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Terms like "fleecing" are subjective, and I wasn't claiming that RH necessary fleeced anyone in this instance. I was pointing out that opaque pricing models are

Terms like "fleecing" are subjective, and I wasn't claiming that RH necessary fleeced anyone in this instance. I was pointing out that opaque pricing models are problematic, since they make it much harder for customers to compare competing services and determine which offers more reasonable costs. In the extreme case, this can harm competition and make everyone worse off than they would be in a transparent regime, aka "people get fleeced". In this case the real questions are: (1) does RH's model result in some customers paying more for the same services than they would pay at competitors, and (2) can these customers realistically make the determination before they choose a service? We don't exactly know the answer to (1), and the reason we don't know the answer to that is because the answer to (2) is "almost certainly not". In fact the RH model is so opaque that even the SEC can't fully answer the question, and on top of this normal opacity RH added a layer of clear misrepresentation. Maybe in the end, it should be totally fine for brokerages to make all their money from order flow fees, in ways that are completely invisible and opaque to the customer, and regulators should just back off the whole thing as long as there are a few lines of text in a ToS somewhere. To me as a customer that seems kind of crummy, but I'm not a regulator.

tptacek 6y ago
What I don't see in this comment is an acknowledgement that for all practical purposes (besides niche venues like IBKR Pro) all retail order flow is done through brokerages that do PFOF. Can you be more precise about what part of Robinhood's "model" you're talking about? Depending on what you mean, I might agree with you, or I might strongly disagree with you. Does your critique apply to all brokerages, or Robinhood in particular? If it applies to everyone, what does it matter what the SEC says? The SEC doesn't have any problem with Schwab.
- matthewdgreen 6y ago
  Rather than asking me the question, you should read the article that summarizes the SEC investigation or the investigation report itself. The article directly addresses the “isn’t PFOF common practice” and “maybe PFOF was beneficial to the customer” arguments and provides fairly detailed evidence that RH did this at a different scale and with more significant detrimental effects on its customers than common practice. Maybe you’ve read both and you disagree with the evidence presented. That’s ok by me: but it would be more efficient for you to state your arguments for why this case didn’t harm customers, rather than asking me to (poorly) litigate the SEC’s case. My only point here is a simple one: that opaque pricing schemes seem like a recipe for anti-competitive behavior.
  - tptacek 6y ago
    I've read both and I'm not sure I know enough about your argument to challenge it directly, which is my critique of it. You're invoking these "isn't PFOF common practice" and "maybe PFOF was beneficial" questions as if they were controversies; of course, they are not. PFOF is practically universal, and it is universal because separating out non-toxic order flow is a win-win. If I had to summon a direct rebuttal to your argument, it would be this: I perceive you to be suggesting that the problem with Robinhood is that it uses PFOF, which means that customer outcomes are dependent on private deals Robinhood inks with companies like Citadel, which aren't transparent. The problem with that argument is that literally everybody, including, apparently, IBKR, inks private deals with companies like Citadel, which means you can't suggest that something is distinctively wrong with Robinhood for having done so. I perceive you to be suggesting that Robinhood would be more honest and transparent if they simply charged a commission that covered their expenses, rather than doing weird PFOF deals. Again: practically every brokerage does PFOF, because it would be dumb not to. Most brokerages charge commissions, but that doesn't make them transparent; they are still turning a private dial in their back office that trades off customer savings with brokerage profits based on PFOF deals. Robinhood, for what it's worth, is bad, and the badness does have something to do with "no commissions". But the problem isn't shady execution; it's that Robinhood is a gambling site, not an investment site.
