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Comment by rwmurrayVT | Hacker News Reader

This article isn't exactly convincing. The SEC identified $34mm in poor execution. If you did 65c each way per option contract & free stock trades that would only be 52.3m option trades. That's miniscule. That's over 5 years. It would take a whole lot of unidentified trades for that to be substantial.

The spread on most trades is probably in the range of 50c on low liquidity shares and $1 on low liquidity options.

Perhaps the reason RH collects more in revenue from order flow is because they:

1) get paid more for their order flow on a per trade basis

2) they don't collect any fees from options driving down revenue

3) they charge less for margin fees with less users using margin

There are any number of reasons, but to say that you're getting royally screwed is a massive stretch in my mind. Prior to RH fees were outrageous. The fees are still outrageous on my self-directed 401k. I'm not getting $10 in losses from bad execution.

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Anytime you move fees from a regime where they’re fully visible to the customer into one where they’re hidden, the customer is eventually going to get fleeced. It may not happen instantly, but it’s inevitable. You’re simply removing one of the only competitive metrics that customers have to choose between brokerage firms and replacing it with something opaque. (The fact that Robinhood even exists is proof that explicit-fee brokerage models produce competition from lower-fee competitors.)

Unfortunately, the degree to which customers are getting fleeced is hard to know. Which, let me repeat, is exactly why this model exists. The article mentions it’s at least $34M but even the SEC seems unable to calculate the exact amount. And if they can’t determine it, then how in the world is the typical customer supposed to? At the end of the day, the degree to which customers are getting fleeced is probably exactly proportional to Robinhood’s revenue from order flow. If RH is receiving vastly less revenue-per-customer from that source than explicit-fee exchanges make from fees and order flow, then customers are getting a possible bargain. If RH is doing as well or even better with this model than competitors, their customers are probably getting screwed and don’t even realize it. (And if by some miracle RH isn’t abusing this, then other brokerages will abuse it and try to outcompete RH.)

> Anytime you move fees from a regime where they’re fully visible to the customer into one where they’re hidden, the customer is eventually going to get fleeced.

I think you misunderstand the payment-for-order-flow business model. The revenue doesn't come from hidden fees to the users. It comes from third-party liquidity providers. They do so because liquidity providers overwhelmingly prefer to interact with retail order flow over the undifferentiated toxic flow in public exchanges.

The best analogy is how Miami club promoters will get pretty girls free entry and drinks. The pretty girls aren't paying any sort of hidden fees, and in fact are getting a better deal than they would with general admission. Rather it's the venues that paying the fees, because they overwhelmingly prefer patrons who are pretty girls compared to the average person who shows up at the door.

The article is very explicit about how price improvements aren’t being passed on to the customer to the same degree as other brokerages, because RH demanded higher payments for order flow. I don’t know how to map that to your club analogy, but it definitely does not seem to map to this situation. Maybe a club where there's no cover fee, but all the drinks are 20% more expensive?

The premise of your argument seems to be that investors are entitled to the best possible price improvement, rather than the RegNMS NBBO, and that any sliver of a penny they get less than the best available price at any brokerage is a "fleecing".

That argument doesn't make much sense to me. People trade slivers of pennies for all sorts of things across the economy. Literally just liking a UI color has a value you can denominate in some sliver of a penny.

The SEC's problem with Robinhood isn't that they weren't offering the best available price improvement. It's that they knowingly weren't, but told customers otherwise. The implication is that if they'd simply been up front about it, and said "we don't charge commissions and have a snappy UI, and we make up for it by taking a bigger share of the rebates our upstreams offer to retail traders", they'd have been just fine.

(Robinhood is bad, but the reasons have very little to do with PFOF).

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.

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.

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.

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.

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.

When you suggest that I'm collapsing this down to a binary issue, is that based on information you have about market structure? Have you done a bunch of research on this? Can you be more specific about it? Or is it just a thing you feel happens on message board threads?

As I've said: I'm a little bit at a loss as to what your problem with Robinhood even is. They don't charge trading commissions. But they do take an 80/20 share of price improvement payments where other brokerages take 20/80. We can all agree that it's not OK to lie about doing that. But now we know†, and they've been fined. What next? Should they take 20/80? Why not 15/85? Is the right split just what the majority of the other discount brokerages take?

Again: I loathe Robinhood. They are a force for evil. But when people come up with weird diagnoses for why they're bad, it leads them to make silly decisions about other discount brokerages, none of whom (a) seriously prioritize their customers (perhaps excepting Vanguard), or (b) operate the way people on message boards believe brokerages operate.

† You might be able to argue that knowing the right Google query here, and also giving a shit††, would have enabled you to know this before the SEC announcement, because Robinhood's most important venue is also Schwab's, and you can just compare the per-share rebate they're getting. My confidence level here is not super high.

