Robinhood’s Threat to Sue The SEC Over Broker-Inducement Regulation Unlikely to Succeed


This article considers a rulemaking effort underway at the Securities and Exchange Commission to regulate the conflicts of interest that result when brokers send client orders to venues that pay the broker a fee in exchange for routing to them. These payments for order flow or rebates present a distortive conflict to a broker’s duty of best execution that has troubled the SEC for over 40 years and which the SEC has tried to regulate through multiple reforms. The SEC’s new Chairman has indicated he will more forcefully address broker conflicts. Robinhood, a popular trading app that makes most of its revenue via payment for order flow, has threatened to challenge the rule in court.

Analysis of this rule, and of the likely outcome in subsequent court challenge, shows that Robinhood is likely to lose. Yet this analysis is of interest not merely to brokers accepting PFOF, as this challenge provides a richer appreciation of the administrative law environment of SEC rulemaking. Along the way the reader is taken on a tour of lesser-known SEC rulemaking objectives that take on surprising significance in the market structure context.

The SEC’s competition objective will play a central role in this rule, reminding readers that the SEC is, at least to some extent, an antitrust regulator. The SEC’s fairness objective will also feature prominently in this rule. This fairness focus does not easily lend itself to economic analysis and therefore will require that a qualitative conflicts analysis be paired alongside any traditional economic analysis. Since prior SEC rule challenges have focused on economic analysis, it would appear a rulemaking under the fairness objective bolster’s the SEC’s chances of success.

What begins as an analysis of a specific rule, and a brewing challenge between Robinhood and the SEC, ultimately provides a richer understanding of the SEC’s multi-factor mission and of the administrative law constraints governing SEC rulemaking.