AOC wants Robinhood to reimburse payment for order flow profits

If Representative Alexandria Ocasio-Cortez, DN.Y., was successful, Robinhood clients would receive more than just an apology from the trading app during Thursday’s congressional hearing on recent GameStop trading restrictions. .

In a hearing convened by the House Financial Services Committee, Ocasio-Cortez urged Robinhood CEO Vlad Tenev to return the revenue the company generates from a system called payment for the flow of orders.

“Earlier, one of my colleagues, Rep. [Michael] San Nicolas [of Guam]Said Robinhood owes his clients a lot more than an apology, and I agree with him, ”Ocasio-Cortez said. “I think the decisions made by you and your business hurt your customers.

Paying for Order Flow is a practice that many brokers use when they receive a payment from a third party, usually a market maker, to direct them a trade order. Market makers are typically large banks or financial institutions that essentially act as wholesalers to buy and trade securities, sometimes from their own inventory. Big names include companies like Citadel Securities, Two Sigma Investments, and Virtu.

Suppose you want to buy a share of Apple stock, which is currently selling for around $ 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 firm like Robinhood who uses the checkout process for order flow will take your order and redirect it to a market maker, who will pay the brokerage firm – usually per share – for the opportunity to finish it. order.

The system allows brokerage houses to manage thousands of orders by sending them to be executed by a market maker. This keeps the costs low for the brokerage as there is less charge to execute the trade. The market maker benefits because he manages a higher trading volume.

The order flow payment process is important because this is how Robinhood makes the majority of its income, Tenev testified on Thursday. It’s not just Robinhood; many large brokerage houses, including Charles Schwab, E-Trade and TD Ameritrade, all generate significant income through payment of order flows.

In his testimony, Tenev said that Robinhood customers benefit from payment for the order flow because they typically get a better deal than the best publicly available price.

“Robinhood Securities regularly assesses its counterparties and routes client orders to market makers who can provide the best quality of execution on those orders,” Tenev said.

While the checkout process for order flow has its benefits, reviews say it may not be in the best interests of customers.

Ocasio-Cortez pointed out that in a 2016 report, the United States Securities and Exchange Commission found that the payment process for order flow created a “potential conflict of interest” with a broker’s duty. to execute transactions at the best possible level and to maximize payment. for the flow of orders. It has been criticized that this situation causes brokerage firms to increase the amount their clients trade, even if it is not in their best interest.

One of the ideas the commission launched in 2016 to resolve these conflicts of interest, Ocasio-Cortez said, was to require brokers to pass the proceeds of payment from the order flow to customers.

“Would you be prepared today to pass the proceeds of your payment for the Order Flow to Robinhood customers today?” Ocasio-Cortez asked Tenev. Instead of responding directly, Tenev took the opportunity to explain the situation.

The solution offered by Ocasio-Cortez seems simple, right? If paying for the order flow results in conflicts of interest, you just need to pass the product on to the customer.

But Tenev said the 2016 SEC report and its proposed recommendations were released before many brokers switched to free commissions. He suggested that the recommendation was not up to date.

“Payment for the flow of orders, Madam, allows commission-free transactions. It is a much more important source of income. [now] than in the past, ”Tenev said.

“Robinhood is a for-profit business and has to generate revenue to pay the costs of running that business,” Tenev continued. “Initially, people were skeptical that the model, even with payment for order flow, would work when you cut commissions. I think we’ve proven otherwise by making this model the standard by which brokers now operate.

Ocasio-Cortez said she took Tenev’s responses to mean he was unwilling to give customers the proceeds from Robinhood’s payment for the revenue from the order flow. She said this raised the question of whether the $ 0 commissions were really free.

“If removing pay-as-you-go revenue would mean removing free commissions, doesn’t that mean trading on Robinhood isn’t actually free because you’re just hiding the cost – the cost of poor execution or the cost of discounts for your customers? ” she asked.

Due to the timing, Tenev did not have a chance to respond. Maxine Waters, chair of the House financial services committee, said there would be additional hearings to continue to dig into the situation and determine whether additional legislation or regulations are needed.

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