†† (my subtext here is that people don't really give a shit)

My point, which I think I made clearly in the very first post of this thread, is that highly opaque pricing structures are bad for consumers. You justify this with “consumers don’t give a shit”. I think consumers clearly do give a shit about trading costs, and my evidence for this is that zero-fee brokerages like RH are taking over the industry.

What consumers don’t have the time or resources to do is try to reverse-engineer the costs that they are actually paying when using RH’s platform. I’m not even sure they possibly could do so given the information asymmetry between firm and customer, and your “maybe there’s a Google search but I have low confidence” counterargument isn’t moving me. The SEC report shows that for some customers RH’s costs were inordinately high compared even to competitors that charged fees and had PFOF revenue, but others weren’t. How do I, as a customer, actually figure out how much a trade is going to cost me at different brokerages? Under the current regime (even without RH actively lying about PFOF revenue) it seems like customers cannot figure this out in any reasonable way.

The question then is: what should regulators do about it? Your position seems to be some kind of binary “we must either disallow PFOF entirely or allow any PFOF arrangement without reservation as long as brokerages disclose that PFOF revenue exists somewhere in their TOS.” My point is that different PFOF arrangements have very different impact on customer prices. For example, it's easy to envision a large class of PFOF arrangements that are undeniably harmful to customers, and yes, absolutely regulators should find some reasonable grounds to police those. Because at the highest level, a situation in which those deals are allowed is going to be terrible for consumers. With brokerages hunting for new revenue sources, those situations are going to become increasingly the norm.

ETA: Even ignoring the “bury it somewhere in the TOS” problem, it’s not obvious to me that simply disclosing “we have PFOF arrangements” is sufficient. It seems problematic that a single disclosure should apply equally to everyone from Vanguard to Schwab to RH (or even some hypothetical future scam brokerage that massively overcharges its customers via PFOF) when all of these companies have wildly different arrangements that affect customer trading prices differently. The nature of the arrangements matter too, and at minimum customers deserve sufficient disclosure of the arrangements that they can make determinations about which company is going to cost more to trade with. I hope we can agree that current disclosures and your random low-confidence Google searches do not achieve this goal.

You understand that all these brokerages are in fact required to disclose many of these details already, and that the SEC pursued Robinhood not because of the details of its PFOF arrangements but because of what it's marketing materials said, right? In what way are the current disclosures in inadequate? I'm prepared to hear that they are, but maybe less sanguine about a thread about how the big problem is you didn't know about them.

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.

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?

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.

You are conflating Reg NMS NBBO with a broker-dealer’s duty of best execution. RH has a fiduciary duty to customers to (on balance) achieve best ex. And a fiduciary duty means they must act in the best interest of their customers — including putting customer interests ahead of their own. Here RH was clearly prioritizing their own interests ahead of their customers.

I don’t think this is accurate, and I think a read of the SEC complaint rebuts it.

I've read the SEC's order and I am certain what I've said is accurate. This is about best execution, not Reg NMS. See paragraphs 5, 13-4, 43-44 and footnote 2.

There are two violations in the order:

(1) Securities Act Sec. 17(a) arising from Robinhood's failure to fulfill their duty (in this case, of best execution).

(2) Exchange Act Sec. 17(a) arising from Robinhood's failure to keep adequate records which means that during the course of the investigation the SEC asked for one or documents and Robinhood, for whatever reason, failed to produce the requested document(s).

Neither of those violations relate to Reg. NMS or NBBO which was promulgated under Exchange Act Sec. 11A and is not mentioned anywhere in the Order.

You're right, of course. I think what happened here is that I jumped the gun on what I perceived your argument to be; that you were expressing something like the sentiment that Robinhood has to maximize customer outcomes on trades; that, for instance, if it has a dial that can go 80/20 -> 20/80 broker/customer on rebates, it actually is required to turn that dial to 0/100 if possible.

The original comment was criticizing payment-for-order-flow as a business model. Whereas you're merely making the point that other RH is delivering a worse customer experience than other payment-for-order-flow venues.

That's an orthogonal criticism. But the point is the same regardless. Even if RH customers see smaller price improvement, they're still better off than at a hypothetical brokerage that eschews payment-for-order flow. Because in that case they'd see zero price improvement (plus pay public exchange fees and commissions).

In real life, RH's competitors aren't hypothetical. They're actual brokerages that negotiate better price improvement for their customers. This is the problem.

A club offers “ladies drink half off” to draw in women. Instead of actually charging $4 for and $8 drink, they charge $6.

The customers are still better off, but not by as much as the advertising said.

I agree that it needs to be more transparent but RH isnt the only one hiding the back office deals. There needs to be a larger inquiry into all the trading platforms like Fidelity, Schwab.

