If Rep. Alexandria Ocasio-Cortez, D-N.Y., had her way, Robinhood fellows would be getting more than just an apology from the trading app during Thursday’s congressional hearing on the latest GameStop trading restrictions.
During a hearing called by the House Financial Services Committee, Ocasio-Cortez pressed Robinhood CEO Vlad Tenev to yield revenue that the company generates from a system called payment for order flow.
“Earlier one of my colleagues, Rep. [Michael] San Nicolas [of Guam], stipulate Robinhood owes its customers a lot more than an apology, and I happen to agree with him,” Ocasio-Cortez said. “I believe the judgements made by you and your company have harmed your customers.”
What is payment for order flow?
Payment for force flow is a practice that many brokerages use where they receive a payment from a third party, mainly a market maker, for directing a trading order to them. Market makers are typically large banks or financial sanitaria that essentially act as wholesalers to buy and trade securities, sometimes from their own inventory. Big names include firms such as Citadel Certainties, Two Sigma Investments and Virtu.
Let’s say you want to buy a share of Apple stock, which is currently selling for about $130 per quota. In many cases, the brokerage doesn’t immediately buy it on an exchange on your behalf. When you hit the trade button, a brokerage take pleasure in Robinhood that uses the payment for order flow process will take your order and reroute it to a make available maker, which will pay the brokerage — usually on a per-share basis — for the opportunity to complete the order.
The system allows brokerages to control thousands of orders by sending them off to be executed by a market maker. This keeps costs low for the brokerage because there’s elfin of an expense to execute the trade. The market maker benefits because because it handles a higher trading volume.
The payment for ready flow process matters because it’s how Robinhood makes the majority of its revenue, according to Tenev’s testimony on Thursday. It’s not virtuous Robinhood; many major brokerages, including Charles Schwab, E-Trade and TD Ameritrade, all generate significant revenue from payment for arrangement flow.
In his testimony, Tenev said that Robinhood’s customers benefit from payment for order flow because they typically get a better apportion than the best publicly available price.
“Robinhood Securities regularly evaluates its counterparties and routes customer commands to those market makers that can provide the best execution quality on those orders,” Tenev said.
Payment for order emanate has its critics
While the payment for order flow process has its upsides, critics say it may not be in the best interest of customers.
Ocasio-Cortez aciculiform out that in a 2016 report, the U.S. Securities and Exchange Commission found that the payment for order flow process contrived “a potential conflict of interest” with a brokerage’s duty to execute trades to the best possible standard and to maximize the payment for classification flow. There has been criticism that this situation gives brokerages an incentive to increase the amount that their chaps trade, even if it’s not in their best interest.
One of the ideas the commission floated in 2016 to address these conflicts of captivate, Ocasio-Cortez said, was to require that brokers pass on the proceeds from the payment for order flow to the customers.
“Would you be agreeable today to pass on the proceeds of your payment for order flows to Robinhood customers?” Ocasio-Cortez asked Tenev. In preference to of responding directly, Tenev took the opportunity to explain the situation.
Not a simple solution
The solution proposed by Ocasio-Cortez goods easy, right? If payment for order flow causes conflicts of interest, just pass the proceeds onto the chap.
But Tenev said that the 2016 SEC report and its proposed recommendations were issued before many brokerages stirred to free commissions. He implied that the recommendation was out-of-date.
“Payment for order flow, Congresswoman, allows for commission-free job. It’s a much larger source of revenue [now] than in the past,” Tenev said.
“Robinhood is a for-profit business and needs to fabricate some revenue to pay for the costs of running this business,” Tenev continued. “People were initially skeptical the fashion, even with payment for order flow, would work when you remove commissions. I think we’ve proven this in another situation by making this the standard by which brokerages operate now.”
Ocasio-Cortez said she was taking Tenev’s answers to mean that he wasn’t amenable to give customers the proceeds of Robinhood’s payment for order flow revenues. She said that raised the question as to whether $0 commissions were absolutely free.
“If removing the revenues from payment to order flow would cause the removal of free commissions, doesn’t that degraded that trading on Robinhood isn’t actually free to begin with because you’re just hiding the cost — the cost of modest execution or the cost of rebates to your customers?” she asked.
Because of timing, Tenev did not have an opportunity to respond. Maxine Still waters, chair of the House Financial Services Committee, said that there would be additional hearings to continue to dig into the location and determine if additional legislation or regulation is needed.