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To add a bit of context: brokerages like Robinhood send buy/sell orders to national exchanges and to private trading firms e.g. high-frequency traders. Private
by allenz 6y ago
To add a bit of context: brokerages like Robinhood send buy/sell orders to national exchanges and to private trading firms e.g. high-frequency traders. Private firms provide price improvement: orders that execute at prices better than the national exchange. All brokerages have a duty of best execution, including a duty of price improvement. Brokerages can also receive payment for order flow from private firms, as long as it does not interfere with best execution. However, "Robinhood explicitly offered to accept less price improvement for its customers... in exchange for receiving a higher payment for order flow," which is illegal.
Full order: https://www.sec.gov/litigation/admin/2020/33-10906.pdf https://www.sec.gov/litigation/admin/2020/33-10906.pdf
- vslira 6y agoIn order words: if I want to buy something that costs 100, the broker is free to get me a price of 95, but they were colluding with the players able to offer this discount to offer me 97 instead and pocket the extra 2, something like that?
- sesuximo 6y agoMore like you want to buy something that would cost 100, and RH got paid 5 to send your order to a trading company, and that trading company executed at 101.
- aynyc 6y agoRH orders aren't LIMIT HELD orders?
- room500 6y agoNo. If you had a limit buy, Robinhood would never exceed your limit. Period. That would be highly illegal. This is more like you want to buy something at 100. Robinhood then goes to the market and looks at all the vendors. The vendors are selling at various prices. Robinhood has a relationship with one of the vendors so they went there and that vendor was willing to sell at 98. However, a vendor down the street (that Robinhood doesn't like) would have been willing to sell at 97. None of that is illegal. What the SEC is arguing here is that Robinhood didn't tell the customers this when they advertised "commision-free" trades. In Robinhood's eyes, they didn't charge a commission, so this was accurate. But in the SEC eyes, the customer was paying a "hidden" commission because they would get a slightly worse price than if they went with a different broker. Imagine you are Fidelity... All of a sudden, you have Robinhood advertising "commission-free" and you just lost a good chunk of business from retail traders. You then complain to the SEC because the advertising here is not entirely accurate - the customers might have even gotten a better price with Fidelity - even if you add in the commission. FTA: > The order finds that Robinhood provided inferior trade prices that in aggregate deprived customers of $34.1 million even after taking into account the savings from not paying a commission.
- sesuximo 6y agoMy post has no bearing on a limit. If you see 103 on your ui and tell RH to limit to 103 then RH is still obligated to do the best it can. If the best execution you could reasonably get is 100 and you execute below your limit but above 100, that’s illegal. The limit in a limit order is really an orthogonal concept.
- tptacek 6y agoRobinhood goes down to vendor street and into the shop of its preferred vendor, who is also the preferred vendor of most other brokerages. The vendor says "The street price on this item is $100, but we can get them for $95. We can get it to your customer for $97 and give you $1, or $98 and give you $2". Robinhood takes the $2, other brokerages don't, and Robinhood (crucially) lies about it, at which point the SEC gets mad.
- hef19898 6y agoI always wondered how these companies made money. My first suspicion was, that they "fed" stupid retail clients thay had no place in trading to the big fishes. I learned so much in this thread, making it one of my favorites. And showing again why HN is the great thing it is. Also, even I wasn't really right, RH and others sure found a way to price and sell an existing service better than incumbents. And in good disruptive tradition seem to have ignored certain regulations.
- tptacek 6y agoThe "certain regulation" here is simply that you can't advertise to your customers that you're getting them the best possible deal when you have deliberately chosen not to give them the best deal. As the SEC points out: their pricing isn't better than traditional brokerages. This isn't like Uber, where the lie is that the low prices are subsidized by investors and will be jacked up later on down the road; here, the lie is taken directly out of the hide of RH customers.
- sweeneyrod 6y agoThat's true only if the service Robinhood is providing is giving customers good deals. It seems quite plausible that instead it is actually providing entertainment in the form of "free" trading. If this is the case, the lack of explicit commission is a key feature.