On the other hand price improvement is so hard to enforce. I'm not sure how SEC can even regulate it.

So you would rather pay a commission fee AND have order-flow sold as opposed to no fee and just sold order-flow? No matter where you trade right now, all the brokerages are practicing this.

Except that other brokerages pass 80% of order flow savings to customers while Robinhood keeps 80% of it.

Robinhood is more expensive than commissioned brokers, it just hides the charges better.

> Robinhood is more expensive than commissioned brokers, it just hides the charges better.

Which do you think is more expensive for the customer:

1. $0.003 per share of inferior execution on a retail order of 50 shares.

2. A $9.99 commission.

Based on actual customer testimony: https://news.ycombinator.com/item?id=25519091

Assuming they have multiple hidden revenue sources, that 9.99$ commission could be up to ~4 orders of magnitude cheaper.

Sloppy handling of expiring options has nothing to do with PFOF or the SEC settlement being discussed in this article.

The implication is their making up the difference in other ways. As such the example linked is a source of profit to make up for the missing 9.99$, not a customer service issue.

So, sure the article is talking about one specific means their using, but that’s hardly the only option they have. Remember the best conmen run multi layered con’s, as people finding the first layer and trying to profit from it are the easiest marks.

Can you explain how you think closing options positions a few minutes early can magically generate profit for Robinhood?

The OP complained that with the benefit of hindsight the options went up in value after being sold, but given that all retail traders are degenerate gamblers with zero actual alpha there was a 50/50 chance the options could have gone in the entirely opposite direction, and selling them early could just as easily have saved the commenter thousands of dollars.

It’s the same game as a bank which reorders transactions after the fact to maximize overdraft fees. Rather than a small profit on 100% of transactions they make significant profit on some low percentage of transactions. Making 10k on 1 in 1,000 transactions = making 10$ on every transaction.

If closing early generates more profit then they don’t win or lose, just executing the trade at close for the customer.

However, if waiting generates more profit then they can always say they executed early while waiting and then pocket the difference.

They could even even pick a mid point at time X, then compare some random time period before and after the transaction looking for a hypothetical less profitable execution time.

> However, if waiting generates more profit then they can always say they executed early while waiting and then pocket the difference.

Do you have an explanation that doesn't involve making up wild, evidence-free conspiracy theories? I can claim that Robinhood secretly makes most of their revenue from selling their users to human traffickers if I want, but that's not an actual reasonable criticism of their business model.

I just provided evidence both in the linked example and the stated policy of “anywhere from 60-90 minutes before close”. Sure, it’s not beyond a reasonable doubt, but the given example is both plausible and there is at least some evidence in favor of the practice.

Anyway, the existence or not of this policy is kind of secondary to the idea that indirect profit can be more expensive to the users. Clearly they need to be generating some revenue, and if you don’t know where it is that’s often a very bad deal. 401k hidden fees for example can sometimes exceed the tax savings.

What mechanism do they use to pass down these savings? I'm definitely not aware of anything like that.

For example: if you want to buy X for $100, but it's available for $98, then the traditional broker will buy it for $98. Robinhood, instead, will go with the $99.99 offer if that seller offers them more money.

You were willing to pay $100, so from your point of view you weren't "harmed" either way, but with the traditional broker you saved $2/share, and with Robinhood all the savings went to them.

Generally, brokers are either required to go with the best offer, or, if they don't, explain to customers that they don't and why. Robinhood violated that rule by marketing themselves and going with the best offers (but actually did the opposite) and that's what the SEC is fining them for.

I suggest you read the article then

Has there been a study that shows that robinhood is more expensive than various commissioned brokers?

I don't know if there's been a study, but that's the substance of the SEC charges that the source article is describing. (It's not clear to me if the full details of the SEC's calculation are private or I just don't know how to find them.)

The linked article contradicts this point. On balance today Robinhood is not more expensive. The parent's point about the slippery slope still stands of course.

Sounds like it’s about to be litigated in court.

Is it though? 80% of order flow savings ... 80% of exactly how much?

I read your first paragraph and now I’m thinking of paying for something in the US where all the taxes and tips are clearly visible and added at the end for you to see, vs paying for something in Europe where what you see is what you pay. I think people overwhelmingly prefer the European system.

> then other brokerages will abuse it and try to outcompete RH.

If you make higher margins but don’t lower your prices, the only other way to outcompete is to offer a broader array of services. Otherwise “outcompete” just turns into “save up more money and buy them out”.

There are an awful lot of businesses that charge huge margins and use that extra cash flow, plus their scale, to essentially fence out new entrants by a mix of sales/marketing, channel spiffery/bribery, and regulatory capture.

