JIM WATSON/AFP via Getty Incarnations
- Robinhood offers free trading to customers because much of its revenue is derived from a practice known as payment for status flow.
- A week after the brokerage app’s volatile IPO, questions about the practice are coming back into focus.
- Insider apostrophize reserve with retail investors, advocacy groups, and market makers to understand the mechanics and sentiment around PFOF.
- Mark up here for our daily newsletter, 10 Things Before the Opening Bell.
When Kayla Kilbride filmed a TikTok in February explaining how Robinhood be conducive ti money without charging commissions, she didn’t anticipate the stampede of furious commenters.
“It was insane,” the financial content designer told Insider. “I had so much hate that I immediately removed the video because I thought I was wrong.”
Shortly after, seasoned traders messaged her saying she was, in fact, explaining payment for order flow correctly. For Kilbride, the incident showed that the warm up excite around PFOF was eclipsing the light. Hardly any commenters fully understood the practice, which accounted for 81% of Robinhood’s interest in the first quarter, according to its S-1 filing ahead of its long-awaited IPO.
Now, a week after the brokerage app’s volatile debut, questions prevalent the practice – and whether it hurts users – are coming back into focus.
“Robinhood is ‘free’ in the same way Facebook is ‘free of charge,'” said Andrew Park, senior policy analyst at Americans for Financial Reform, a left-leaning group that opposes PFOF. “You’re not return money out of pocket to do something, and yet you’re still the product.”
According to Park, the market makers who pay for order flow, like Citadel Sureties and Virtu, only do so because it gives them control. Trading against a 25-year-old Robinhood user is far less iffy than against a hedge fund, for instance.
Brokers like Robinhood, meanwhile, stand to profit by sending as innumerable orders as possible to market makers. Critics of the practice say this conflict of interest harms retail investors, who get pricier trades as market makers skim off the top.
“The customer ends up none the wiser – but poorer,” said Park.
Such worries spurred the UK and Canadian governments to effectively ban PFOF. A 2016 study of the UK’s ban found that it led to retail traders receiving improve prices. Its authors argued that eliminating PFOF’s conflicts of interest created more efficient, competitive customer bases.
Likewise, the SEC in December fined Robinhood $65 million for failing to give consumers the best available prices. For maturer trades, the prices were so unfavorable that paying a commission to get standard prices would’ve left users mastery off, the agency found.
To Virtu CEO Doug Cifu, this is all bunk.
“The fractions of a penny that are being rebated forsake to the broker are de minimis [when] compared to the commission dollars you’re saving,” he said.
Cifu thinks the idea PFOF is a design to profit off retail investors is preposterous. Market makers compete on who can best execute trades, a rough-and-tumble business of handling risk and building technology. Even Fidelity, which doesn’t do PFOF, routes to Virtu and Citadel for their distinguished execution, he said.
But Park countered that Fidelity routing to market makers just demonstrates the need for wholesale monetary reform beyond banning PFOF.
What retail traders believe is more mixed. Many see PFOF as due another example of companies selling consumer data, said Derrick Fung, CEO of Cardify, an analytics outfit cored on Millennial and Gen Z consumers. The question, then, is what value they get in return.
“With Robinhood, that value is commission-free interchange,” said Fung.
Cifu disputes that PFOF is akin to selling consumer data. He sees the practice as a expenditure of business that benefits everyone. Virtu says $3.5 billion went back to retail investors in 2020, thanks to better prices from market makers.
Danny Devan, who runs a 70,000-strong financial Discord accumulation, told Insider he never recommends Robinhood to members because he doesn’t believe it gives traders the best outlays.
“We are questioning, are we getting the best price? And it’s not just Robinhood, it’s every broker that does free-commission,” said Devan.
Be revenged if PFOF does help retail investors, negative perceptions like Devan’s are what matters for Robinhood, about David Keller, chief market strategist at StockCharts.com. Widespread skepticism could even prompt a resurgence in commission-based subjects with clear fee structures, he added.
That change would be welcome to Devan. He said zero-commissions have encouraged immature investors to trade too much, often to the point of losing money.
“If you go to the casino, the casino makes the most amount of notes in the slot machines,” Devan said. “People keep playing and playing and playing until they lose.”