Brendan McDermid/Reuters
Robinhood dropped as high as 9% Monday, before closing 7% below after Gary Gensler, Chairman of the SEC, stated that a ban on the payment for order flow model was "on the table."
Gensler made these comments during a Monday interview with Barron's.
Robinhood's revenue comes mainly from the payment of order flow for stocks and options trades.
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Following comments by Gary Gensler, the SEC Chairman, Robinhood shares fell as high as 9% Monday afternoon. The stock closed 7% less than the previous day.
Gensler stated that a ban on payment for order flow models used by many brokerage firms was "on the table" in a Monday interview with Barron's.
Order flow payment is when brokers route trade orders to market makers from customers. They then execute the trades and often get a small commission.
Barron's was informed by Gensler that the practice had an "inherent conflict of interest." They have the data, the first look, and they can match buyers with sellers from that order flow. This may not be the most efficient market for 2020.
Barron's reports that Gensler did not say whether the SEC had found instances where conflicts of interest resulted in investors being hurt. Gensler stated that the SEC could make proposals on this practice in the next few months.
The spread in price paid by market makers to the end user for a few shares Apple or Microsoft is often less than a tenth of one penny.
Robinhood used payment for order flow to reduce its trading commission from $9.99 to $0 when it was launched in 2014. This was in contrast to discount brokerages that were charging up to $9.99 per trade. Payment for order flows, in addition to a $0 commission on trades, has allowed fractional share investment.
Robinhood's revenue comes in large part from transaction rebates and payment for order flow. These practices accounted for 75% of Robinhood's revenue in 2020. This number grew in the first quarter and second quarter of 2021.
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In its S-1 filing, the company identified a possible ban on payment for order flows as a risk to their business.
Robinhood stated that because a large portion of our revenue is transaction-based, including payment for order flow or "PFOF") reduced spreads in securities prices, decreased levels of trading activity overall, and changes in our business relationships to market makers, any new regulation or bans on PFOF or similar practices could result in reduced profitability and increased compliance costs, and increased potential for negative publicity.
