> Or did the trading firms treat order flow from RH differently than from other sources?

I'm not well versed in financial language by any stretch, but i believe it's this.

Matt Taibbi did a piece on them last week and goes into this. https://taibbi.substack.com/p/pandemic-villains-robinhood

The article seems somewhat on the fluff-and-feathers side. It doesn't really explain anything. The only non-obvious thing it says is:

> Robinhood receives a fixed rate per spread (vs. a fixed rate per share by the other eBrokers). Rather than receiving simple payment by volume, Robinhood receives a percentage of the spread between the bid and the ask in each trade. This is interesting because while HFT proponents insist their practices narrow spreads, some critics maintain that high-frequency trading ends up widening spreads.

Unfortunately, what this excerpt claims as "interesting" makes no logical sense. The fact that RH is paid by HFT on the spread would suggest that HFT like to get order flow in stocks that already have a large spread. It is completely unclear how this is related to the claim that HFT tend to increase the spread.

The "traditional" interpretation is that HFT make money from creating liquidity. This means they take illiquid stocks (with large spread) and make them liquid (reducing the spread). Since they make money doing that, they are willing to pay for orders in illiquid stocks.

Is this the correct interpretation? I have no clue. But it seems the article's author has even less clue, and adds nothing of value to the discussion.

That was a good article.

Payment for order flow trade never helps the consumer. RH accepted unusually large amounts of it. They harmed the consumers to the tune of $34m relative to normal practices. They lied about what they were doing.

This is incorrect. The benefit of order flow to the consumer is additional sources of liquidity. If a consumer submits an order to buy 500 shares of AAPL for $100, there may only be 100 shares available on the public market at that price in which case the price of AAPL will increase from $100 to at a minimum $100.01.

The way pay for flow works is that firms can execute against that order agreeing to fill any portion of it up to and including the full 500 shares.

Furthermore by agreeing to pay for flow, it's a criminal offense for my firm to use that information to front run the order by buying it on the open market without first executing against the client. The allegation made by the SEC against Robinhood is that some kind of indirect front running was performed and perhaps even facilitated by Robinhood.

The problem is that the SEC is pretty weak overall, and if their allegation is true then Robinhood should be punished much more severely than this $65M fine given that Robinhood and others likely profited at a minimum some $40M dollars.

The quality of comments in this thread is atrocious. I wonder what makes so many presumably technically trained people, to make confident claims about topics on which they very clearly have no bloody clue.

payment for order flow helps the consumer a lot. By separating toxic from non-toxic order flows, retail traders get much better price improvements than institutional traders.

Here's an analogy I once heard from Matt Andresen (founder of Island, one of the major early electronic exchanges). Equity markets are like a high-end clubs in Miami. A club that doesn't make any effort at "face control" at the door will find that it's ratio of guys-to-girls will continuously skew higher. And both groups will eventually stop going to any venue where the guy-to-girl ratio is persistently too high. However guys generally are willing to pay more than girls for entry, so it's a balancing act between maximizing short-term revenue and long-term brand value.

Similarly in any given market there's the ratio of informed trading to uninformed trading. Generally the former are large institutions, and the latter are small retail daytraders like the Robinhood customers. Since active management is a zero sum game, a venue with all informed traders is not a place you want to trade at.

By law the public exchanges are not allowed to segment order flow. Imagine a club that's legally prohibited from discriminating based on gender at the door. As you can imagine, the ratio at these venue is extremely biased towards informed traders.

Dark pools and internalizers are not bound by that restriction. However they're legally obligated to meet or beat the best price in the public market. (More on that in a second.) Retail brokers like Robinhood are essentially like club promoters, whose job is to get paid for bringing as many pretty girls to these venues as possible. And on the other side the informed traders at these venues (usually just the internal prop desk) pay big money for the privilege of trading somewhere with such a good ratio.

Is this a bad deal for the girls being herded by club promoters? To a first order approximation: no. At the very least they're getting free entry and drinks, instead of paying listed fees at the public venues. Sometimes they even get other perks like free meals or zero-commissions from the promoter. Still it feels exploitive because the promoter is making far more money off the girls than any fringe benefits they're getting.

As a second-order effect, the segmentation may degrade the overall ecosystem. Eventually all the girls wind up at the private clubs, and the public ones become ~100% dudes. Analogously the public lit exchanges have become highly toxic. Which is bad because market makers set prices based on the quality of the flow they interact with.

Remember that price protection on dark pools is based on the best price available at the lit exchanges. This creates a negative feedback loop. Dark venues can improve on prices at lit exchanges by segmenting order flow. Which forces lit market makers to worsen their prices. Which gives the dark venues even more of an advantage, allowing them to price out even more desirable order flow. Which then makes the lit order flow even more toxic, and the public quotes worsen. Which then drives even more flow to dark pools and internalizers...

Basically, if you want to buy AAPL at $100 and as your broker, I take that info and share it with someone else, such as an HFT, they will quickly (milliseconds/nanoseconds) buy AAPL and sell you at a higher price. So, while you expected to pay $100, you ended up paying $100.10.