    - matthewdgreen 6y ago
      I think what you are trying to do is take an argument that has shades of gray and turn it into a black/white argument. This is a very CS thing to do, but I'm not sure it's really a very good way to look at this business situation. From what little I've read here it seems that there is a continuum of different business strategies in which brokerages use their customer base and clout to negotiate PFOF deals that simultaneously (1) produce revenue for the brokerage, and (2) produce better prices for their customers. Since exchanges have finite financial resources, there is some tension between these two goals, which means that at some point brokerages are essentially trading their own interests against their customers' interests. This creates a power and information imbalance that can probably harm customers if the exchange behaves in ways that maximize (1) at the cost of (2). (RH is alleged to have pushed this balance much farther than common industry practice.) But that does not mean all PFOF deals are definitionally bad. The question in this case is not "is PFOF always bad", but rather "is there some point at which brokerage-revenue-maximizing PFOF negotiations actually harm customers by overcharging them compared to a more transparent system." The answer to that question is simple: almost certainly there does exist such a point and when a brokerage reaches that point, customers probably won't be able to tell that the point has been reached. Moreover, brokerages with no commissions seem clearly incentivized to optimize towards or beyond that point. Maybe you could argue that RH hasn't reached that point in this specific case, but this does not seem to be your argument. The question then is: what do you do about it? Should all PFOF be disallowed? You seem to be making a compelling argument that this is not a good solution. Should there be some kind of standard for how much that brokerage/customer balance should be allowed to stretch? Plenty of business practices are regulated along lines like this, where the regulation doesn't outright ban the practice but instead provides some guidelines and standard practices to prevent abuse of weaker parties like customers. I'm not here to give an answer: I'm just pointing out that eventually if you allow brokerages to keep optimizing for revenue, customers will be harmed. Maybe they already have. At that point it's up to the regulators to do something, because that's their job.
psanford 6y ago
The SEC documents answer at least your (1): > For most orders of more than 100 shares, the analysis concluded that Robinhood customers would be better off trading at another broker-dealer because the additional price improvement that such orders would receive at other broker-dealers would likely exceed the approximately $5 per-order commission costs that those broker-dealers were then charging. The analysis further determined that the larger the order, the more significant the price improvement losses for Robinhood customers—for orders over 500 shares, the average Robinhood customer order lost over $15 in price improvement compared to Robinhood’s competitors, with that comparative loss rising to more than $23 per order for orders over 2,000 shares. Given who RH's target customers are, it seems that the majority of them benefited from no commission and worse execution than if they used a competing broker. I've never used RH, but I'm happy that they forced all competitors to get rid of their per trade fees.
- matthewdgreen 6y ago
  So in other words, a small subset of customers significantly overpaid so that a large number of customers could get a bargain. The question is whether that's this a good thing, and also whether it's sustainable. Presumably those high-paying customers are going to be top candidates for competing brokerages to steal away with offers of better execution price. If that happens, does RH just content itself with lower profits -- or do they start finding new ways to increase revenue on the backs of their remaining customers?
  - deleted 6y ago
    [deleted]
  - psanford 6y ago
    I don't think that's correct. I think RH makes most of its money from the customers who are executing lots of small transactions.

