Casten pushes SEC Chairman Gary Gensler to update regulation to protect investors
Washington, DC – U.S. Congressman Sean Casten (IL-06) questioned Securities and Exchange Commission (SEC) Chair Gary Gensler during the third House Committee on Financial Services ?Committee (FSC) hearing on Gamestop, digital platforms, and retail investors.
In his questioning, Casten raised the inherent conflict of interest built into Robinhood's business model-of prioritizing the profit from payment for order flow and providing the best execution of trades for their customer while purporting to be a ‘democratizer of finance' to the public. In December the SEC fined Robinhood $65 million for misleading customers about revenue sources and failing to satisfy their duty of best execution. Casten highlighted that this fine has not seemed to deter their practices. It was clear from Chair Gensler's comments today that he and the SEC are committed to reviewing these practices.
Casten expressed concern over the gamification of trading. He pointed out incentivizing retail investors to trade frequently is usually not in their best interest. Casten fears that these problems will only get worse--opening the door for further risks to individuals and to healthy markets.
"Robinhood functions like a virtual casino gamified to harness human psychology -- where market makers are the House -- designed to drive frequent, short duration, Roulette-like trades, ready to extract fast money from investors against the best interest of investors."
"Regardless of party, we all want to see us investors create as much wealth as possible. [Yet] if you couple gamification with an incentive based on the spread and you couple that with only funneling money to people who are on the spread, I cannot conceive of a world where you are also fulfilling your best execution obligations." Casten said during the hearing.
Casten has been the Congressional leader against Robinhood's failure to protect investors since last summer, when a 20-year-old-resident of the Illinois district he represents died by suicide after seeing a negative balance of more than $700,000. In a suicide note, Kearns named Robinhood, asking how it allowed a novice trader get into that position. After Casten learned that Robinhood failed to respond to Alex's repeated inquiries and, at that time, did not have a customer support phone number for Alex to call, he led his House colleagues in efforts calling on Robinhood directly to improve transparency and user safety and in urging federal regulators at SEC and FINRA to take action to protect investors.
At the first FSC hearing on Robinhood this February, Casten grilled Robinhood CEO, Vlad Tenev on his failure to provide adequate support to protect young investors like Alex and capped his remarks by calling Robinhood's support phone number and playing on speaker for Mr. Tenev the 10-second recording on the other end directing users to email in their inquiries before it hung up. When Robinhood announced changes to their support two days later, Casten stated that he remains concerned that the announced changes are insufficient and could distract from the real problems that persist—from the limits on which users have access to phone support, insufficient disclosures, and inadequate identification requirements that have allowed children to gamble tens of thousands of dollars with just a few clicks to the lack of transparency around payment for order flow and how it may harm consumers.
Please find a transcript of Rep. Casten's questioning from the hearing below.
Rep. Sean Casten 0:00
Thank you, Madam Chair, you caught me by surprise with the technical glitch there. Really appreciate you all coming. Chair Gensler, I'd like to dive into some of the weeds here on payment for order flow. And, and I want to frame this in the context of Robinhood because it's top of mind in this hearing, but I think it's more illustrative of some challenges than the specifics for them. Number one, I would just point out that last year Robinhood paid $65 million in fines for failing to disclose the reliance on payment for order flow as their revenue stream. 65,000,000. By comparison, they earned $91 million in payment for order flow revenue in the first quarter of 2020, $180 million in the second quarter of 2020 and $331 million, 5 times the fine in the first quarter of this year. Now, you weren't at the SEC and I'm not gonna ask you to comment on that, but I just make the observation that if the pain of the fine is so much lower than the benefit of the crime, I'm not sure it has been the kind of deterrent property we would like. Now, in our hearing with Mr Tenev, he noted that their payment for order flow agreements are structured where their revenue is earned as a percent of the spread earned by the wholesalers. Now, leaving the question of payment order flow broadly aside. That seems to me like a total conflict of interest. The structure of that agreement puts the interests of the wholesalers and the brokers directly at odds with the investors, is it not?
Chair Gensler 1:50
I think you highlight two really important points if I may. One is that an enforcement regime should, I believe, without fear or favor lean into individuals and corporations and hold them accountable, and that what you're highlighting is sometimes just a dollar payment doesn't fully address holding companies or individuals accountable, and change the behavior in the market. As to the behavior itself, what that finding in that case in December showed is that there was an inherent conflict, that there was the wholesaler saying "Well, which way do you want me to go on this?" It's either you or the investor and so that's why I've asked staff, I think that we have to take a holistic look at the market structure and see not only whether customers are really getting best execution but how the market structure can be addressed to get that, and also address some of the increasing concentration in the markets.
Rep. Sean Casten 2:58
I appreciate that because again it's the structure. It's one thing to be paid 10 cents a trade, it's something else to say I'm going to get a percent of the spread. The second point that Mr. Tenev said in those hearings was that, at least for their options orders, that they only route trades to the four firms listed on their 606 that they have payment for order flow contracts with. To my mind, I don't understand how that's consistent with the best execution obligation, if you are consciously not even talking to firms who might be able to do this but don't pay you a fee on it. Would you agree that, again, I'm talking about the structure of how you implemented payment for order flow, not the concept, generally,
Chair Gensler 3:39
I think that you highlight a very good point that that in circumstances where you don't have that, then a broker service says alright I've got to institute best execution and it goes down surveys, I think it was earlier some congressmen, said it was a horse race but you can go out and you think kind of set mark, now I think it was Congressman Foster but they sure, you know, who can I go out and sort of find the best execution, rather than a limited two or three or in this case four firms that are sending money back to the broker.
Rep. Sean Casten 4:16
Okay, well, I'd like to then just tie this all to the gamification question because I think all of us on this committee, regardless of party, want to see US investors create as much wealth as possible. And I don't think any of us have evidence to suggest that retail investors, you know, with high trading frequency come out better than retail investors who just invest in index funds and are long hold, other than a couple lucky casino winners. And yet that is precisely what gamification is designed to do. And so if you couple gamification, with an incentive based on the spread, and you couple that with only funneling money to people who are on the spread, it seems to me like, I cannot conceive of a world where you are also fulfilling your best execution obligations. So, in the time we've got left. What tools do you have to enforce compliance with folks who are violating that best execution. And can you commit to making sure that the, the fines are commensurate with the gains from the crime.
Chair Gensler 5:18
Well that is certainly what we're going to lean in to do. I think that without fear or favor and it's not just about the firm's but individuals, it's about sanctions and bars, and when needed to have borders that makes sure of that
Rep. Sean Casten 5:34
Thank you. I yield back.