If Congresswoman Alexandria Ocasio-Cortez, DN.Y., did what she wanted, Robinhood’s customers would receive more than just an apology from the trading app during Thursday’s congressional hearing on the company’s recent trade restrictions. GameStop.
During a hearing called by the Chamber’s Financial Services Committee, Ocasio-Cortez pressured Robinhood’s CEO Vlad Tenev to return the revenue the company generates from a system called payment by order flow.
“Previously, one of my colleagues, Rep. [Michael] San Nicolas [of Guam], said Robinhood owes its customers much more than an apology and, incidentally, I agree with him “, said Ocasio-Cortez.” I believe that the decisions made by you and your company have hurt your customers. “
What is order flow payment?
Payment by order flow is a practice that many brokers use when receiving a payment from a third party, usually a market maker, for directing a trading order to them. Market makers are usually large banks or financial institutions that essentially act as wholesalers to buy and trade securities, sometimes from their own stock. Big names include companies like Citadel Securities, Two Sigma Investments and Virtu.
Say you want to buy a share of Apple, which is currently selling for around $ 130 per share. In many cases, the broker does not buy it immediately on a stock exchange in your name. When you click on the trade button, a broker like Robinhood that uses the payment process for order flow will take your order and redirect you to a market maker, who will pay the broker – usually per share – for the opportunity to complete the order .
The system allows brokers to manage thousands of orders, sending them to be executed by a market maker. This keeps costs down for the broker because there is less expense to execute the trade. The market maker benefits because it deals with a higher volume of trading.
Payment for the order flow process is important because it is how Robinhood gets most of its revenue, according to Tenev’s testimony on Thursday. It’s not just Robinhood; many major brokers, including Charles Schwab, E-Trade and TD Ameritrade, generate significant payment revenue for order flow.
In his testimony, Tenev said that Robinhood customers benefit from payment for the order flow because they usually get a better deal than the best publicly available price.
“Robinhood Securities regularly evaluates its counterparties and routes customer orders to market makers who can provide the best quality of execution for those orders,” said Tenev.
Payment for order flow has its critics
While the payment process for order flow has its advantages, critics say it may not be in customers’ best interest.
Ocasio-Cortez pointed out that, in a 2016 report, the United States Securities and Exchange Commission concluded that the payment process for order flow created “a potential conflict of interest” with a broker’s duty to execute trades with the best possible and maximize the payment for the order flow. There has been criticism that this situation gives brokers an incentive to increase the value that their clients trade, even if it is not in their interest.
One of the ideas the commission launched in 2016 to resolve these conflicts of interest, said Ocasio-Cortez, was to require brokers to pass on payment proceeds to the flow of orders to customers.
“Would you be willing today to pass on the proceeds from your payment to order flows to Robinhood’s customers?” Ocasio-Cortez asked Tenev. Instead of responding directly, Tenev took the opportunity to explain the situation.
It is not a simple solution
The solution proposed by Ocasio-Cortez seems easy, right? If payment for the order flow causes conflicts of interest, just pass the product on to the customer.
But Tenev said the 2016 SEC report and its proposed recommendations were issued before many brokerages adopted free commissions. He hinted that the recommendation was out of date.
“Payment by order flow, congressman, allows negotiation without commissions. It is a much bigger source of revenue [now] than in the past, “said Tenev.
“Robinhood is a for-profit company and needs to generate some revenue to pay the costs of running this business,” continued Tenev. “People were initially skeptical that the model, even with payment by order flow, would work when you remove commissions. I think we proved that by making this the standard by which brokers operate now.”
Ocasio-Cortez said he considered Tenev’s responses that he was not willing to give customers the proceeds of Robinhood’s payment for order flow proceeds. She said it raised the question of whether the $ 0 commissions were really free.
“If removing revenue from payment into the order flow would cause the removal of free commissions, it doesn’t mean that trading on Robinhood is not really free to start with because you’re just hiding the cost – the cost of poor execution or the cost of discounts for your customers? “she asked.
Because of the weather, Tenev had no opportunity to respond. Maxine Waters, chairman of the House’s Financial Services Committee, said there would be additional hearings to continue investigating the situation and determining whether additional legislation or regulation is needed.
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