Commission-free trading means ‘you are the product’, legislator says at Robinhood-GameStop hearing


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Major players in the GameStock saga faced tough questions from members of the House Financial Services Committee on Thursday, as the rapid rise and fall of the video game retailer’s stock has highlighted some of the darker aspects, and some would argue worrying. of the structure of the stock market in the US Robinhood CEO Vlad Tenev defended his company’s decision in late January to temporarily restrict the trading of so-called meme stocks, including GameStop Inc. GME, -11.43%, as needed to meet collateral requirements at your clearinghouse.

“Any allegation that Robinhood acted to help hedge funds or other special interests to the detriment of our clients is absolutely false and market-distorting rhetoric,” he said. Ken Griffin, founder of Citadel Securities, one of Robinhood’s main sources of income, also denied having had any influence on this decision. Griffin’s hedge fund recently made a large investment in GameStop short seller Melvin Capital, and this deal led to allegations that Robinhood was influenced by its relationship with Griffin. The practice of pay-per-order flow, whereby market makers like Citadel Securities pay stock brokers like Robinhood to ship client orders their way, was a major focus on the audience. Rep. Brad Sherman, a Democrat from California, attacked these deals, saying, “Everybody I’ve talked to in this industry says that when a broker is paid for order flow, you get worse execution.” He added that a commission-free trading model creates a system in which “you are the product” while the market makers are the real customer. Griffin responded by noting that trading costs in terms of bid-ask spreads and broker commissions have steadily declined in recent decades. “It has allowed the American retail investor to have the lowest cost of execution that it has ever had in the history of the American financial markets,” he said. See also: We were ‘dangerously close’ to the collapse of ‘the whole system’, says Interactive Brokers founder before GameStop hearing. Legislators discussed the importance of options trading to Robinhood’s income model. Rep. Sean Casten, D-Illinois, noted that prior to 2018, Robinhood’s revenue per user was fairly constant at around $ 10 per user per year. After it began offering options in 2018, revenue per user increased dramatically, reaching $ 50 a year for each user in 2020, “in line with the adoption of options,” he said. In fact, regulatory filings show that Robinhood earned roughly two-thirds of its pay stream revenue on order from options trading, even though it only engaged 13% of its clients. Rep. Joyce Beatty, a Democrat from Ohio, noted that Robinhood is paid “much higher” fees than its competitors for order flow, and asked why companies like Citadel pay a premium for Robinhood exchanges. Tenev said it is because Robinhood receives payment for order flow as a percentage of the bid-ask margin of a traded security, rather than a fixed rate. Critics, however, have said that this practice incentivizes Robinhood to push clients toward the most illiquid securities with large spreads between buy and sell. For example, options tend to have much higher buy-sell margins than stocks and are riskier investments. Republicans largely joined in arguing that the GameStop saga only highlights that the financial services industry is over-regulated. The ranking Republican on the committee, Rep. Patrick McHenry, attacked what he sees as the unfairness of the accredited investor rule, which allows sophisticated investors to buy securities of unlisted 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 ready, if you are not, you are considered too dumb to be entrusted with your own money,” he said. Better Markets, a nonpartisan group that promotes the public interest in the markets, objected to this line of reasoning. Democrats 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. “Robinhood has gambling characteristics that seem to manipulate retailers into making rash, reckless and potentially ruinous investments,” said Ritchie Torres of New York. In December, securities regulators filed a complaint against the company for “aggressively marketing itself to Massachusetts investors without regard to the best interests of its clients” and for “using strategies such as gamification to encourage and attract continued and repetitive use. of its commercial application. “The Financial Industry Regulatory Authority announced earlier this month that it would review the practices of application-based brokers regarding gamification, and whether the characteristics of these applications count as values ​​of marketing that are not suitable for investors. The Securities and Exchange Commission and FINRA have previously reviewed the practice of pay-per-flow of orders without forcing radical reform, but today’s hearing makes clear that Democrats will pressure regulators to review again. President Waters said in her closing statement that “I am more concerned than ever that retail investors are being scammed.”