Shares of Robinhood fell as much as 9% on Monday afternoon following comments from SEC Chairman Gary Gensler. The stock closed 7% lower on the day.
In a Monday interview with Barron’s, Gensler said a ban of the payment for order flow model used by many brokerage firms “is on the table.”
Payment for order flow is a practice in which brokers route trade orders from customers to market makers, who then execute those trades and often collect a small spread from the transaction.
Gensler told Barron’s the practice has “an inherent conflict of interest. They get the data, they get the first look, they get to match buyers and sellers out of that order flow. That may not be the most efficient markets for the 2020s.”
According to Barron’s, Gensler didn’t say whether the SEC found any instances of where the conflicts of interests resulted in harm to investors. Proposals on the practice could come from the SEC in the coming months, Gensler said.
To the end user buying a few shares of Apple or Microsoft, the spread taken by market makers in price paid is often to the tenth of a penny and negligible.
Robinhood utilized payment for order flows to lower its trading commission to $0 when it launched in 2014, as most discount brokerages were charging upwards of $9.99 per trade. Besides $0 commission trades, payment for order flow has helped enable the ability for fractional share investing.
Robinhood derives a bulk of its revenue from payment for order flow and transaction rebates. In 2020, 75% of its revenue was derived from those practices, and that number increased in the first and second quarter of 2021.
The company listed a potential ban of payment for order flow as a risk to its business in the firm’s S-1 filing.
“Because a majority of our revenue is transaction-based (including payment for order flow, or “PFOF”), reduced spreads in securities pricing, reduced levels of trading activity generally, changes in our business relationships with market makers and any new regulation of, or any bans on, PFOF and similar practices may result in reduced profitability, increased compliance costs and expanded potential for negative publicity,” Robinhood said.