tptacek 6y ago

What I don't see in this comment is an acknowledgement that for all practical purposes (besides niche venues like IBKR Pro) all retail order flow is done through brokerages that do PFOF. Can you be more precise about what part of Robinhood's "model" you're talking about? Depending on what you mean, I might agree with you, or I might strongly disagree with you. Does your critique apply to all brokerages, or Robinhood in particular? If it applies to everyone, what does it matter what the SEC says? The SEC doesn't have any problem with Schwab.

matthewdgreen 6y ago
Rather than asking me the question, you should read the article that summarizes the SEC investigation or the investigation report itself. The article directly addresses the “isn’t PFOF common practice” and “maybe PFOF was beneficial to the customer” arguments and provides fairly detailed evidence that RH did this at a different scale and with more significant detrimental effects on its customers than common practice. Maybe you’ve read both and you disagree with the evidence presented. That’s ok by me: but it would be more efficient for you to state your arguments for why this case didn’t harm customers, rather than asking me to (poorly) litigate the SEC’s case. My only point here is a simple one: that opaque pricing schemes seem like a recipe for anti-competitive behavior.
- tptacek 6y ago
  I've read both and I'm not sure I know enough about your argument to challenge it directly, which is my critique of it. You're invoking these "isn't PFOF common practice" and "maybe PFOF was beneficial" questions as if they were controversies; of course, they are not. PFOF is practically universal, and it is universal because separating out non-toxic order flow is a win-win. If I had to summon a direct rebuttal to your argument, it would be this: I perceive you to be suggesting that the problem with Robinhood is that it uses PFOF, which means that customer outcomes are dependent on private deals Robinhood inks with companies like Citadel, which aren't transparent. The problem with that argument is that literally everybody, including, apparently, IBKR, inks private deals with companies like Citadel, which means you can't suggest that something is distinctively wrong with Robinhood for having done so. I perceive you to be suggesting that Robinhood would be more honest and transparent if they simply charged a commission that covered their expenses, rather than doing weird PFOF deals. Again: practically every brokerage does PFOF, because it would be dumb not to. Most brokerages charge commissions, but that doesn't make them transparent; they are still turning a private dial in their back office that trades off customer savings with brokerage profits based on PFOF deals. Robinhood, for what it's worth, is bad, and the badness does have something to do with "no commissions". But the problem isn't shady execution; it's that Robinhood is a gambling site, not an investment site.
  - matthewdgreen 6y ago
    I think what you are trying to do is take an argument that has shades of gray and turn it into a black/white argument. This is a very CS thing to do, but I'm not sure it's really a very good way to look at this business situation. From what little I've read here it seems that there is a continuum of different business strategies in which brokerages use their customer base and clout to negotiate PFOF deals that simultaneously (1) produce revenue for the brokerage, and (2) produce better prices for their customers. Since exchanges have finite financial resources, there is some tension between these two goals, which means that at some point brokerages are essentially trading their own interests against their customers' interests. This creates a power and information imbalance that can probably harm customers if the exchange behaves in ways that maximize (1) at the cost of (2). (RH is alleged to have pushed this balance much farther than common industry practice.) But that does not mean all PFOF deals are definitionally bad. The question in this case is not "is PFOF always bad", but rather "is there some point at which brokerage-revenue-maximizing PFOF negotiations actually harm customers by overcharging them compared to a more transparent system." The answer to that question is simple: almost certainly there does exist such a point and when a brokerage reaches that point, customers probably won't be able to tell that the point has been reached. Moreover, brokerages with no commissions seem clearly incentivized to optimize towards or beyond that point. Maybe you could argue that RH hasn't reached that point in this specific case, but this does not seem to be your argument. The question then is: what do you do about it? Should all PFOF be disallowed? You seem to be making a compelling argument that this is not a good solution. Should there be some kind of standard for how much that brokerage/customer balance should be allowed to stretch? Plenty of business practices are regulated along lines like this, where the regulation doesn't outright ban the practice but instead provides some guidelines and standard practices to prevent abuse of weaker parties like customers. I'm not here to give an answer: I'm just pointing out that eventually if you allow brokerages to keep optimizing for revenue, customers will be harmed. Maybe they already have. At that point it's up to the regulators to do something, because that's their job.

psanford 6y ago

The SEC documents answer at least your (1): > For most orders of more than 100 shares, the analysis concluded that Robinhood customers would be better off trading at another broker-dealer because the additional price improvement that such orders would receive at other broker-dealers would likely exceed the approximately $5 per-order commission costs that those broker-dealers were then charging. The analysis further determined that the larger the order, the more significant the price improvement losses for Robinhood customers—for orders over 500 shares, the average Robinhood customer order lost over $15 in price improvement compared to Robinhood’s competitors, with that comparative loss rising to more than $23 per order for orders over 2,000 shares. Given who RH's target customers are, it seems that the majority of them benefited from no commission and worse execution than if they used a competing broker. I've never used RH, but I'm happy that they forced all competitors to get rid of their per trade fees.

matthewdgreen 6y ago
So in other words, a small subset of customers significantly overpaid so that a large number of customers could get a bargain. The question is whether that's this a good thing, and also whether it's sustainable. Presumably those high-paying customers are going to be top candidates for competing brokerages to steal away with offers of better execution price. If that happens, does RH just content itself with lower profits -- or do they start finding new ways to increase revenue on the backs of their remaining customers?
- deleted 6y ago
  [deleted]
- psanford 6y ago
  I don't think that's correct. I think RH makes most of its money from the customers who are executing lots of small transactions.