The lack of action by regulators in recent years in reforming market structure issues – including payment for order flows, or the practice of market makers paying stock brokers to route client orders to them – like many of the former regulators responsible for such reforms will be of particular interest. now work for companies in the industry who engage in and profit from the practice.

“For 12 years we have had persistent problems failing to address the acute and pressing problems of market structure,” said James Cox, professor of law at Duke University, specializing in corporate and securities law. .

Cox said the Securities and Exchange Commission and the Financial Industry Regulatory Authority should have done more in recent years to drastically curb the practice of paying for order flow and to establish new rules on what types of orders hold. market and exchanges can accept traders. that can give them informational advantages over individual investors.

Robinhood generated over $ 190 million in revenue from Order Flow Payment in Q4 2020, according to regulatory declarations and achieved more revenue per transaction than competitors like E-Trade and Charles Schwab. Robinhood did not respond to requests for comment.

Read more: SEC could cripple Robinhood’s business model by enforcing existing rules, experts say

Government watchdogs have long denounced the practice of regulators letting government work for companies they once regulated, and Robinhood has been one of the more aggressive deployers of this tactic in recent months, hiring former SEC commissioner Dan Gallagher will be its chief legal officer this May.

In addition to Gallagher, the broker recently brought in other SEC alumni Lucas moskowitz and Janet Broeckel, according to LinkedIn. He also enlisted Andrew Ceresney, who served as director of the SEC’s Enforcement Division from 2013 to 2017, as an outside lawyer to help him settle charges he misled investors into. error in the practice of paying for order flow and that it cost investors $ 34.1 million. by not executing transactions at the best price.

Robinhood settled the case after paying a $ 65 million fine, without admitting or denying fault. The company said in December that “the settlement relates to historical practices that do not reflect Robinhood today” and that it is now fully transparent with clients about its revenue streams and vigilant to get them the best prices on the securities. .

“Companies understand that their business model requires a soft touch from regulators, and the best way to ensure this is to have financial ties with regulators associated with both political parties,” said Jeff Hauser , executive director of The Revolving Door Project, which aims to track corporate political influence.

Citadel Securities, which paid Robinhood more for order flow than any other company in the fourth quarter of last year, has also been a landing place for former regulators. Stephan Luparello, former director of the Trading and Markets division, which oversees market structure issues, has been its legal advisor since 2017. Citadel declined to comment for this article.

Market structure issues, including payment for order flows, were last in the public spotlight in 2014, when former Democratic Senator Carl Levin of Michigan held hearings on the matter and recommended regulators to ban it.

Regulators have made some reforms since then, with the SEC forcing brokers to provide greater disclosure of payment income from order flows, while Finra has stepped up crackdown on brokers who do not regularly analyze their orders for s ” ensure that clients, on average, get the best price and execution of their orders.

But critics say they haven’t gone far enough and that order flow payment is a byproduct of a system of unnecessary competition between market makers for information and faster access to the major ones. scholarships.

Peter Van Doren, principal researcher at the Cato Institute and editor-in-chief of the journal Regulation, told MarketWatch that “payments for order flow are part of this high-frequency trading system where there is an arms race. »To build faster trading systems that are ever closer to the main stock exchanges, in order to arbitrate slight differences between market prices and those listed on the stock exchanges.

He pointed to a study of the activityy on the London Stock Exchange, which showed that if market makers did not have to engage in this competition, they would be able to offer prices that save investors $ 5 billion worldwide every year.

Other experts, however, claim that the lack of action on the order flow payment was simply due to the fact that it is not clear that the practice is harming individual investors. Indeed, the cost of individual transactions and bid-ask spreads have fallen dramatically over the thirty-year history of the practice, Gabriel Rauterberg, capital markets expert at Michigan Law, told MarketWatch.

“It seems deeply strange that if you are a retail trader your order does not go to a stock exchange, but your broker gets paid to send it to a market maker,” he said, but said. added that this appearance of corruption is not supported by evidence that retail traders have been deceived on a large scale.

Instead of regulators outlawing this practice, resulting in widespread and costly disruption to the industry as a whole, regulators could require brokers to pass all payments for the order flow to their clients through improved pricing. , suggested Rauterberg.

“Education doesn’t seem to alter people’s feeling that there is something wrong about it,” he said. “Eliminating the appearance of a conflict of interest would go a long way in building investor confidence. “