Pat Tommy (R-PA) speaks during a press conference to present the Republican infrastructure plan, at the US Capitol in Washington, April 22, 2021.
Erin Scott | Reuters
On Thursday, Senator Pat Toomey will introduce legislation to protect a controversial practice known as pay for order flow, which is the main source of revenue for online brokerages such as Robinhood Markets.
Securities and Exchange Commission Chairman Gary Gensler, Wall Street’s top regulator and critic of the practice, made payment reform for order flow a top priority after the stock-trading frenzy like GameStop earlier this year.
Specifically, the Tommy bill would prevent the Securities and Exchange Commission from imposing an outright ban on payment for order flow, an idea Gensler said he is considering as part of his broader effort to reform the practice in the United States.
The Pennsylvania Republican defended the practice to help develop new investment applications, lower cost trading, and more efficient execution.
“New innovations — such as commission-free trading and easy-to-use mobile apps — have allowed more Americans to participate in the stock market than ever before,” Tommy, a senior member of the Senate Banking Committee, said in a press release. “These technologies are made possible in part by paying for the order flow.”
Advocates like Toomey say paying for order flow allows Robinhood and other online brokers to offer deals without upfront commission fees. These no-commission stock trades helped Robinhood convince millions of younger clients to invest for the first time, and they are credited with wider market participation across the US.
Many of its competitors also generate revenue from paying for order flow, although this practice has significant implications for Robinhood. In a government filing published in July, Robinhood said 81% of its revenue in the first quarter came from payment for order flow.
The Securities and Exchange Commission has reviewed pay-to-order flow multiple times before and has so far agreed with brokers and traders that it benefits small investors, a key concern of SEC President Gensler.
He and other critics argue that paying for the flow of orders poses a conflict of interest for brokerages as brokers can either earn more by selling their clients’ order volume or pass that cash on to clients in the form of cheaper deals.
Those who are wary of paying for order flow, or PFOF, also note that there are only two large, high-speed trade firms to execute deals for clients of retail brokerages like Robinhood.
One such high-speed trading company, also known as a market maker, is Citadel Securities. That one company handles 27% of US stock trading volume and 37% of total US retail volume.
Robinhood’s chief legal officer said last month that he believes the Securities and Exchange Commission “will come to the conclusion that paying for order flow is undoubtedly an amazingly good thing for retail investors and they won’t ban it.”
Gensler acknowledges that high-speed trading and easy-to-use applications have made investing cheaper and more popular. But the dominance of a few large market makers, he warns, can limit competition and lead to more expensive trades for the average investor.
“Individual investors can trade on commission-free brokerage applications,” Gensler said in prepared testimony in September. Communications have changed the speed of high-frequency trading. “This wasn’t the case until a few years ago.”
However, he added, “nearly half of the trading volume is carried out in ‘dark pools’ or by wholesalers.” “I believe it is appropriate to consider ways to update the SEC’s rules to ensure that stock markets reflect our mission and are as efficient and competitive as possible.”
Outside of the Securities and Exchange Commission’s analysis, the odds of the Tommy Act becoming law any time soon appear slim in the Democratic-controlled Congress. Progressive lawmakers have encouraged Gensler, who was nominated by President Joe Biden to lead the Securities and Exchange Commission, to step up regulatory oversight.
Moreover, with Democrats intent on enacting trillions in spending, facing a looming debt ceiling and ready to review the slate of new Federal Reserve candidates, it is unclear whether the Senate can consider the legislation before the end of the year.