Will the SEC take 79% of Robinhood’s revenue?


Robinhood is one of the most popular brokerage firms, especially among new investors. There are many factors behind its popularity, but one of the most important is that it was one of the pioneers of commission-free stock trading. The investing app allows you to trade without paying a fee to buy or sell stocks, which means you don’t necessarily need a lot of money to start investing since you don’t pay for every trade.

Many brokers are now offering commission-free transactions, thanks in large part to innovative companies like Robinhood, who have made it an option for consumers. Traditionally, investors had to pay around $ 7 to $ 10 for each buy or sell transaction, which meant that frequent trading didn’t always make sense, especially when it came to small amounts of money. money.

Brokers, however, need to make money. And Robinhood’s main source of revenue could be threatened by upcoming regulatory action from the Securities and Exchange Commission. Here’s what you need to know.

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Could Robinhood lose a crucial source of income?

Robinhood risks losing one of its most important sources of income. In the second quarter of 2021, the brokerage firm got around 79% of its revenue through something called Payment For Order Flow (PFOF). And he got 77% of his money from PFOF in the first quarter of the year.

PFOF occurs when brokerage firms like Robinhood send the buy / sell orders that their clients place to specific high frequency trading firms for execution. In exchange for sending orders to these companies, brokers receive discounts on transactions. These discounts are given to brokers when buying and selling all types of investments, including stocks, options, and cryptocurrencies.

The SEC, however, is concerned that PFOF transactions cause “an inherent conflict of interest,” and SEC Chairman Gary Gensler has criticized the practice. This is because brokers can route orders placed by retail investors to different firms based on what is in the best interest of the broker, rather than who is offering the best order execution.

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In other words, retail investors might end up indirectly covering the cost of fees paid to the brokerage firm when the broker routes their trades to trading companies based on which firm pays them the biggest bribe. -wine.

The PFOF has been around since at least the 1990s, and brokerage firms are required to disclose their policies and publish details of their relationships with the trading companies they work with. This includes information about the payments that the broker receives. Brokers are also required to provide quarterly reports on how they are channeling orders.

However, the SEC is concerned that the current regulations are not stringent enough to protect consumers, especially as a growing number of brokers rely on PFOF revenues to support their business models. The practice also gained renewed attention when Robinhood had to limit trading in certain high-risk securities when investors began to grab GameStop shares after a group of Redditors staged a short-squeeze.

In light of its concerns, the SEC said a full-scale ban on the practice is under consideration. If PFOF is banned, Robinhood would likely have a hard time making up for the revenue it is losing without fundamentally changing its business model, which is to provide a no-cost experience to retail traders in an effort to democratize investing.

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