High-frequency traders are in the spotlight
"FROM ONE perspective, retail stock traders have never had it so good. There is fierce competition among brokers, including the likes of Charles Schwab and Fidelity, for their business. This broke out into an all-out price war in 2019 when these firms cut stock-trading commissions to zero, four years after Robinhood, a startup promising commission-free trading, came on the scene. Retail participation in stock trading is at a new high.
This happy picture is somewhat muddied by the practice of payment for order flow (PFOF). Instead of charging users for each trade, brokers are paid by marketmakers to direct users’ trades—or “order flow”—through them. Marketmakers take small profits on the difference between the price that a broker’s user pays and that at which a share is offered for sale in the market. The mania around GameStop, a seller of video games, has put the practice, and its practitioners, in the spotlight.
On January 28th Robinhood decided to suspend buy orders for GameStop, after the retailer went viral in a forum on Reddit, a social-media site, and its shares spiked in value. The decision outraged users and was condemned by lawmakers on both sides of the aisle. Robinhood contends the decision reflected its obligations to the DTCC, a clearing-house that settles most equity trades. There is a two-day lag between an equity trade and its settlement, when the buyer gets their share and the seller receives their cash. In the interim, brokers must post collateral for users’ trades.
Vladimir Tenev, one of Robinhood’s founders, said he received a “nerve-wracking” call from the DTCC as GameStop prices surged, asking him to post $3bn in collateral. To meet these demands, the firm drew down its credit lines with banks and raised $1bn in capital. (It has since raised a further $2.4bn.) And to limit the amount of collateral it would have to post, it also temporarily halted buy orders for certain stocks.
Users decried the decision. Robinhood earned around $200m from PFOF in the fourth quarter of 2020 (see chart). Last year most of its orders flowed through Citadel Securities, a marketmaker run by Ken Griffin, a Chicago-based billionaire. The same parent company owns Citadel, a hedge fund. It had bailed out Melvin Capital, one of the funds short-selling GameStop, which had been targeted by the army of retail investors.
Users have questioned whether these links played some part in Robinhood’s decision to halt buy orders. (As has Elon Musk, the boss of Tesla, who nicknamed Mr Tenev “Vlad the stock impaler” when he interviewed him about the decision on social media on January 31st.) Mr Tenev has said “we absolutely did not do this at the direction of any marketmaker or hedge fund.” And Citadel has said it is not involved in, or responsible for, any retail broker’s decision to stop trading. 
But questions about the ethics and prevalence of the practice, which is banned in Britain and Canada, are likely to linger. . .READ IN BETWEEN THE LINES
Robinhood has been in trouble with regulators before. In December the Securities and Exchange Commission told it off for not telling users it made money from PFOF. The commission also found the broker failed in its duty to execute users’ trades at the best possible price. Robinhood paid $65m to settle the charges. (It has said the fine relates to historical practices.)
Mr Tenev is due to testify in front of the House Financial Services Committee on February 18th. The subject of PFOF will inevitably come up. As its share price tumbles, GameStop’s time in the spotlight may soon be over. For Robinhood and PFOF, though, this is perhaps just the start. ■
This article appeared in the Finance & economics section of the print edition under the headline "Pay-per trade"
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How Robinhood Convinced Millennials to Trade Their Way Through a Pandemic
The $8.3 billion stock trading startup fumbled into the financial crisis — and is now winning it
If there was a day everything changed for stock traders, it was Monday, March 2. The prior week, a Centers for Disease Control official warned that as the coronavirus pandemic sweeping Asia and Europe spread in the U.S., “disruption to everyday life may be severe.” China reported 202 new Covid-19 cases, bringing the total there to more than 80,000 despite massive lockdowns. Hundreds of new cases were confirmed in Italy; deaths were reported from Australia to South Korea; and cases in the U.S. tipped past 100. The S&P 500 had fallen for five straight days, plunging nearly 10% on spiking volume. For anyone working the markets, this would be the day to be ready for action . . .
FOLLOW ALONG:
The core premise of Robinhood as a product is straightforward: You can trade stocks with no commission charge at all. But as the name of the company suggests, Robinhood’s founders have always promoted their product as having a loftier mission: leveling the financial playing field.
Co-founders Tenev, now 33, and Bhatt, 35, became friends while studying math and physics at Stanford. They went on to found a New York-based startup that designed algorithmic trading software for financial institutions, but found this unsatisfying. During this stretch, in late 2011, they began to follow what they have claimed as their inspiration: the Occupy Wall Street movement.
“That was the one sort of cultural moment for defining what would become Robinhood,” Bhatt says now. “That stems from how it intersected with our individual lives. We were working in finance, and building technology for other financial institutions. And we realized our entire generation of consumers was feeling pretty left out from the way the financial system worked.” Watching the protests unfold, Tenev later told Fast Company, they realized: “We were making the top 1% of people wealthier.”
The underserved market segment Bhatt and Tenev had in mind wasn’t the financially disadvantaged underclass, or even the financially stressed working class. It was young people.
