If there’s one thing that Robinhood has been known for recently, it is getting in trouble with regulators over its business model.
The company has always been in the spotlight, even before it was listed on the NASDAQ. From one technical difficulty to the other, Robinhood has paid fine upon fine. When it was eventually listed, the troubles kept coming. Now, once again, Robinhood is finding itself in the midst of a significant battle.
Threatening Payment for Order Flow
The difference between this case and the others is that this one directly impacts Robinhood’s entire operating and business model. It’s not just retaliation for the company’s failures. Three weeks ago, Gary Gensler, the Commissioner for the Securities and Exchange Commission (SEC), spoke in an interview with Barron’s that the agency might be looking towards banning payment for order flow - a controversial act that has been in practice for years.
Payment for order flow is simply compensation that brokerage firms and services get for directing orders to different parties to execute trades. The brokerage firm - in this case, Robinhood - gets a small payment for their action, and while this can be small on a trade, it accumulates as trade orders pile up.
Essentially, the act has become more profitable for brokerage firms with the explosion of these firms themselves. With more brokerage firms available - especially online - retail trader numbers have also grown. So, these companies have more sources of income for payment for order flow.
Companies that accept this payment argue that it allows them to give better prices to investors while also opening up new markets. However, some consumer advocates have criticized it, arguing that it makes these brokerages open to conflicts of interest. It also definitely doesn’t help that the concept was pioneered by Bernie Madoff - one of the most notorious Ponzi scheme operators.
The SEC itself has been critical of payment for order flow. In a special study back in December 2000, the agency claimed that payment for order flow is a means of transferring some part of trading profits from market makers to brokers who route customer orders.
The Possible Impact on Robinhood
When Robinhood first made waves, the company’s most striking benefit was its ability to offer commission-free trades to customers. This was a game-changer, and it made Robinhood an instant hit. But, getting paid for directing its trades to market makers would be one of the ways the company would make up for the lost commission revenues.
Robinhood eventually took off, and payment for order flow became even more alluring. Several traditional brokers like Charles Schwab and TD Ameritrade launched services that also offered zero-commission trading, and they all used payment for order flow to compensate for these losses.
So, there is no doubt about it. Payment for order flow isn’t just a big part of how Robinhood makes money - it is the mechanism behind what made the company so successful from the start.
In his Barron’s interview, Gensler drummed the same belief that payment for order flow creates an inherent conflict of interest. The SEC has so far declined to give any additional comment about what further action it would take. Although, Gensler has said on several occasions that an outright ban of payment for order flow is one of the options that the regulatory agency is considering.
Another alternative will be clearer, stricter reporting requirements for these brokerage firms. But, for now, the market will need to wait and see.
Robinhood is Still Standing
It’s easy to see why this might be the biggest test for Robinhood yet. The company has managed to get away with multiple technical outages and tripping on regulatory traps by doing no more than pay fines. But, if a major source of income is threatened, it could be in serious trouble.
The issue is also coming at a time when Robinhood is looking to expand its business offering. Earlier this month, the company confirmed that it would launch a feature to allow customers to make recurring purchases of their favorite cryptocurrencies. Users will be able to buy cryptocurrencies on a daily, weekly, bi-weekly, or monthly basis with as little as $1. Purchases will be commission-free, and they will go straight to users’ portfolios.
Robinhood is also reported to be testing a new crypto wallet feature. According to reports, evidence of the wallet was shown in a beta version of Robinhood’s iPhone app. By adding wallets, Robinhood could become the home of cryptocurrency users, allowing them to save their coins on its platform and use them.
Robinhood has always allowed customers to buy their favorite coins, but this could mark the first time that customers would be able to directly manage their coins from the app.