Robinhood Markets has agreed to pay $65 million to settle Securities and Exchange Commission allegations that the broker failed to properly inform clients that it sold their stock orders to high-frequency traders and other financial firms.

Robinhood, known for its popular smart-phone app that offers commission-free trading, also agreed to have an outside consultant monitor its compliance with rules that require firms to provide best execution for trades. Robinhood has gained notoriety during the pandemic by attracting a massive customer base of younger investors.

The case involves disclosures from 2015 to late 2018 by a Robinhood unit, according to a Thursday SEC statement. The company, which didn’t admit or deny the regulator’s allegations, said it is now fully transparent in its communications with customers about how it makes money.

“The settlement relates to historical practices that do not reflect Robinhood today,” said Dan Gallagher, the firm’s chief legal officer. “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.”

Controversial Practice

At the heart of the SEC’s case is payment for order flow, a controversial practice employed by almost all retail brokerages in which they sell customer orders to outside market makers. Critics argue that it’s riddled with conflicts that enable high-speed traders and other firms to profit by taking advantage of retail investors.

Robinhood has profited handsomely from payment for order flow, though it didn’t widely publicize that fact until October 2018, after Bloomberg reported that the firm made almost half its revenue by selling customers’ trades to Citadel Securities, Two Sigma Securities and other firms.

The settlement resolves one of several compliance headaches Robinhood is seeking to put behind it ahead of a potential initial public offering next year.

Still, issues keep popping up. On Wednesday, Massachusetts securities regulators filed a complaint against the company, alleging that it violated its responsibilities to puts its customers’ interests first. Specifically, the state said Robinhood’s app exposed users to “unnecessary trading risks” by promoting a “gamifacation” of stock investing to keep novice customers engaged.

Robinhood rejected the claims, arguing that the case lacks merit because the firm doesn’t make investment recommendations for clients.

Robinhood also faces additional scrutiny from the SEC and the Financial Industry Regulatory Authority, which polices brokerages. The regulators are investigating the company’s handling of a March trading outage that prompted a deluge of customer complaints, Bloomberg reported in August.

(Updates with details on payment for order flow starting in fifth paragraph.)

—Robert Schmidt (Bloomberg)