If Alexandria Ocasio-Cortez, DN.Y., had her way, Robinhood customers would receive more than an excuse from the trading app during Thursday’s congressional hearing about the recent GameStop trading restrictions.
During a hearing convened by the House Financial Services Committee, Ocasio-Cortez pressured Robinhood CEO Vlad Tenev to return the company’s revenue from a system called order flow payment.
“Previously, one of my colleagues, Rep. [Michael] San Nicolas [of Guam], said Robinhood owes its customers much more than apologies and happens to agree with him, “Ocasio-Cortez said.” I think the decisions you and your company have made have affected your customers. “
What is the order flow payment?
Order flow payment is a practice that many brokerages use when receiving a payment from a third party, usually a market maker, to direct a trading order to them. Market makers are usually large banks or financial institutions that act essentially as wholesalers to buy and trade securities, sometimes from their own inventory. Big names include companies such as Citadel Securities, Two Sigma Investments and Virtu.
Suppose you want to buy some of Apple’s stock, which currently sells for about $ 130 per share. In many cases, the brokerage does not immediately buy it on an exchange on your behalf. When you press the trade button, a brokerage like Robinhood that uses payment for the order flow process will take your order and redirect it to a market maker, which will pay the brokerage – usually on an action basis – for the opportunity to complete the order.
The system allows brokerages to handle thousands of orders, sending them to be executed by a market maker. This keeps costs low for brokerage, as there is a lower cost to execute the transaction. The market producer benefits because it deals with a higher trading volume.
Paying for the order flow matters because the way Robinhood makes the most of its revenue, according to Tenev’s testimony on Thursday. It’s not just Robinhood; many major brokerages, including Charles Schwab, E-Trade and TD Ameritrade, all generate significant revenue from payment for order flow.
In his testimony, Tenev said that Robinhood customers receive payment for the order flow, because they usually get a better offer than the best publicly available price.
“Robinhood Securities regularly evaluates its counterparties and directs customer orders to those market makers that can provide the best execution quality for those orders,” Tenev said.
Payment for order flow is critical
While the order flow payment process has its advantages, critics say it may not be in the best interest of customers.
Ocasio-Cortez pointed out that in a 2016 report, the U.S. Securities and Exchange Commission found that payment for the order flow process created “a potential conflict of interest” with an intermediary’s obligation to trade at the best standard. possible and maximize payment for order flow. There have been criticisms that this situation gives brokerages an incentive to increase the amount traded by their clients, even if it is not in their interest.
One of the ideas the commission launched in 2016 to address these conflicts of interest, Ocasio-Cortez said, was to ask brokers to pass on customer receipts for order flow.
“Would you be willing to pass on your order payment revenue today to Robinhood customers?” Ocasio-Cortez asked Tenev. Instead of answering directly, Tenev took the opportunity to explain the situation.
It is not a simple solution
The solution proposed by Ocasio-Cortez sounds easy, doesn’t it? If payment for the order flow causes conflicts of interest, all you have to do is send the receipts to the customer.
But Tenev said the 2016 SEC report and its proposed recommendations were issued before many brokerages switched to free commissions. He suggested that the recommendation was outdated.
“The payment for the order flow, congressional, allows trading without commissions. It is a much larger source of income [now] than in the past, “Tenev said.
“Robinhood is a for-profit business and it needs to generate some revenue to pay for running this business,” Tenev said. “People were initially skeptical, the model, even with the payment for the order flow, would work when you remove the commissions. I think we have demonstrated this differently, making it the standard by which brokerages now operate.”
Ocasio-Cortez said he took Tenev’s answers to mean he was unwilling to offer customers Robinhood payment receipts for order flow revenue. She said she raised the question of whether the $ 0 commissions were really free.
“If eliminating revenue from payment to order flow would eliminate free commissions, doesn’t that trading on Robinhood isn’t actually free to begin with, because you’re just hiding the cost – the cost of poor execution, the cost of discounts for your customers?” ” she asked.
Due to the timing, Tenev did not have the opportunity to respond. Maxine Waters, chair of the House Financial Services Committee, said further hearings would be held to further investigate the situation and determine whether additional legislation or regulations were needed.
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