Robinhood, Market Makers Vow to Fight SEC Trading Reforms

Robinhood (HOOD) and allied market makers including Virtu Financial (VIRT) have come out against newly proposed rules that, if passed, would amount to the largest change in securities market regulation in over a decade.

Both companies' shares are down more than 7% since Wednesday's market open, with Virtu suffering its largest intraday decline since April on Thursday.

The proposed rules take aim at payment for order flow (PFOF), the order execution process that many brokerages, including Robinhood, say helps them offer zero-commission trades. One rule would force brokers to show how they obtained the best execution for trades for which they receive payment for order flow. Another would require orders from retail investors to be auctioned off for best execution in public marketplaces, such as a securities exchange, before they could be executed by a market maker. The SEC estimates that auctions for execution could save retail investors $1.5 billion annually, or 1.08 basis points of the turnover on such trades.

The rule changes pose a threat to the business models of market makers such as Virtu and Citadel Securities, as well as brokers that rely on their payments. Lucas Moskowitz, Robinhood's deputy general counsel, criticized the SEC's proposals, telling Bloomberg News they would "resurrect discriminatory barriers to entry and hurt millions of retail investors." He also complained the proposal's 60-day public comment period is too short for "a package of this size and complexity."

On the other end of the spectrum, retail investor advocates argue the SEC should have banned payment for order flow altogether.

The SEC says it's unlikely commission-free trades will disappear if payment for order flow is restricted. Many large brokerages make more from other sources, including margin lending and share loans to short-sellers.

The rules are expected to benefit the public exchanges that would host the execution auctions, including New York Stock Exchange owner Intercontinental Exchange (ICE) and Nasdaq (NDAQ).

The SEC has grown increasingly concerned that the parsing of trading executions among public exchanges, market makers, and dark pools has diminished the transparency of securities trading and raised its costs for individuals. "The markets have become increasingly hidden from view, especially for individual investors," said SEC Chair Gary Gensler in prepared remarks backing the rule changes. "These everyday individual investors don’t have the full benefit of various market participants competing to execute their marketable orders at the best price possible."

One of the other two rules is less targeted at Robinhood, but will likely be opposed by market makers. It would reduce the size of stock ticks to a tenth of a penny, and require market makers, who currently execute trades at prices down to a hundredth of a cent, to trade stocks using the same tick sizes as exchanges. The last rule would expand disclosure requirements about stock pricing data for brokerages with more than 100,000 customers.