- smabie 6y agoNo, that's not how it works
- deleted 6y ago[deleted]
- willdearden 6y agoMore like broker 1 offered it to me for 95 and to pay Robinhood 1. Broker 2 offered it to me for 97 and to pay Robinhood 2. Robinhood took the offer from broker 2. No collusion necessary but they weren’t acting in the best interests of their customers according to stated offers.
- jjtheblunt 6y agoI always thought that Robinhood's customers were not folks with the Robinhood app, but rather the association of their traffic with clearing houses like Citadel?
- kasey_junk 6y agoThat may be true in the “your customers are who pay you” judgement but it’s definitely not true in the “who you have a fiduciary duty to” sense.
- jjtheblunt 6y agowell said
- tptacek 6y agoThere is a notional standard "best price", the NBBO, that a broker-dealer has to meet; you can't take payment to route an order somewhere that doesn't meet the NBBO. But the NBBO captures pricing from all kinds of traders. Retail traders are cheaper to trade with than institutional traders, because retail traders aren't moving gigantic blocks of stock that are going to blow up the market makers that are facilitating the trading. Everybody knows that retail traders are cheaper to trade with, and everybody knows where the retail trades come from: the retail broker-dealers. So market makers cut deals with retail broker-dealers: they chop up the cost savings between themselves and their customers, who get prices below the NBBO. That's called "price improvement". What happened here is that Robinhood claimed in its marketing to be obtaining the best available prices for its customers. But it wasn't living up to that claim. Its upstream market makers made it clear to them that they could get more price improvement for their customers, if they took less in PFOF rebates. The SEC filing suggests that Robinhood was offered 80/20 price-improvement/rebate, and instead took 20/80. The two big problems here: first, 20/80 is worse than other retail brokerages (virtually all of which do PFOF, because none of them are especially competent at actually executing trades) --- even if you factor in the lack of trading fees, and second, Robinhood had claimed in its own marketing that they did the opposite.
- smabie 6y agoI work at a market maker, and what you say is mostly correct. However, I would like to add that retail customers get better prices not primarily because they move less volume (though this is certainly a factor), but because their order flow is significantly less toxic. Retail traders don't really know anything and their order flow contains less alpha, so market makers can quote better prices to them without getting run over. It's very important for market makers to separate out order flows and assign a toxicity to each flow. This way, they can provide tighter spreads and better execution on less toxic flows while being a little looser for highly toxic institutional flows.
- smogcutter 6y agoJust to check my own understanding... So roughly, the idea is that if I’m smart money (say a big hedge fund or institutional trader), behind any of my trades is an implication that I know something worthwhile. So my trades will move the market, and this can leave market makers holding the bag if prices move quickly. But if I‘m the proverbial dentist, my trades are just noise that don’t signal anything real about the market. I can get better execution because market makers aren’t worried about my trades moving the price out from under them. Am I in the right neighborhood here?
- deleted 6y ago[deleted]
- hef19898 6y agoThanks for answering my question how Robinhood, Traderepublic and so on make money.
- smithza 6y agoThis is one way they make money. Robinhood is free because it makes interest on the money you ACH transfer in that sits while you make your decision on what to buy. They have a big bank account holding all of the user's funds and get interest on it. Of course they cannot make interest on the money traded for a stock though.
- ram_rar 6y agoDoes it mean that its always better to do limit orders as apposed to market order in RH? I'm guessing, its a lot more easy for RH to give you sub-optimal prices for market orders.
- toast0 6y agoAssuming they don't change their practices, it's always better to use a different broker. Robinhood was the first to eliminate comissions, but now most brokerages have also eliminated comissions, so say thanks to Robinhood and then use an established broker. I would expect market and limit orders to have been handled similarly. Market makers would like to trade with retail investors, and they're willing to pay X for that; if Robinhood takes 80% of X, and passes on 20% to clients as price improvement, and other brokerages pass on 80%, your limit orders may execute sooner at other brokerages (as your limit is effectively 0.6X higher/lower), or may end up executing with bigger price improvement.