Robinhood (HOOD) and allied market makers including Virtu Financial (VIRT) have opposed newly proposed rules that, if passed, would represent the biggest change in securities markets regulation in over a decade.
Shares of both companies are down more than 7% since the market open on Wednesday, with Virtu suffering its biggest intraday drop since April on Thursday.
The central theses
- Two new rules proposed by the Securities and Exchange Commission (SEC) have incensed Robinhood and the market makers, which are its main source of income.
- The rules are part of a set of four rules that will mark the biggest change in stock trading regulation in over a decade.
- A rule significantly increases the disclosure of brokers receiving payments for order flow.
- The other would require stock trades to go through an auction before they can be executed by market makers paying for order flow agreements.
The proposed rules target payment for order flow (PFOF), the order execution process that many brokers, including Robinhood, say helps them offer commission-free trades. A rule would force brokers to show how they achieved best execution on trades for which they receive flow payment. Another would require retail client orders to be auctioned for best execution on public marketplaces such as a stock exchange before they could be executed by a market maker. The SEC estimates that auctions for execution could save retail investors $1.5 billion annually, or 1.08 basis points of revenue from such deals.
The rule changes threaten the business models of market makers like Virtu and Citadel Securities, as well as brokers who rely on their payments. Lucas Moskowitz, Robinhood’s deputy general counsel, criticized the SEC’s proposals, telling Bloomberg News they would “resurrect discriminatory barriers to entry and harm millions of retail investors.” He also complained that the proposal’s 60-day public comment period was too short for “a package of this size and complexity.”
At the other end of the spectrum, retail investor advocates argue that the SEC should have banned payment for order flow altogether.
The SEC says commission-free trades are unlikely to go away if payment for order flow is restricted. Many large brokerage firms make more from other sources, including margin loans and stock loans to short sellers.
The rules are expected to benefit the public exchanges where the execution auctions would take place, including owners of the New York Stock Exchange, Intercontinental Exchange (ICE) and Nasdaq (NDAQ).
The SEC is increasingly concerned that analyzing trade executions between public exchanges, market makers and dark pools has reduced the transparency of securities trading and increased its cost to individuals. “Markets have become increasingly out of sight, particularly for individual investors,” SEC Chairman Gary Gensler said in prepared comments in support of the rule changes. “These everyday individual investors do not have the full benefit of different market participants competing to fill their marketable orders at the best possible price.”
One of the other two rules is less aimed at Robinhood, but is likely to be opposed by market makers. It would reduce the size of stock ticks to a tenth of a cent, and would require market makers currently executing trades at prices down to a hundredth of a cent to trade stocks with the same tick sizes as exchanges. The final rule would expand stock price data disclosure requirements for brokers with more than 100,000 clients.
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