Robinhood, facing the potential consequences of a regulatory plan to revamp the way small investors’ trades are handled, has decided to fight back. The brokerage, known for offering zero-commission trading, argues that the proposals from the Securities and Exchange Commission would take investors back to the pre-zero-commission era when they had to pay fees for buying and selling stocks. 

In their first public response to the SEC’s proposals since their release in December, two executives from Robinhood spoke with The Wall Street Journal and labeled the agency’s plan as a sneaky attempt to eliminate payment for order flow (PFOF), a practice in which electronic trading firms, referred to as wholesalers, pay brokers a portion of their profits from executing investors’ orders.

Payment for order flow is a crucial aspect of Robinhood’s business model, and the company is set to announce its fourth-quarter results on Wednesday. Despite criticism from figures such as SEC Chair Gary Gensler, who believe the practice creates a conflict of interest for brokers, payment for order flow allows firms like Robinhood to generate income without imposing commission fees and facilitated the rise of zero-commission trading, which saw millions of new investors enter the stock market during the pandemic.

According to Robinhood’s Chief Brokerage Officer, Steve Quirk, the SEC’s proposals would mean “essentially shutting the door and saying we liked it better when it was the old boys’ club.” Despite exploring other revenue sources such as collecting interest on cash balances, Robinhood continues to heavily rely on payment for order flow. In the third quarter of 2022, the company generated 43% of its total net revenue from payments for routing stock and options orders.

The Securities and Exchange Commission has stated that their proposals aim to provide better deals for investors in their trades. The center of these proposals is a plan to make retail brokerages send a significant number of their customer orders to auctions, where high-speed traders and other firms can compete to execute each order, in order to increase competition and provide better prices.

According to Mr. Quirk, Robinhood is determined to do everything in their power to prevent charging commissions, however, he added that other brokers may be forced to bring back commissions.

Alongside Mr. Quirk, Lucas Moskowitz, Robinhood’s Deputy General Counsel, expressed his expectations for the SEC to soften their proposals, which were formed from a review prompted by the chaotic trading in GameStop Corp. in early 2021. He criticized the agency for implementing sweeping changes without adequate industry input.

Mr. Moskowitz stated that he has never seen a rule-making effort of such a large and complex size, being done so quickly with so little advance study and discussion.

According to an SEC spokesman, the public is allowed to provide feedback on the proposal via the agency’s website.

Anthony Denier, the CEO of Robinhood’s competitor Webull, stated that his company would find alternative means of generating revenue if payment for order flow were to diminish. However, he warned that the changes would impact smaller competitors negatively, pointing out that Webull relied heavily on PFOF during its early stages.

Tyler Gellasch, the president of the investor group Healthy Markets Association, argued that the claims of the SEC’s plans reviving commissions were alarmist and self-serving. He stated that brokers who seek to impose new costs would likely face competition from those who have already found ways to avoid PFOF or charging commissions.

Data from Bloomberg Intelligence shows that last year, the twelve largest retail brokers received $3.1 billion in PFOF. Although the SEC’s proposals do not outright ban the practice, some elements of the proposals could reduce the flow of payments.

For instance, the auctions proposal imposes a cap on rebates that the auction operator may send to brokers, with the SEC proposing to set the cap at 5 cents per 100 shares. This would effectively limit PFOF for orders executed in the auctions. Regulatory filings reveal that in December, Robinhood made between 25 to 44 cents per 100 shares for routing market orders for S&P 500 stocks to wholesalers.

According to the SEC, there is a proposal that outlines the duties of brokers in providing the best possible executions for their customers. If the proposal is implemented, it would put strict obligations on any brokerage involved in conflicted transactions, meaning trades where the broker receives payment for order flow. This would include a heightened responsibility to search the market for better prices on each trade.

The best-execution proposal applies to both options and equities, unlike the auction plan, which only applies to equities. This could affect the highly profitable business of options PFOF, which generates approximately double the amount of brokerage revenue as equities PFOF, as per the data from Bloomberg Intelligence.

The SEC acknowledges that the new rule could be harmful to brokers, as stated in the analysis accompanying the proposal. The agency says that the new requirements could further solidify the advantages of larger brokers and lead to the exit of some smaller brokers from the market.