SEC Will Not Prohibit Payment for Order Flow

Investing News

The U.S. Securities and Exchange Commission (SEC) reportedly will not seek to ban payment for order flow (PFOF), despite earlier indications that SEC Chair Gary Gensler had been inclined to issue such a prohibition. A notable winner from this apparent decision is online broker Robinhood Markets, Inc. (HOOD), whose business model is based on PFOF.

In the immediate wake of the report in Bloomberg News, published before the market open on Sept. 22, 2022, shares of Robinhood hit a high of $11.07, up by 11.6% from the prior close. However, by late morning the stock was trading at around $9.94, reducing the gain to about 0.2%. For the year to date in 2022, Robinhood’s shares are down by roughly 46%.

Key Takeaways

  • The SEC is not going to seek a ban on payment for order flow (PFOF) at this time, according to a report in Bloomberg on Sept. 22, 2022.
  • This represents a win for online broker Robinhood (HOOD), but its shares have sunk after an early rally.
  • Robinhood has paid large fines in the past to the SEC and FINRA over PFOF and other practices.

What Is Payment for Order Flow (PFOF)?

Some market makers and exchanges will compensate brokerage firms for routing trades to them. In general, the more trades that market makers and exchanges execute, the greater will be their trading profits. Payment for order flow (PFOF) effectively transfers part of these trading profits to the brokerage firms where these orders originated.

Importance of PFOF to Robinhood

A key element of Robinhood’s business model is attracting clients with the promise that they will not have to pay commissions on trades. Instead, Robinhood relies on PFOF as its primary source of revenue. Critics of the practice allege that PFOF represents hidden charges ultimately borne by the investor in the form of poorer executions (that is, in the form of higher prices when buying and lower prices when selling). Robinhood and the market maker that receives most of its order flow disputed this charge in a 2021 Congressional hearing, claiming that Robinhood clients actually get better execution than is offered by the exchanges.

Robinhood Fined Over Practices

In December 2020, Robinhood agreed to pay a $65 million fine to settle charges raised by the SEC. The SEC had found “repeated misstatements that failed to disclose the firm’s receipt of payments from trading firms for routing customer orders to them, and with failing to satisfy its duty to seek the best reasonably available terms to execute customer orders.” This enforcement action was related to actions taken by Robinhood between 2015 and late 2018.

In June 2021, the Financial Industry Regulatory Authority (FINRA) imposed penalties totaling $69.6 million on Robinhood. FINRA found that: “during certain periods since September 2016, the firm has negligently communicated false and misleading information to its customers. The false and misleading information concerned a variety of critical issues.” However, PFOF and trade executions were not among the issues covered by FINRA’s complaint.

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