It's often a fairly "bad for you"/"predatory" product, too, but the problem is that it's very hard to create a new entrant doing it the "good for you" way, because all that extra margin the bad guys make can be used to squeeze you out of the market. Legacy industry examples would include whole life insurance, title insurance, payday lending, and whatever it was that "Dun & Bradstreet Credibility Corp" was selling (not the historical D&B) a few years back.

I consider it enough of a pattern of "bad money chases out good" that I identify it regularly among pitches I receive.

Premium credit cards, for example. The ones that give customers sweet points or cash-back deals, but then charge huge (invisible to the customer) merchant fees on the back end. https://thepointsguy.com/guide/guide-to-credit-card-merchant...

This really hurts those of us that are unable to access these types of reward points. It pushes additional costs onto us all, but especially onto those without exceptional credit.

Someone taught me long ago that if you're using a debit card in a store you actually like, you should chose the debit option rather than the credit option, as the fees are lower.

I sometimes do the reverse when I'm in a shop that I don't have good things to say about, especially if I think they just cheated me in some legally defensible way. Like Captain Ahab trying to kill the whale with his pocket knife. Fuck you, I'm taking 1.5% of your life away!

How is doing at least as good as NBBO mean I'm getting fleeced?

> Anytime you move fees from a regime where they’re fully visible to the customer into one where they’re hidden, the customer is eventually going to get fleeced.

It would be interesting to apply this insight to "surveillance capitalism" industry. You get to use Google/Facebook/Twitter/etc for free, even though there is some fixed amount you would theoretically be willing to pay to use them. In exchange, the companies use your personal information to display ads to you, but you have no idea what that is worth to those companies. In other words, your personal info (which is used to sell ads) is by definition worth more than the cost to serve Google/Facebook/Twitter to you (otherwise those companies would make no money). But you have no way of knowing how much more.

Don't have much to say about the rest of the comment but

>The spread on most trades is probably in the range of 50c on low liquidity shares and $1 on low liquidity options.

Is demonstrably wrong. The minimum spread on options contracts is $1 and the spread on liquid options contract (not SPY liquid but like TSLA or AAPL) is generally in the mid $10s and often hits $100+ on ATM contracts). Right now an ATM call on AAPL a month out quotes 4.75 to 4.85 which is $10 and the same on TSLA quotes 44.05 to 44.40 which is $35. Not a trivial amount, and it implies that the broker could get price improvement that is an order of magnitude more than the typical commission on options (~1$ per contract).

RH sets an initial default value for the limit order at the middle point between the bid/ask. You are in control of your limit order pricing there. If you wish to join the queue at the bid you can. There is no option for a market order. You can leave your bid and wait to be filled same as others.

The article mentions that may just be the amount the SEC can actually prove.

> Overall, Robinhood’s investors may not have been harmed by their decision. The SEC identified $34 million that Robinhood customers lost by not receiving best execution, which is much less than the money they saved by forgoing trading commissions. (That said, their losses might also be much higher. That $34 million comes only from “certain” transactions, which might be the tip of the iceberg that the SEC possessed the ability to measure.) They were, however, duped.

I think the author has misunderstood the SEC Order. The article says (emphasis added):

> The SEC identified $34 million that Robinhood customers lost by not receiving best execution, which is much less than the money they saved by forgoing trading commissions.

But paragraph 42 of the Order[1] says (emphasis added):

> ... certain Robinhood orders lost a total of approximately $34.1 million in price improvement compared to the price improvement they would have received had they been placed at competing retail broker-dealers, even after netting the approximately $5 per-order commission costs those broker-dealers were charging at the time.

[1]https://www.sec.gov/litigation/admin/2020/33-10906.pdf

I came here to post the same. The author of this article really missed the mark with this conclusion.

I am not a lawyer, but the problem with this $34mm is that seems to be illegal. Quote: "In the United States, accepting payment for order flow is only allowed if no other trading venue is quoting a better price on the National Market System"

Retail order flow directed to electronic market makers obtains better prices than the NBBO. That's what "price improvement" refers to. The entire controversy here is about how much better than the NBBO Robinhood's prices were.

Right... so everyone quotes the same price, and then they compete based on paying more for order flow instead of the sticker price. It’s the difference between having a larger bid-ask spread or larger transaction fees: either way, the cost of execution will be paid.

Even prior to the potential news of RH routing orders to certain market makers for greater margins, I think any serious trader looking to optimize orders would have not been using RH to begin with.

The feature set in RH is straight up heavily diluted compared to other brokers like IB or TD (TOS). There's no way to set exchange parameters in RH, users can't edit the charts for TA, and the functionality is heavily reduced on purpose for the sake of not overloading users that have basically no clue what they are looking at anyways.

Not that any of this excuses RH. Given RH's user base, some random person trading PLTR and GME calls probably is not even looking into any of this stuff to begin with.

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