Payment-For-Order-Flow Implications for Robinhood Users

Abstract

The digital age has transformed financial exchanges from high-stress trading floors to automated processes ruled by algorithms and online brokerage firms. Payment-for-order-flow is a controversial practice, ironically instituted by Bernard Madoff (Farrell, 2008, pg.19) and approved by the New York Stock Exchange (NYSE) in 2009. Although the practice has expanded liquidity to the NYSE and has made markets more efficient, there are questionable aspects of payment-for-order-flow, spearheaded by online brokerage firms, that contribute to the potential exploitation of retail investors.

This term paper highlights problems associated with payment-for-order-flow, assesses current policies regulating and allowing this practice, and explores policy alternatives. Additionally, it utilizes Robinhood Financial, an online brokerage firm, as a case study to characterize payment-for-order-flow and its broader implications for stakeholders in the United States. This term paper addresses implications of Financial Industry Regulatory Authority and Securities and Exchange Commission policies, the use of data by market makers, lack of transparency, and conflicts of interest that brokers face.

The recommended policy alternative, in this paper, aims to respect individual autonomy over digital financial data yet allows for the market and economy to maximize benefits. The proposed policy will enable payment-for-order-flow to continue to exist but ensure that retail investors have the option to opt-out but continue to engage in the market. Additionally, the policy requires that brokerage firms immediately notify retail investors of any order routing decisions along with accompanying explanations for these decisions.