Robinhood Shares Tumble as SEC Considers Banning Payment for Trades
Robinhood, the crypto-friendly stock trading app, has been beset by one issue or the other – even before the company was listed on the NASDAQ exchange.
The company appears to be in trouble again, with regulators possibly coming for its top revenue generator.
Ban of PFOF ‘On The Table’
Earlier this week, Gary Gensler, Chairman of the Securities and Exchange Commission (SEC), said in an interview that the agency is looking into possibly banning payments for order flow (PFOF). Speaking with Barron’s, Gensler explained that a ban on the controversial practice is on the table, especially with the SEC looking to regulate the financial services industry better.
A highly controversial practice, PFOF is compensation that brokerage firms get for directing orders to different parties in the trade execution process. In exchange for directing trade orders to a particular market maker, brokerage firms will get a cut – usually fractions of a penny per share.
Gensler reiterated the conflict of interest angle in his interview, adding that market makers now make more than just the small spreads on each trade. The regulator chief added that market makers also get data, a first look, and the opportunity to match buyers and sellers out of the order flow.
The news immediately crushed Robinhood, with the company’s stock down 7 percent in the past 24 hours. PFOF makes a significant part of Robinhood’s revenues. While the company has reiterated that it will be able to adapt if rule changes affect the practice, a drop in revenues is never easily forgiven on Wall Street.
PFOF has come under heavy criticism, with a 2000 study by the SEC calling the act a method of transferring trading profits from market makers to brokers that route orders to specialists for execution. The report pointed out,
“Internalization allows a firm to capture trading profits from trading against the firm's own customers' orders. However, payment for order flow and internalization create conflicts of interest for brokers because of the tension between the firms' interests in maximizing payment for order flow or trading profits… and their fiduciary obligation to route their customers' orders to the best markets.”
PayPal Lurking in the Corner
Gensler’s announcement isn’t the only problem for Robinhood at the moment. Yesterday, CNBC reported that top payment processor PayPal is working on partnering with a broker-dealer to bring stock trading to its users.
Citing anonymous sources, CNBC noted that PayPal had already conducted discussions with several industry players, but the stock trading service might not launch until 2022. With the company looking to get approval from the Financial Industry Regulatory Authority (FINRA) as a brokerage firm, 2021 doesn't seem feasible anymore.
PayPal has allegedly hired Rich Hagen – a brokerage industry veteran- as part of its play – to lead the upcoming stock trading division. Hagen’s LinkedIn page already shows that he will be responsible for the company’s “efforts to explore opportunities in the consumer investment business.”
With PayPal having more customers than Robinhood and a more recognizable brand in the fintech industry, launching into stock trading will further increase the latter’s profits.