- At a forum Thursday, Robinhood’s Daniel Gallagher talked payment of order flow, SPACs, and crypto.
- An SEC alum, Gallagher said regulators will likely scrutinize SPACs and cryptocurrencies.
- The SEC won’t likely overhaul the trading mechanism brokers like Robinhood are built on, he said.
- Visit the Business section of Insider for more stories.
Daniel Gallagher, Robinhood’s chief legal officer and former regulator, is a “pretty free-market guy.”
Gallagher’s skeptical that the Securities and Exchange Commission (SEC) will overhaul payment for order flow — the method that enables online brokerages like Robinhood to charge zero fees to retail investors, he said during this year’s Berkeley Spring Forum on M&A and governance on Thursday.
Regulators likely will, however, scrutinize SPACs and cryptocurrency, two booming areas that are capturing the market’s attention, Gallagher said, who was a former SEC commissioner under Barack Obama.
Gallagher’s comments largely reflect Robinhood’s stated mission of democratizing access to financial markets, and the structural issues that hinder this access. The trading app has recently come under fire after it blocked purchases of GameStop, AMC, and other companies that have become subjects of a trading frenzy in late January. The move also drew criticism from lawmakers like Rep. Alexandria Ocasio-Cortez of New York, who are calling for increased regulatory scrutiny.
Gallagher was tapped by Robinhood to lead its legal team last May, joining from the law firm WilmerHale, where he served as deputy chair of its securities department.
Here’s what else Robinhood’s head lawyer had to say about the topics that have investors and regulators alike buzzing.
Stock Market Payment for order flow is not a ‘seedy underbelly’
There’s “irony” in the fact that payment for order flow (PFOF) has become headline news following the GameStop trading frenzy, said Gallagher.
PFOF is a mechanism by which retail brokerages sell their customers’ buy-and-sell orders directly to market-making firms, and is a key piece of their ability to offer commission-free trading to retail investors. While it’s a common practice among brokerages in the industry, Robinhood has relied on it more heavily than others, as previously reported by Insider.
Commission-free trading didn’t become the norm for most traditional brokerages, like Charles Schwab and Fidelity, until 2019, a move that was very much influenced by Robinhood’s success.
“The irony that killed me here is that the model in retail brokerage five years ago was payment of order flow, plus a commission on top — that’s the cherry on top — but no one understood it. No one was talking about it,” Gallagher said at the Thursday panel.
It was only until a couple of “crazy Stanford grads,” Vladimir Tenev and Baiju Bhatt, founded Robinhood and built a model around PFOFs that it sparked calls for heightened scrutiny from regulators, he said.
“There’s tons of disclosure around [PFOF]. If they want to add more disclosures, God bless, we’ll do it,” said Gallagher. “But the idea that it’s a seedy underbelly or something like that is crazy. It’s been around since the eighties.”
When it comes to possible government action, the former commissioner said that he doubts that Congress and the SEC will overhaul PFOFs and “start charging commissions to investors again,” since the move is “probably not a good look.”
Stock Market The SEC will likely scrutinize the SPAC ‘bubble’
Proper disclosure also played a central role in Gallagher’s discussion of SPACs, special-purpose acquisition companies, also called blank-check companies, that are formed for the sole purpose of acquiring a private company to take it public.
Nearly 70% of this year’s IPO activity is in SPACs, up from about 20% in 2019, per the Wall Street Journal.
“I don’t want to be at all negative about this
binge, but, look, we’ve all seen bubbles. It feels like a bubble to me. And so I think it’s worth having a critical eye,” said Gallagher.
He went on to say that, if he were still a commissioner, he’d be asking questions about disclosure to ensure there’s transparency in the IPO process and no conflicts of interest. In December, the SEC issued disclosure guidance for blank-check companies, including whether the SPAC has disclosed, in IPO documents and other publicly-filed documents, if payment of underwriter fees are contingent upon completion of the combination.
“I’m strongly guessing there’s going to be a lot of SEC scrutiny over fee disclosure in particular,” Gallagher said. He added that if these proper regulatory mechanisms are in place, the idea of vehicles that come along to help companies go public adds more opportunities for the average American to invest in otherwise private companies that they couldn’t.
Stock Market The government will take a policymaking approach toward cryptocurrency
The SEC is also likely to take a more normal regulatory approach to define policy around cryptocurrency, said Gallagher.
Cryptocurrency has taken the stock market by storm, riding the waves amplified by figures like Elon Musk who tout the value of bitcoin, as well as by traditional investors — including the world’s biggest asset manager BlackRock — that are finally dabbling in the crypto space.
Regulators have perked up in response, and the question has become one of whether the SEC will take on a hardline enforcement approach versus a more traditional policymaking one.
That said, Gallagher said that Gensler is “not some knee-jerk regulatory person,” and that he’s “going to surprise folks” given his “pretty forward-leaning” stance on cryptocurrency. Gensler teaches about digital currencies as a professor at the MIT Sloan School of Management.
During the Senate hearing, Gensler said that while the SEC should promote innovation in blockchain technology, the government should “ensure that there’s appropriate investor protection” if there are securities involved that trade on exchanges.
While the Commodity Futures Trading Commission was set up to specifically oversee virtual currency markets, the SEC needs to take the lead in some respects, said Gallager.