By Natalie DeCoste
The popular trading app Robinhood filed to go public last week, revealing significant amounts of revenue as the United States Securities and Exchange Commission (SEC) sets its sights on the way the company makes its money.
In the online brokerage company’s IPO filing released last Thursday, Robinhood disclosed that it made 81% of its first-quarter revenue from a practice known as payment for order flow.
Robinhood sells its customers’ stock, options, and cryptocurrency orders to high-speed trading firms. Brokers use payment for order flow to offset trading fees, thus providing zero commission trading to their retail customer base.
“Our mission to democratize finance for all drives our revenue model. We pioneered commission-free trading with no account minimums, giving smaller investors access to the financial markets. Many of our customers are getting started with less, which often means they’re trading a smaller number of shares. Rather than earning revenue from fixed trading commissions which, before Robinhood introduced commission-free trading, had often ranged from $8 to $10 per trade, the majority of our revenue is earned through payment for order flow,” Robinhood said in its filing.
However, this business model has drawn criticism from top regulators and is set to be challenged by SEC Chairman Gary Gensler. Gensler and other critics said that payment for order flow poses a conflict of interest for brokerages. Brokers can either make more money for selling their customers’ order flow or pass that money on to customers in the form of price savings on their trades.
“Payment for order flow raise[s] questions about whether investors are getting best execution,” Gensler said after the public was made aware that the SEC was reviewing payment for order flow. He noted that brokers are banned from paying for order flow in the United Kingdom, Canada, and Australia.
The SEC’s distaste for Robinhood’s business model has gone beyond just criticism as the company paid a $65 million fine imposed by the SEC back in December amid allegations that Robinhood misled retail customers about the use of PFOF.
“Robinhood explicitly offered to accept less price improvement for its customers in exchange for receiving higher payment for order flow for itself. As a result, many Robinhood customers shouldered the costs of inferior executions; these costs might have exceeded any savings they might have thought they’d gotten from zero-commission trading,” said Gensler while discussing the fine imposed by the SEC.
The scrutiny that payment for order flow has been under only increased following the trading frenzy in stocks for “meme stocks” such as GameStop, which occurred earlier this year. The trading mania prompted a series of congressional hearings on how retail brokerages like Robinhood handle investors’ orders, and these hearings coincided with Gensler’s confirmation to the SEC.
The SEC has not indicated how it might change its rules on payment for order flow, but Robinhood has made it clear that changes would hurt the company. The company stated that stringent regulations or an outright ban would negatively impact its business.
