The epic drawdown in GameStop shares last week shed light on the widespread practice of payment of order flow by brokerage firms after Robinhood restricted trading to a few volatile stocks.
Paying order flow is a practice whereby brokerage firms are compensated for directing their clients trading orders to specific market makers to execute trades, rather than directly to the exchange, creating a potential conflict of interest between broker and client.
PFOF practice allowed trading at $ 0 commission, the jump started with the launch of Robinhood in 2015, which was groundbreaking at a time when most investors had to pay more than $ 10 for each buy or sell order.
Almost every brokerage firm now offers trading with a commission of $ 0.
But the PFOF practice has met with backlash from many, including venture capitalist Bill Gurley, who tweeted Sunday: "If the SEC / government wants to fix the plumbing, they should be banned from paying for order flow."
Gurley noted that this practice "smells bad" and is already banned in the UK and Canada.
But Robinhood makes most of its money through PFOF practice, according to the SEC, generating over $ 100 million in revenue in the first quarter of 2020 from a number of market makers including Citadel Securities.
The free-trade brokerage now goes against the PFOF practice and changes its business model to tip.
In a Monday blog post, Public.com announced that it would end the practice of selling its customers' order flow to market makers and instead direct them directly to exchanges like the Nasdaq and the New York Stock Exchange.
“To align our incentives with our members' motivations, we will stop participating in the PFOF practice and will instead introduce a tip feature in transactions," Public said, adding that this would essentially remove a large conflict of interest from its business model.
"Transactions will remain commission-free, and tip is completely optional," added Public.
The firm notified its clearing company APEX on January 30 of its intention to remove the PFOF rails, according to a blog post. All trading orders from the brokerage firm will now be sent directly to exchanges for execution.
“Direct routing to exchanges is more expensive and so we are turning what used to be a revenue stream (PFOF) into a cost center and hope the difference will be offset by the additional tip function,” said Public.
The company says the transition from PFOF to tip overflow could take several weeks.
"Transparency is the foundation of building trust, and we think it's important to live up to its name," concluded Public.