Now that doesn't seem a lot to you but times the difference (10 cents) by volume and number of Robinhood customers placing orders and it can add up to be a lot.

The buy ahead of you scenario described in this comment is not what the allegations are in the filing (and wouldn’t work in practice because of the way exchanges work).

What is actually being alleged here is that Robinhood did not fulfill their obligation to secure the best price. There is a literal system in the US equities space that says what the best price for a symbol is across the exchanges.

The internalizer can arbitrage this system due to physics & CAP there on but they can also do it in more prosaic ways, by having previous inventory that is priced better or by simply taking the spread between an internal netting (thus internalizing it).

In any case it’s Robinhood who holds the fiduciary duty not the internalizer so if they aren’t getting appropriate execution they need to change their contracts with the internalizers, switch to a different set or send directly to lit exchanges (which destroys their business model & likely gives worse execution than a more fair internalization setup would).

That's not true. A $100 buy order will only ever execute at $100.

This is wrong on several levels. First of all limit orders place a limit on the worst case price that can be executed but SEC rules impose a duty to execute orders at the best price. If there's a $100 buy order and the best price is 99 dollars, then there is a duty to fill the order at 99 dollars.

Second, the allegation made by the SEC, for which they most likely have very strong evidence, is that Robinhood didn't fulfill its duty to execute orders at the best price to the tune of some 30 million dollars.

Not a market order which majority of people on Robinhood are using market orders since they are the default. Most don't even know what a limit order is I'm guessing.

The default trade option on Robinhood isn’t a dollar value buy order. It’s a number of shares order at the market rate.

No that's not how it works at all.

Source: work at a hft market making firm

If you have a few minutes, would you mind giving some technical overview of what's going on?

This is front running and illegal.

Yes, exactly. That's what this submission and charge by the SEC is all about.

Is everyone just forgetting the entire purpose of this submission is that Robinhood used pay for order flow to facilitate front running?

All the press release says is:

>Robinhood failed to seek to obtain the best reasonably available terms when executing customers’

That could mean pretty much anything.

I disagree that your sentence fragment is all the press release says. I believe the press release says a lot more, such as Robinhood making substantial amounts of money from pay for order flow and Robinhood executing orders at prices that are not only worse than what is available on the market, but also worse than competing brokers, and this in spite of the fact that Robinhood advertises this to the contrary.

These facts taken together can not be used to "mean pretty much anything". These facts, along with the additional fact that the SEC is charging Robinhood of engaging in illegal activity, strongly suggest illegal activity involving pay for order flow that resulted in worse price execution to the customer.

If you think that means "pretty much anything" then we can simply agree to disagree on this matter.

> Robinhood executing orders at prices that are not only worse than what is available on the market, but also worse than competing brokers

This sentence doesn't make much sense given how PFOF works. It would make sense if it were flipped around and said "not only worse than competing brokers, but worse than what is available on the market" because brokers typically provide retail traders better than what is available on the market (assuming: public exchanges = market).

I agree with GP that the press release suggests that Robinhood was not giving worse prices than NBBO, but was instead giving prices better than NBBO (like every broker), but intentionally not _as good_ prices as other brokers, in exchange for greater PFOF.

I am not fundamentally against PFOF, but the "honesty" required on the part of the broker in situations like this has always troubled me, and it's interesting to see it rear its head. I think an ideal market structure might keep PFOF, but in a more public way, such that payments were more transparent/competitive in real time, and not something arbitrarily negotiated between brokers and wholesalers.

Front running is a very specific malfeasance, and this release does not accuse Robinhood of it, by name or otherwise.

Despite what many apologists claim about front running being this very specific and formal type of activity that never happens because it's illegal and no one involved in finance ever commits crimes, the reality is that front running is not a technical term, neither in law nor in any academic or formal financial treatment.

Front running is an informal term that is used in many different domains to refer to when a principal acting on behalf of a client uses privately obtained information gained from that client to benefit at the client's expense. The term is used in finance, it's used in real estate dealings, heck there was even a scandal involving domain name registrars front running their clients:

http://www.circleid.com/posts/81082_network_solutions_front_...

The more formal and academic term is the principle agent problem:

https://en.wikipedia.org/wiki/Principal%E2%80%93agent_proble...

> the reality is that front running is not a technical term, neither in law nor in any academic or formal financial treatment.

There is literally a FINRA rule with with front running in the name (5270). It doesn't have to be a technical term for it to still have meaning (outside of Michael Lewis's intent to change its meaning). It specifically refers to a broker trading based on the knowledge of their client's intent to trade. The examples you give actually are instances of the true definition. It doesn't really happen in equities because of how automated and smooth that market is, but it certainly happens in other areas of finance.

The principal agent problem is much more general.

That's not what they charged with. What they charged with:

- You trying to buy 100 shares for $100 each - Someone is selling 100 shares for $98 each - RH supposed to fill order at best price ($98) - RH didn't do that.