Commission-Free Trade Means “You Are the Product,” Lawmaker Told at Robinhood-GameStop Hearing
On Thursday, the main players in the GameStock saga faced tough questions from members of the House Financial Services Committee, as the video game retailer’s rapid rise and collapse in stock took shed light on some of the more obscure, and some would say disturbing, aspects of the structure of the US equity market
Robinhood CEO Vlad Tenev defended his company’s decision to temporarily restrict trading in so-called memes stocks, including GameStop Inc. GME, in late January.
if necessary to meet the guarantee requirements of its clearing house.
âAny claim that Robinhood has acted to aid hedge funds or other special interests to the detriment of our clients is absolutely bogus rhetoric and distorts the market,â he said.
Ken Griffin, founder of Citadel Securities, a major source of income for Robinhood, also denied having had any influence on the decision. Griffin’s hedge fund recently made a large investment in GameStop short seller Melvin Capital, and this arrangement has led to allegations that Robinhood was influenced by his relationship with Griffin.
The practice of payment order flow, where market makers like Citadel Securities pay brokerage firms like Robinhood to route clients’ orders as they see fit, was the focus of the audience.
Representative Brad Sherman, a Democrat from California, attacked these provisions by saying, âEveryone I’ve spoken to in this industry says that when you’re a broker paid for the flow of orders, you get worse execution. He added that a commission-free business model creates a system in which “you are the product” while the market makers are the real customer.
Griffin countered by pointing out that trading costs in terms of bid-ask spreads and brokerage commissions have fallen steadily over the past decades. “This has allowed the US retail investor to have the lowest cost of execution he has ever had in the history of US financial markets,” he said.
See also: We were “dangerously close” to “whole system” collapse, says founder of Interactive Brokers ahead of GameStop hearing
Lawmakers have emphasized the importance of options trading to Robinhood’s revenue model. Representative Sean Casten, the Illinois Democrat, noted that prior to 2018, Robinhood’s revenue per user was fairly stable at around $ 10 per user per year. After starting offering options in 2018, revenue per user increased sharply, reaching $ 50 per year for each user in 2020, “in line with options taking,” he said.
Indeed, regulatory documents show that Robinhood derived about two-thirds of its payment revenue for orders from options trading, even though this only affected 13% of its customers.
Representative Joyce Beatty, a Democrat from Ohio, noted that Robinhood was paid “much higher” rates than its competitors for order flow, and asked why companies like Citadel pay a premium for transactions. by Robinhood. Tenev said this was because Robinhood was receiving payment for order flow as a percentage of the bid-ask spread for a traded security, rather than a flat rate.
Critics, however, have said the practice prompts Robinhood to push clients into the more illiquid stocks with large bid-ask spreads. For example, options typically have much larger bid-ask spreads than stocks and are riskier investments.
Republicans were broadly united in the argument that the GameStop saga only underscores that the financial services industry is overregulated. Committee Ranking Republican Rep. Patrick McHenry attacked what he sees as the injustice of the Accredited Investor Rule, which allows sophisticated investors to buy securities of non-public companies, but not the general public. An investor is considered accredited if he earns more than $ 200,000 per year or has $ 1 million in wealth.
“If you are rich you are good to go, if you are not you are considered too stupid to be trusted with your own money,” he said. Better Markets, a non-partisan group that promotes the public interest in markets, objected to this reasoning.
Democrats have also focused on the issue of “gamification,” or features of the Robinhood app that critics say encourage more frequent use of the app than is financially beneficial. âRobinhood has in-game features that appear to manipulate retail traders into making reckless and reckless and potentially ruinous investments,â said Ritchie Torres of New York.
In December, securities regulators filed a complaint against the company for “aggressively marketing itself to Massachusetts investors without considering the best interests of its clients” and for “using strategies such as gamification to encourage and induce continued and repetitive use of its trading application “.
The Financial Industry Regulator announced earlier this month that it will be reviewing the practices of app-based brokers when it comes to gamification, and whether the features of those apps count as unsuitable marketing titles. to investors.
The Securities and Exchange Commission and FINRA have previously reviewed the practice of paying for order flow without forcing sweeping reform, but today’s hearing makes it clear that Democrats will urge regulators to reconsider. President Waters said in her closing statement that “I am more concerned than ever that retail investors are being robbed.”