Robinhood hits back at SEC, warns of threat to zero-commission trading

The popular brokerage says a set of proposals from the Securities and Exchange Commission would turn back the clock to the days before zero-commission trading, when investors had to pay fees for buying and selling stocks.

In Robinhood’s first extended comments about the SEC’s proposals since their release in December, two company executives, in an interview with The Wall Street Journal, called the agency’s plan a backdoor attempt to ban payment for order flow, or PFOF. That is a practice in which electronic trading firms known as wholesalers pay brokers a share of their profits from executing investors’ orders.

Payment for order flow is a crucial part of the business model of Robinhood, which is set to report fourth-quarter results Wednesday. Critics of the practice, including SEC Chair Gary Gensler, say it poses a conflict of interest for brokers. But PFOF makes it possible for firms such as Robinhood to make money without charging commissions, and it opened the door to zero-commission trading, which brought millions of new investors into the stock market during the pandemic.

“If you think about the ramifications of these proposals, you’re essentially shutting the door and saying we liked it better when it was the old boys’ club,” Robinhood Chief Brokerage Officer Steve Quirk said.

Robinhood leans heavily on PFOF, even as it has begun to rely more on other revenue streams such as collecting interest on cash balances. During the third quarter of 2022, the company earned 43% of its total net revenue from payments for routing stock and options orders.

The SEC says its proposals are aimed at getting investors a better deal on trades. Their centerpiece is a plan to require retail brokerages to send many of their customers’ orders to auctions, where high-speed traders and other firms could compete to execute each order. The idea is to unleash competitive forces so investors get better prices.

“We’ll do everything in our power” to ensure that Robinhood doesn’t start charging commissions, Mr. Quirk said. But other brokers might be forced to revive commissions, he added.

Speaking alongside Mr. Quirk, Robinhood Deputy General Counsel Lucas Moskowitz said he expected the SEC to soften its proposals, which grew out of a review prompted by the frenzied trading in GameStop Corp. in early 2021. He criticized the agency for pushing through sweeping changes with insufficient industry input.

“I’ve never seen a rule-making effort of this size and complexity and interconnectedness being done all at the same time, this quickly, with so little advance study and discussion,” Mr. Moskowitz said.

An SEC spokesman said members of the public could comment on the proposal through the agency’s website.

Anthony Denier, chief executive of Robinhood rival Webull, said his firm could find other ways to make money if payment for order flow dries up. But he warned that the changes would hurt smaller competitors, noting that Webull relied heavily on PFOF in its early years.

“Any company that wants to be the next Webull or the next Robinhood won’t have a chance to even grow,” he said.

Others doubt that the SEC’s plans could revive commissions, dismissing such claims as self-serving and alarmist. “Any brokers seeking to impose new costs will likely face stiff competition from brokers that have already figured out how to not take PFOF or charge commissions,” said Tyler Gellasch, president of Healthy Markets Association, an investor group.

Last year the dozen largest retail brokers collected $3.1 billion in PFOF, according to Bloomberg Intelligence data. There is no outright ban on the practice in the SEC’s proposals, but various elements of the proposals could slow that stream of payments to a trickle.

The auctions proposal, for instance, imposes a cap on rebates that the auction operator could send to brokers. This cap—which the SEC is proposing to set at 5 cents per 100 shares—would effectively limit PFOF for orders executed in the auctions. In December, Robinhood made from 25 to 44 cents per 100 shares for routing market orders for S&P 500 stocks to wholesalers, regulatory filings show.

Another threat to PFOF lies in a separate SEC proposal to spell out brokers’ duties to provide the best possible executions for customers. If implemented, the proposal would impose hefty requirements on any brokerage engaged in “conflicted transactions”—in other words, any trades for which the broker gets payment for order flow. These include a stepped-up obligation to scour the market for better prices on each trade.

Unlike the auction plan, the best-execution proposal applies to options as well as equities. That could hammer the lucrative business of options PFOF, which accounts for around twice as much brokerage revenue as equities PFOF, Bloomberg Intelligence data shows.

Even the SEC says the rule could hurt brokers. In an analysis accompanying the proposal, the agency says the new requirements could entrench the advantages of larger brokers and prompt some smaller brokers to exit from the market.