Robinhood dodged a major blow to its business model following a vote by the House Financial Services Committee that resulted in the quiet shelving of an initial legislative effort to ban a practice known as “payment for order flow,” FOX Business has learned.
Payment for order flow (PFOF) is a practice in which discount brokers sell their customers’ buy and sell orders to third-party brokerages like Citadel and Virtu Financial. It allows firms like Robinhood, Charles Schwab Co., and ETrade to offer commission-free or low-fee trading to investors.
But the practice is not without its critics, including Gary Gensler, chairman of the Securities and Exchange Commission, who has said PFOF could lead to abuses such as not providing customers with the best price execution.
The House Financial Services Committee, led by Chairwoman Maxine Waters, D-Calif., launched its own inquiry earlier in the year and, according to people familiar with the matter, some of its ranking members had pushed for a ban of PFOF.
But the legislation that the committee passed on July 30, introduced by Rep. Brad Sherman, D-Calif., fell far short of a ban. It simply directs the Securities and Exchange Commission to”study” and “consider” banning or limiting PFOF.
The bill also directs the SEC to look at conflicts of interest based on PFOF arrangements and the impact of PFOF on the quality of order execution.
According to the language in the latest bill, the SEC has exactly 180 days to report all their findings from the so-called “study” to Congress. The SEC then has 18 months to “revise its rules consistent with such study, including, if warranted to prohibit or limit the payment for order flow.” The bill goes on to say the SEC may end the study early and issue rules to limit, regulate or prohibit payment for order flow if the Commission finds such a rule necessary in the public interest for the protection of investors.
In other words, the ban is not off the table… yet.
The move by the committee to study PFOF came after lobbying by Robinhood and other Wall Street firms. They provided committee members with evidence that trading has never been cheaper and more democratized since discount brokers have engaged with third-party brokers to sell their order flow, according to people with knowledge of the matter.
While the final committee bill has received some coverage, details of the bill, including committee members opting for a study as opposed to an outright ban amid the lobbying, have yet to be reported.
Shares of Robinhood popped more than 5% when FOX Business first aired these details on Friday.
A Robinhood spokesman had no comment. Press officials for the SEC and the Financial Services Committee didn’t return calls for comment.
The lobbying underscored how underserved communities – middle-class people of all races – and a new generation of millennial investors are now trading stocks and benefiting from stock market gains that traditionally had been reaped by the richest Americans, people familiar with the matter say.
The pushback from Robinhood forced GOP committee members and moderate Democrats to embrace the watered-down bill, these people say, and the resulting legislation shows that any attempt by Gensler to push for major changes in PFOF would likely face congressional resistance.
It’s also unclear if House Speaker Nancy Pelosi, D-Calif., will even introduce the legislation to the full House, the sources added.
Investors believe that’s great news for Robinhood, the upstart no-fee brokerage firm and app that just became a public company last month. Many discount brokers like Schwab have diversified business models but Robinhood’s business relies on trading more than other discount firms.
PFOF was responsible for a whopping 81% of Robinhood’s total revenue in the first quarter of this year.
In fact, fears of a PFOF ban dampened appetite for Robinhood’s IPO among large, institutional investors, FOX Business has reported.
Democrats on the House Financial Services Committee have been eyeing a ban on PFOF since the historic meme stock frenzy in January, and after criticism by Gensler.
At the time, Gensler said PFOF could create conflicts of interest for customers and brokerages. Firms like Robinhood might be incentivized to send order flow to third-party brokers based on a business relationship rather than best execution.
Brokerages, meanwhile, could gain an information advantage in trading knowing where retail order flow is headed.
For these reasons, PFOF is currently banned in the United Kingdom and Canada; Gensler said the SEC would study whether similar bans could be applied in U.S. markets.
Robinhood and the third-party brokers deny those allegations and at least initially those denials were mostly ignored.
According to an initial draft of the House bill, an amendment to the Securities Act of 1933 would not make it “unlawful to solicit, receive or provide payment for order flow (as such term is defined under section 240.10b-10(d)(8) of title 17, Code of Federal Regulations, on the date of enactment of this subsection) that consists of a monetary payment, service, property, or other benefit that results in remuneration, compensation, or consideration to a broker or dealer…”
Sherman, who also introduced the bill in its current form, has been a vocal skeptic of the PFOF model. In February, during hearings on the practices, he attacked Citadel Securities chief Ken Griffin, alleging that PFOF somehow hides true costs of trading to retail investors.
Griffin’s firm is one of the largest PFOF providers. During the heated exchange, he countered that the practice has saved retail investors billions of dollars over the years in contrast to other execution strategies, an argument that ultimately resonated with most members of the committee and resulted in the proposed legislation falling far short of a ban.
A media official for Sherman didn’t return calls for comment.
In December of 2020, the SEC reached a settlement with Robinhood, which paid $65 million for allegedly misleading investors about how it makes its money through PFOF. The company neither admitted nor denied wrongdoing. The SEC alleged customers lost millions by trading on Robinhood instead of with other brokers who could have given them better prices.
With a ban of PFOF off the table, at least for now, shares of Robinhood have recovered from their initial offering price of $38 to close over $50 on Friday. Traders interviewed by FOX Business say they doubt Gensler will spend valuable political capital seeking a ban through a vote of the full commission that would upset his relationship with Congress.
“I say good luck with that one,” said Teddy Weisberg, founder of Seaport Securities. “It will be very hard or impossible to stuff that genie back into the bottle.”