Robinhood shares have dropped as regulatory worries stack up

Buy the dip?
Buy the dip?
Image: Reuters/Andrew Kelly
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CEO Vlad Tenev will have plenty to discuss with investors and analysts when Robinhood reports third-quarter results tomorrow (Oct. 26). Shares of the Menlo Park, California-based brokerage have fallen about 12% during the past month, going in the opposite direction from rivals like retail-brokerage pioneer Charles Schwab and Coinbase, the crypto exchange.

Robinhood shares are under pressure as the company plans a stock sale by existing investors. A regulatory filing about the share sale noted that more than 70% of the brokerage’s revenue came from payment for order flow (PFOF) and transaction rebates in 2020. That business model has become controversial: Instead of sending customer trades to a stock exchange, those orders get sent to large trading firms (market makers) like Virtu Financial and Citadel Securities. Those firms pay Robinhood for the right to execute the transactions. Some market-structure experts say, thanks to PFOF, retail traders are getting the cheapest stock trading ever. (You can read more about PFOF here and here.) Robinhood handles its crypto orders via a similar process, from which it earns transaction rebates. And regulators, as it happens, also have crypto in their crosshairs.

Scrutiny over payment for order flow is growing

The US Securities and Exchange Commission isn’t entirely convinced retail traders aren’t getting quite as good a deal as they think. Officials worry that PFOF creates a conflict of interest, and SEC chair Gary Gensler told Barron’s that a ban on the practice is “on the table.” “Our markets have moved to zero commission, but it doesn’t mean it’s free,” Gensler said on CNBC. “There’s still payment underneath these applications. And it doesn’t mean it’s always best execution.”

Other US retail brokerages like Schwab and E-trade also make money from PFOF, but Robinhood is more dependent on the practice than most other firms.

The agency is also reviewing whether some apps have become “gamified,” encouraging users to trade more often than they need to, which can cut into investments returns and increase their risk of losses. In response to an SEC request for comments, some academics have argued that SEC should be concerned about brokerage apps that have “behavioral prompts or personalized recommendation algorithms.” For its part, Robinhood said it “does not target customers to induce trading based on who they are or what we predict they will do.”

In the meantime, there are growing questions as to whether the retail trading boom will abate as workers go back to offices. Robinhood said it added 5.1 million accounts in the second quarter, almost twice the number added a year earlier but down from the 5.7 million new accounts during the previous quarter. A key question for Robinhood executives tomorrow is whether the retail trading boom could turn into a bust.