Robinhood Stock Sinks by 7% After Gensler Discusses PFOF Ban

In an interview with Barron’s, SEC Chairman Gary Gensler declared that a full ban on the controversial payment for order flow (PFOF) model is “on the table.” Gensler said FPOF has “an inherent conflict of interest” and mentioned how the U.K., Australia, and Canada forbid this arrangement.

The news is disastrous for Robinhood since a large portion of the brokerage firm’s revenue is from PFOF. Therefore, it comes as no surprise that the shares of Robinhood Markets stumbled by around 7% on Monday. 

A Full SEC Ban on PFOF is Plausible 

Payment for order flow is the compensation a brokerage firm receives from a market maker in exchange for routing trades. The practice is specifically beneficial to small brokers as they can funnel orders to a wholesaler and receive compensation while saving costs and resources.

However, the practice is considered controversial since it has “an inherent conflict of interest.” Here is how the SEC Chair describes this controversy:

“They [marker makers] get the data, they get the first look, they get to match off buyers and sellers out of that order flow. That may not be the most efficient markets for the 2020s.”

Gensler then added more details on how PFOF can harm investors:

“It provides an opportunity for the market maker to make more, and for ultimately the investing public to get a little less when they sell, or have to pay more when they buy.” 

While Gensler didn’t mention any specific case that might have resulted in harm to investors, he did say the SEC is reviewing PFOF and might propose a solution within a couple of months. He also pointed out that the United Kingdom, Canada, and Australia have already banned the practice. He added:

“I’m raising this because it [a ban] is on the table. This is very clear. Also on the table is how do we move more of this market to transparency. Transparency benefits competition, and efficiency of markets. Transparency benefits investors.”

Gensler also mentioned that PFOF can be a barrier to “fair, orderly and efficient markets.” If so, companies that use this model and go public might get a misleading valuation. “I think it also affects companies raising money,” he said.

$HOOD Drops Following Gensler’s Remarks of PFOF Ban

For the majority of brokers, PFOF represents only a small portion of their revenue — usually less than 10%. However, the practice constitutes Robinhood’s primary method of revenue generation, oftentimes accounting for 80% of its revenue.

In 2020, Robinhood raked in $7.45 million in net profit and a staggering $959 million in net revenue. However, data reveals that PFOF and transaction rebates accounted for 75% of the company’s revenue for all of 2020. In other words, Robinhood garnered $719 million from PFOF and transaction rebates in 2020.

Before going public, Robinhood disclosed risks related to the prohibition or regulation of PFOF in a S-1 form. The form said:

“Because a majority of our revenue is transaction-based (including payment for order flow, or “PFOF”), reduced spreads in securities pricing, reduced levels of trading activity generally, changes in our business relationships with market makers and any new regulation of, or any bans on, PFOF and similar practices may result in reduced profitability, increased compliance costs and expanded potential for negative publicity.”

Considering such remarks, it is no wonder that investors started dumping the company’s stocks following the interview with Gensler.

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More Trouble on Horizon for Robinhood

Things might even get worse for Robinhood as the company is slated to encounter two more powerful rivals. Reports from yesterday suggest that PayPal is exploring the possibility to launch a stock-trading platform for US customers. 

PayPal’s announcement comes amid a boom in retail trading that saw more than 10 million new users join stock trading in the first half of 2021. Reportedly, PayPal has hired a brokerage industry veteran to lead a previously unreported division of the company called Invest at PayPal. Considering that PayPal has over 360 million accounts worldwide, the company’s entrance to stock trading would be game-changing.

How Can Robinhood Survive?

A ban on PFOF along with the rise of more powerful rivals is everything that can literally knock down the infamous trading brokerage Robinhood. However, the firm still has other possible routes to take, even in a worst-case scenario.

The company can become “the single money app” that the company’s CEO has previously spoken about. In an interview with AP News, CEO Vlad Tenev asserted that he plans to turn Robinhood into an all-in-one financial app.

He said:

“Over time, we want to be the single money app, the most trusted and most culturally relevant money app worldwide. So, everything that you use your money for, you should be able to do through Robinhood.”

However, while this is an ambitious goal, there is very little chance of achieving it in the short term. So, there comes another potential option: an acquisition involving Robinhood.

In an interview with Yahoo Finance, Thomas Peterffy, chairman and founder of Interactive Brokers, suggested regulatory authorities in the US are unlikely crack down on PFOF. He added that if the US were to ban PFOF, then Citadel Securities would have to buy Robinhood. Peterffy said:

“If they were to prohibit payment for order flow, what has to happen is you would have Citadel [Securities] buy Robinhood and Schwab would buy Virtu, and the two sides would be put together into one company.”

Do you think Gensler will eventually push for a ban on PFOF? Let us know in the comments below.