Robinhood CEO Vlad Tenev endorsed an SEC push to refine how stocks are priced, writing in a blog post that the move would “level the playing field” for retail investors.
Tenev backed a suggestion by SEC Chair Gary Gensler that the agency might waive a rule requiring exchanges to price stocks in pennies. Allowing sub-penny pricing would put exchanges like Robinhood on equal footing with non-exchange market makers like Citadel and Virtu Financial, he argued.
Earlier this month, Gensler acknowledged that the rule banning sub-penny pricing on exchanges could constitute an unearned advantage for non-exchange market makers. He said the SEC would consider changes to the rule, though no formal proposal has yet been offered.
Tenev called for all stock quotes to be given to four decimal places, or a hundredth of a penny.
Such a change – once considered too insignificant to matter – could smooth trades on low-price, high-volume shares with minuscule bid-ask spreads. In these trades, non-exchange market makers can benefit by undercutting exchanges’ bids by a fraction of a penny.
“If the sub-penny limitation is removed, and exchanges reduce fees for retail orders, we could see tighter [bid-ask spreads], even better execution quality for retail investors, more transparency and perhaps more retail order flow executed on lit markets,” Tenev wrote.
Robinhood routes its order book to non-exchange market makers in exchange for compensation, a model known as payment for order flow. Gensler has questioned the setup, noting it is non-transparent and banned in the UK and Canada.
Market makers contend that their profits come only when they succeed in cutting prices for clients – or retail investors, in the case of Robinhood.
The ongoing fiasco that grew out of online broker Robinhood’s decision to limit customers’ ability to buy “meme stocks” like GameStop in January has produced a lot of noise, but also a silver lining.
Robinhood’s move, which angered customers and some online commentators, also brought attention to how retail brokers like E*Trade, Charles Schwab, TD Ameritrade and Robinhood handle orders on behalf of their retail customers.
When a customer attempts to buy or sell a share of a stock or other security brokers have a legal and moral obligation to provide their customers with “best execution,” which means that these companies must give their customers the best price “reasonably available.” But this certainly is not happening in US securities markets today.
Retail customer orders with commission-free broker-dealers like Robinhood – that do not charge customers a fee to execute their trade – are sold to high-speed market makers like Citadel Securities and Virtu Financial in a scheme called “payment for order flow.” In essence, Robinhood and other brokers do not actually match a buyer and a seller to complete a full stock trade.
Instead, Robinhood sells their customers “orders” by the millions to market makers like Citadel, who do the hard work of lining up buyers and sellers in exchange for a fee. These high-speed market makers process massive amounts of trades every day and have taken over the market. By paying billions of dollars in kickbacks to retail brokers, on a typical day Citadel processes 40% of all retail securities orders in the US stock market, making Citadel the most powerful middleman on Wall Street.
Citadel, Virtu, and Robinhood claim to benefit the retail investor by offering better prices than they might get on exchanges. It is true that Citadel sometimes gives retail investors a better price than the National Best Bid and Offer (NBBO), basically what regulators have determined to be the best selling and buying price for each security, displayed by the Securities Information Processor (SIP). But the NBBO SIP is a slow data feed that provides incomplete information on buy and sell orders displayed on exchanges.
The NBBO benchmark Citadel and Virtu use is widely understood to be outdated and incomplete. But brokers selling their order flow and the market makers who buy that flow and execute their trades have a strong incentive to ignore non-displayed orders because poor execution quality for retail investors translates directly into profits for them.
The best execution requirement requires best execution. It is not sufficient to provide a slight improvement on an inferior price. To illustrate how the market works, suppose that the displayed NBBO SIP for a stock is a bid, the highest price a buyer is willing to offer, of $10.00 and an offer, the lowest price at which a seller is willing to sell, of $10.30.
A Robinhood customer sends an order to sell 100 shares to Robinhood, which sells the order to Citadel. Citadel might, at its discretion, give a sort of imaginary “price improvement” over the NBBO SIP and buy the 100 shares from the seller at $10.01, a one penny improvement over the “best” bid of $10.00. This gives the retail seller price improvement of ($0.01 x 100 shares) $1.00 over the best displayed bid on the SIP.
