As Rep. Alexandria Ocasio-Cortez, DN.Y. had gotten her way, Robinhood customers would get more than just an apology from the trading app at Thursday’s congressional hearing on GameStop’s recent trade restrictions.
At a hearing convened by the House Financial Services Committee, Ocasio-Cortez urged Robinhood CEO Vlad Tenev to repay revenue the company generates from a system called payment for order flow.
“Previously one of my colleagues, Rep. [Michael] San Nicolas [of Guam]Robinhood said he owes his customers far more than an apology, and I agree with him, “said Ocasio-Cortez.” I believe the decisions made by you and your company have hurt your customers. “
What is the payment for the order flow?
Payment for order flow is a practice many brokers use when they receive payment from a third party, usually a market maker, to send a trade order to them. Market makers are typically large banks or financial institutions that essentially act as wholesalers to buy and trade securities, sometimes from their own stock. Big names include companies such as Citadel Securities, 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 share. In many cases, the brokerage does not immediately buy it on a stock exchange on your behalf. When you hit the trade button, a brokerage such as Robinhood that uses the payment process for the order flow process will take your order and forward it to a market maker, who pays the brokerage – usually per share – for the order.
The system allows brokers to manage thousands of orders by submitting them to be executed by a market maker. This keeps costs down for the brokerage as there is less of a cost to execute the transaction. The market maker benefits because he handles a higher trading volume.
Payment for the order flow process is important because that’s how Robinhood earns most of its sales, according to Tenev’s testimony on Thursday. It’s not just Robinhood; many major brokers, including Charles Schwab, E-Trade, and TD Ameritrade, all generate significant income from order flow payment.
In his testimonial, Tenev said Robinhood’s customers benefit from payment for the order flow because they typically get a better deal than the best available price.
“Robinhood Securities regularly evaluates its counterparties and routes client orders to those market makers who can provide the best quality of execution for those orders,” said Tenev.
Payment for order flow has its critics
While the order flow checkout process has its advantages, critics say it may not be in the best interest of the customers.
Ocasio-Cortez pointed out that the U.S. Securities and Exchange Commission found in a 2016 report that the payment for the order flow process created “ a potential conflict of interest ” with a broker’s duty to execute transactions to the best possible standard and to ensure payment to maximize. for order flow. It has been criticized that this situation gives brokers an incentive to increase the amount their clients trade, even if it is not in their best interest.
One of the ideas put forward by the committee in 2016 to address these conflicts of interest, Ocasio-Cortez said, was to require brokers to pass on the proceeds from the order flow payment to the clients.
“Would you be willing to pass on the proceeds of your order flow payment to Robinhood customers today?” Ocasio-Cortez asked Tenev. Rather than responding immediately, Tenev took the opportunity to explain the situation.
Not a simple solution
The solution suggested by Ocasio-Cortez sounds simple, right? If payment for order flow causes conflicts of interest, simply pass the proceeds on to the customer.
But Tenev said the 2016 SEC report and proposed recommendations were issued before many brokers turned to free commissions. He suggested the recommendation was out of date.
“Payment for order flow, Congressman, allows commission-free trading. It’s a much greater source of income [now] than in the past, ”Tenev said.
“Robinhood is a for-profit company and needs to generate some revenue to pay for the costs of running this business,” Tenev continued. “People were initially skeptical that even with payment for order flow, the model would work if you removed commissions.
Ocasio-Cortez said she took Tenev’s responses that he was unwilling to give customers the proceeds from Robinhood’s order flow revenue payment. She said that begged the question of whether $ 0 commissions were really free.
“If removing the revenue from payment to order flow would result in the removal of free commissions, it doesn’t mean trading on Robinhood isn’t really free in the beginning because you’re just hiding the cost – the cost of poor execution or the cost of discounts for your customers? ”she asked.
Due to the timing, Tenev had no opportunity to respond. Maxine Waters, chair of the House Financial Services Committee, said there would be additional hearings to further investigate the situation and determine if additional laws or regulations are needed.
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