the company is to policies around this issue. While it hadn’t been a secret that order routing was a key revenue driver for the company, it wasn’t clear to what extent until the numbers were made public. 

In 2020, payment for order flow and transaction rebates comprised 75% of the company’s total revenues. In the first three months of March 2021, that figure had superseded 80%—nearly 60% of that revenue was coming from four market makers.

Robinhood has already experienced run-ins with regulators and faced litigation over some of its order flow practices, disclosures or its customer trading execution.

The SEC settled with Robinhood for $65 million in December 2020 over allegations that the brokerage was making “materially misleading statements” about its lines of revenue and that it hadn’t been conducting a thorough review of the quality of its customers’ trading execution. In December 2020 and January 2021 there were six putative securities fraud class action lawsuits filed against Robinhood or its affiliated entities over similar allegations. 

If this revenue line does come under attack from regulators in their rulemaking in coming months, that could have deep implications for the company’s bottom line, according to the company.

“Any decrease in transaction-based revenue from market makers could have an adverse effect on our business, financial condition and results of operations,” the filing says.

There’s other major regulatory risks for the business, too. For one, FINRA just dished out its largest penalty ever to Robinhood over allegations of misleading customers and approving traders for risky strategies they weren’t eligible for, among other claims. 

Robinhood’s IPO filing states that its mission to “democratize finance for all” drives its revenue model. Evidently, so does payment for order flow.