But Robinhood’s customers are entitled to more than a discretionary increment of price improvement over the NBBO. They are entitled to the best price “reasonably available,” which means that they should have access to the vast swathes of the market that are not displayed on the NBBO SIP, but are available Citadel and Virtu through their network of systems that track buy and sell orders that are not displayed on the SIP.
In particular, it often is possible to execute a trade at the midpoint between the NBBO best bid and the best offer. Midpoint pricing would have given the Robinhood seller $10.15 for their shaper share price improvement of $15.00 rather than just $1.00. That extra $14.00 represents the profit that Citadel makes on the trade minus whatever pennies Citadel paid for the order flow.
Of course, if payment for order flow were eliminated, commissions for discount brokers likely would return, but even with commission of $7.00 per trade the retail customer is better off without payment for order flow.
In a nutshell, Citadel is in direct competition with the retail investor for the best prices and has paid retail brokers like Robinhood billions of dollars to help them cover up this conflict. In fact, on March 11, Virtu CEO Douglas Cifu admitted in a TV interview that retail customers of brokers like Fidelity, who don’t pay for order flow get better execution quality than customers on venues like Robinhood.
The biggest question facing Gary Gensler as he takes the helm of the Securities and Exchange Commission is whether Citadel and Virtu have a duty to seek the best price in the market or whether the “duty of best execution” has been truncated to mean that customers are only entitled to the NBBO SIP.
At present, Virtu and Citadel decide what, if any, price improvement to give to customers. Price improvement is arbitrary and discretionary. And it’s a zero sum game. The better the deal the retail gets, the less money that Citadel and Virtu make.
In a Tuesday hearing held by the United States Senate Committee on Banking, Housing, and Urban Affairs, Senators sat down with five experts to discuss “Who Wins on Wall Street? GameStop, Robinhood, and the State of Retail Investing.”
In the hearing, Duke Law Professor Gina-Gail S. Fletcher was asked by Sen. Sherrod Brown (D-OH) about stock brokerages using the payment for order flow business model.
Payment for order flow (PFOF) entails brokerages selling customers’ buy and sell orders to market-makers like Citadel Securities, Virtu, or Two Sigma. This allows the firms to generate revenue without charging commissions for trades.
When asked about the PFOF model, Duke law professor Gina Fletcher said that payment for order flow models “undermine the relationship between the broker and their client.”
The testimony was a rebuke of brokers like Robinhood, which rely on payment for order flow for the majority of their revenue.
Fletcher said that payment for order flow “pits the broker’s primary revenue source directly against the clients to whom they owe a duty of best execution.”
She also noted that it allows brokers to “say that they are offering zero-commission trading to retail investors when commissions are being subsidized by wholesalers.”
Professor Fletcher continued: “Under the payment for order flow model, brokers are incentivized to put their own profit-seeking interest above their clients’ in deciding where to route orders.”
Other experts on the panel included Rachel J. Robasciotti, the founder & CEO of Adasina Social Capital, who said that payment for order flow allows brokerages to profit while they give clients trading execution prices that are well below market value.
Robasciotti argued that the practice should be banned altogether due to the lack of disclosure adding, “if you don’t see what you are paying you are probably paying more than you would be comfortable with.”
Other experts weren’t as quick to call for a ban on the practice, but the group all agreed that the Securities and Exchange Commission should look into the payment for order flow model to decide if it should be allowed to continue.
To find out if a broker is getting paid for order flow, check out this article to learn more.
Just weeks after the GameStop stock bubble popped, the US House of Representatives Financial Services Committee held an hours-long hearing examining what happened.
Though that hearing featured a variety of chief executives, from Reddit CEO Steve Huffman to Citadel CEO Ken Griffin, and even featured one popular financial influencer, the main target of questioning was Robinhood CEO Vlad Tenev.
