If Rep. Alexandria Ocasio-Cortez, DN.Y., had her way, Robinhood clients would receive more than an apology for the negotiation application during Thursday’s hearing in Congress on the recent negotiation restrictions GameStop.
During a hearing convened by the House Financial Services Committee, Ocasio-Cortez pressured Robinhood CEO Vlad Tenev to return the revenue the company generates from a system called order flow payment.
“Before one of my colleagues, Rep. [Michael] St. Nicholas [of Guam], said Robinhood owes its customers much more than an apology, and I agree with him, “Ocasio-Cortez said.” I think the decisions you and your company have made have hurt your customers. “
What is payment for order flow?
Order flow payment is a practice that many brokers use when they receive 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 a portion of Apple’s stock, which currently sells for about $ 130 per share. In many cases, the broker does not immediately buy it in a bag on your behalf. When you press the trade button, a broker like Robinhood that uses the payment process for order flow will take your order and redirect it to a market maker, who will pay the broker (usually per share) to complete the opportunity l ‘order.
The system allows brokers to manage thousands of orders by sending them to be executed by a market maker. This keeps costs low for brokerage, as there are fewer costs to run the trade. The market maker benefits because he engages in a higher trading volume.
Payment for the order flow process is important because Robinhood gets most of its revenue, Tenev testified Thursday. It’s not just Robinhood; many major brokers, including Charles Schwab, E-Trade, and TD Ameritrade, generate significant revenue by paying for order flow.
In his testimony, Tenev said Robinhood customers benefit from paying for order flow because they usually get a better deal than the best price publicly available.
“Robinhood Securities regularly evaluates its counterparties and directs customer orders to those market makers who can provide the best execution quality in those orders,” Tenev said.
Order flow payment has its critics
While the order flow payment process has its advantages, critics say it may not be in the best interest of customers.
Ocasio-Cortez noted 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 the duty of a broker. execute transactions at the best possible level and maximize payment for order flow. It has been criticized that this situation gives brokers an incentive to increase the amount their customers trade, even if it is not in their best interest.
One of the ideas the commission raised in 2016 to address these conflicts of interest, Ocasio-Cortez said, was to require brokers to pass on the benefits of order flow payment to customers.
“Would you be willing today to pass on the benefits of your order flow payment to Robinhood customers?” -He asked Tenev Ocasio-Cortez. Instead of responding directly, Tenev took the opportunity to explain the situation.
It is not an easy solution
The solution proposed by Ocasio-Cortez sounds easy, right? If payment for the order flow causes conflicts of interest, simply forward the product to the customer.
But Tenev said the 2016 SEC report and its proposed recommendations were issued before many brokers switched to free commissions. He hinted that the recommendation was out of date.
“Payment for the flow of orders, congressman, 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 has to generate some revenue to pay for the running costs of this business,” Tenev continued. “People were initially skeptical, the model, even with the order flow payment, would work when you remove commissions. I think we’ve proven otherwise, making it the standard that brokers operate with now.”
Ocasio-Cortez said he was taking Tenev’s responses to mean he was unwilling to give customers the proceeds of Robinhood’s payment for order flow revenue. He said this raised the question of whether the $ 0 commissions were really free.
“If removing revenue from payment in the order flow would result in the elimination of free commissions, it doesn’t mean that trading on Robinhood isn’t really free because you just hide the cost: the cost of a bad run or the cost of bonuses for your customers? ”she asked.
Due to the schedule, Tenev did not have a chance to respond. Maxine Waters, chair of the House Financial Services Committee, said there would be additional hearings to further delve into the situation and determine whether additional legislation or regulation is needed.
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