The SEC decision seems a little harsh on Robinhood. If RH had executed all of its customers orders on the public exchanges, instead of routing any to brokers, it would be in the clear (and a lot of people would be saying how great it was that RH didn't take payment for order flow). Directed orders are absolutely fine.
But because they chose to shop around for better prices than they could have achieved with directed orders, they had an obligation to pass on more of that price improvement to the customer. How much more? It's not clear. Seems like the SEC is hinting at "roughly as much as everyone else does" - brokers shouldn't be allowed a business model that subsidises low trading fees with high PFOF.
Other brokers subsidise their low or zero trading fees by collecting interest on their customers' cash balances. This only works when the balances are relatively large. The SEC's approach arguably encourages transparency, but I don't find either business model particularly transparent - the bigger effect is to discourage brokers targeting smaller clients.
As a matter of law, brokers have a duty to seek what’s called “best execution”, meaning they’re required to both shop around for better prices and pass all of the price improvement they can find onto their customers. Payment for order flow is still kosher in many circumstances; there's no clear duty to go to the people offering it and demand price improvement instead. But what you definitely can’t do is accept a worse deal (or stop trying to find better deals) in order to protect your payment for order flow revenue stream.
It’s fair to say that this rule cuts off some interesting business models which might better serve different market segments, but that’s largely the point. In the SEC’s judgment, the potential for abuse is too high if stock brokers start acting like retail stores.
> As a matter of law, brokers have a duty to seek what’s called “best execution”, meaning they’re required to both shop around for better prices and pass all of the price improvement they can find onto their customers.
That's the definition of best execution as it applies to undirected orders. But you can also offer your clients direct execution on the exchange, in which case you don't have to (and must not) shop the order around. If RH had done that, they'd be in the clear.
Yes, I understand that retail brokers aren't usually in the business of directed orders (because shopping round the orders is in the interest of both them and the client).
No, because if they do direct execution, that means they don't send the orders to the brokers who are giving them the PFOF. If you send it direct to NYSE or Nasdaq, the exchange charges you, not pays you.
> Payment for order flow is still kosher in many circumstances; there's no clear duty to go to the people offering it and demand price improvement instead. But what you definitely can’t do is accept a worse deal (or stop trying to find better deals) in order to protect your payment for order flow revenue stream.
This seems like a distinction without a difference. If you accept any payment for order flow you're always implicitly rejecting a hypothetical alternate arrangement where you agree to give up all PFOF in exchange for better price improvement.
But because they chose to shop around for better prices than they could have achieved with directed orders, they had an obligation to pass on more of that price improvement to the customer. How much more? It's not clear. Seems like the SEC is hinting at "roughly as much as everyone else does" - brokers shouldn't be allowed a business model that subsidises low trading fees with high PFOF.
Other brokers subsidise their low or zero trading fees by collecting interest on their customers' cash balances. This only works when the balances are relatively large. The SEC's approach arguably encourages transparency, but I don't find either business model particularly transparent - the bigger effect is to discourage brokers targeting smaller clients.