Questions to Robinhood focused on the app’s decision to halt trading and how it “gamifies” stock trading
With over 50 members of the House of Representatives participating, the lines of questioning varied wildly. Some representatives asked Tenev about Robinhood’s choice to halt trading of GameStop and other such “meme stocks” on January 28, while others asked him about Alex Kearns, a 20-year-old Robinhood user who thought he had lost $730,000 on the app. Kearns died by suicide in June 2020.
“I’m sorry to the family of Mr. Kearns for your loss,” Tenev said.
Kearns repeatedly contacted Robinhood’s help desk, but didn’t receive a response before he died. During his allotted time, Rep. Sean Casten played Tenev the recording that users hear when they call Robinhood for help.
He also criticized Robinhood for the “innate tension” at the heart of its business model, which he said is split “between democratizing finance, which is a noble calling, and being a conduit to feed fish to sharks.”
Lawmakers primarily focused on Tenev due to the stock trading app’s critical role in the explosion of GameStop’s stock value: Between January 20 and January 26, GameStop’s stock value leaped from just over $35 per share to north of $140 per share. By January 27, it hit new highs of over $325 per share – an over 8,000% increase from just a few months ago.
The next morning, Robinhood halted trades of the stock because it ran out of money to cover the upfront cost of its customers stock purchases. The company even had to dilute its own value in order to quickly raise capital – a $3.4 billion investment from several different firms was announced in early February.
Tenev repeatedly told lawmakers the same story he’s told previously: Robinhood was forced to temporarily halt trading of GameStop and several other stocks because the National Securities Clearing Corporation demanded $3 billion to cover volatile trades.
And he refuted claims that the decision was driven by the hedge funds which had taken out short positions on GameStop stock, as did Melvin Capital Management CEO Gabe Plotkin who also joined the hearing.
Another notable criticism repeatedly leveled at Robinhood: Gamification. The app notoriously features audio and visual elements that cheer on user actions. “We didn’t encourage anyone to tap on anything,” Tenev said in one such exchange. “We wanted to give our customers delightful features so they know we’re listening to them and we care about them.”
Technical difficulties persisted throughout the nearly 5-hour hearing
From the very beginning of the hearing, technical issues plagued the video conference. Hot mics were frequent, and a few major sound issues caused pauses.
As the hearing – which kicked off at noon – pushed on, exchanges between legislators and interviewees got more and more brief.
Legislators frequently cut in mid-answer with “I’ll reclaim my time” in an effort to squeeze another question in. And an exchange between Rep. Rashida Tlaib and Citadel CEO Ken Griffin just after the five-hour mark got particularly contentious, as he attempted to talk over her. “Let me finish my answer. I think it’s important,” he said. “No, no,” Tlaib responded.
The few exchanges with Keith “Roaring Kitty” Gill, a stock trader who made a name for himself as a YouTuber, were largely focused on what he specializes in: stock advice. Gill said he would still buy GameStop stock at its current value, and that he initially bought in months ago because it was “undervalued.” Also of note: Gill’s opening statement included at least one notable meme reference.
Ultimately, there were no huge revelations about the GameStop stock bubble or the major players involved in it from Thursday’s hearing. It’s the first of several such hearings that the financial services committee plans in the wake of the bubble’s popping.
You can watch the full hearing below:
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Melvin Capital Management lost over half its assets after GameStop burned short-selling funds this month.
The hedge fund, which was at the heart of the GameStop frenzy, lost 53% in January, sources close to the fund told Insider. The Wall Street Journal first reported the loss.
Melvin Capital, founded by star portfolio manager Gabe Plotkin, started the year with $12.5 billion in assets and ended the month with more than $8 billion in assets under management after current investors committed additional capital, the source said. Billionaire investors Steve Cohen and Ken Griffin invested $2.75 billion into the hedge fund earlier this week.
New and existing clients signed up to invest additional funds into Melvin Capital on February 1, the Journal reported, but the firm would not disclose how much.
Citron Research also closed its short position on GameStop after covering a 100% loss. Citron Research managing partner Andrew Left, a target for impassioned investors on Wall Street Bets, announced the firm would stop publishing “short reports.”