The developers of Robinhood’s zero-fee cryptocurrency trading app have been criticized for the lack of transparency in their business model. Founded in April of 2013 and currently valued at over $5.6 billion, Robinhood is reportedly charging “high-frequency trading” (HFT) companies over 10 times the amount they normally pay other brokerage firms for the same volume.

Robinhood’s founders aim to “disrupt” the traditional brokerage industry by providing zero-commission trading of fiat-based exchange-traded-funds (ETFs) and digital currencies. However, a closer examination of its business operations by the US Securities and Exchange Commission (SEC) has revealed that the California-based broker is selling its customers’ orders at huge premiums.

Selling Users’ Data At Exorbitant Rates

Notably, recent SEC’s filings indicate that Robinhood is selling its users’ orders for over 10 times what other brokerage firms charge. There are several brokers, such as Vanguard, that do not sell its customers’ order data to HFT firms.

Interactive Brokers (IBKR), which provides a high-end platform for experienced retail traders, does not sell its customers’ order flow. IBKR’s customers also have the option to place their orders through any exchange they prefer.

Selling user data, which is part of Robinhood’s business model, is a highly controversial practice. Moreover, it claims to generate revenue mainly from margin lending and interest accrued on customers’ account balances.

Based on the SEC’s filings, Robinhood may be earning quite a substantial amount from charging hefty fees for its customers’ data. The SEC requires that all brokerage firms who sell their customers’ order flow to disclose who they sell it to and how much they are paid for it.

Questionable Clients

Notably, several companies that purchase financial data from Robinhood have been investigated by the SEC for illegal trading. Citadel Securities LLC, one of Robinhood’s clients, was fined $22 million by the SEC (in January of 2017) for issuing “misleading statements” to brokerage firms “about the way it priced trades.”

Hedge fund firm Two Sigma Investments, which also works with Robinhood, was subpoenaed by the SEC in 2014 over a questionable survey program aimed at obtaining financial information about various companies from stock market analysts.

Another Robinhood client, Wolverine Securities, was ordered by the SEC (in October of 2017) to pay a $1 million fine for insider trading. In addition to working with companies that have been fined or investigated for illegal trading, SeekingAlpha notes that there’s a “a material difference in the disclosures between what Robinhood and other discount brokers are showing.”

Most brokerage firms such as E*TRADE and TD Ameritrade (AMTD), which has $1.2 trillion in assets under management, report their earnings from order flows in “tenth of penny per share.” However, Robinhood discloses the payments it receives as “per dollar of executed trade value.”

Exploiting Customers

Although there aren’t any guidelines that specifically require a company to report trade earnings as “per share”, Robinhood’s financial figures “appear small” if not examined carefully, and closely compared with the disclosures from its competitors.

As explained by SeekingAlpha:

Assume the average stock traded has a share price of $50. It takes 20,000 shares traded at $50 for $1,000,000 in volume, for which E*TRADE makes $22 per $1,000,000 traded, which sounds like a small number until you realize they cleared $47,000,000 last quarter from this. But off an identical $1,000,000 in volume, Robinhood gets paid $260 from the same HFT firms. If Robinhood did as much trade volume as E*TRADE, they would theoretically be making close to $500 million per quarter in payments from HFT firms.

Robinhood appears to be taking advantage of its zero-fee trading service because it has helped attract millions of young investors. However, what the company’s customers may want to consider is that their personal financial data is being sold for exorbitant amounts. This data can then be used by other companies to exploit users.