How much did Robinhood pay for order flow, and was it a violation of securities laws and customer agreements?
That’s the question regulators have vowed to answer as an increasing number of customers have sued the company, claiming Robinhood violated their contracts and its own fiduciary duty after halting trades on frenzied stocks. The trading app earned the ire of both Washington, D.C., and Wall Street critics after it unexpectedly restricted purchases of GameStop Inc. and other hot stocks after online speculators caused the stocks’ prices to surge.
The Securities and Exchange Commission, the Financial Industry Regulatory Authority and at least two congressional panels are looking into the matter, as the number of customer lawsuits grew to 30 on Thursday.
The public outcry centered on the theory that Robinhood blocked purchases of GameStop and other stocks in order to benefit Citadel Securities—a sister to the hedge fund Citadel and one of Robinhood’s largest sources of revenue. Robinhood, however, claims it halted the frenzied trading in some stocks to reduce its own risk of running out of capital: As the volume of margin trades for GameStop, the gaming merchandise company, and other stocks rose, Robinhood was getting margin calls from its clearinghouse.
“It’s Robinhood’s regulatory requirement to protect their balance sheet” and halt trading, said D.R. Barton, a veteran Baltimore-based technical trader. “I think the way they did it was a bit blunt and ham-handed, but they were getting their own margin calls from the clearinghouse saying: ‘You don’t have enough money for all the stock your people are buying.’”
Citadel Securities said in a statement last week that it had “not instructed or otherwise caused any brokerage firm to stop, suspend or limit trading or otherwise refuse to do business.”
But with Robinhood CEO Vlad Tenev scheduled to testify before the House Financial Services Committee, and Treasury Secretary Janet Yellen holding a meeting with top federal regulators to address last week’s events, a deeper dive into Robinhood’s relationship with Citadel Securities is likely. That could force the SEC and Finra to take a hard look at the firm’s payment for order flow arrangements—in which trading firms pay Robinhood for the privilege of executing investor trades.
The SEC and Finra have allowed these payments for years. But veteran traders and securities experts say that with new regulatory agencies and Congress led by Democrats, it will be tougher to reconcile these payment arrangements with regulations that require firms to find the best prices for retail client trades.
In a series of tweets over the weekend, renowned venture capitalist Bill Gurley zeroed in on the practice in a series of tweets, and he told the SEC it “creates an obvious and substantial conflict of interest between broker-dealers and their customers.”
According to one former SEC lawyer, the practice is long held and perfectly legal. Nevertheless, it may become more odious as Congress and the Biden administration pressure regulators and firms to further reduce conflicts of interests.