Robinhood makes most of its money selling customer orders. Is payment for order flow ethical?

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PFOF. If you say it out loud (P-fof!), the acronym sounds like a dessert topping or a rude way of telling someone where to go. But PFOF is becoming critical to how the stock-trading app Robinhood, as well as old-school brokerages, make money.

The acronym stands for “payment for order flow” and describes the fees Robinhood and others receive from electronic market makers for passing on customer orders. For example, when you buy a share of Tesla on your phone, Robinhood sends that order to a trading giant like Citadel Securities and receives a few pennies in return—the PFOF. Citadel, meanwhile, completes your trade and makes a few pennies itself.

For Robinhood, those pennies add up. A recent SEC filing, first cited by The Block, reveals Citadel Securities and a handful of other firms paid Robinhood nearly $100 million in the first quarter of 2020 alone. These payments are the company’s primary revenue stream—far outstripping what it earns from its premium service, Robinhood Gold, or from the interest it makes on cash balances in customer accounts.

All of this raises the question of whether PFOF is fair or ethical. Namely, should a brokerage—especially one like Robinhood that brands itself with an anti-Wall Street Everyman gloss—be selling its customers’ trades?

As it turns out, in most cases, there’s nothing nefarious about PFOF. In fact, the practice can help retail investors get a better price on their trades. As Bloomberg wiseman Matt Levine explained in late 2018, amid an earlier controversy over Robinhood and PFOF, it’s actually hedge funds and other institutional investors who ultimately pay more when brokerages outsource their retail orders. (Levine also explains what the likes of Citadel Securities get from paying Robinhood—in short, he says, Citadel pays to execute retail trades because it lets them avoid getting squeezed by something called “adverse selection” by professional traders).

That doesn’t mean PFOF arrangements are always above board. Former SEC Commissioner Mary-Jo White has warned that the practice can create conflicts of interest, leading brokerages to betray their “best execution” obligations to their customer in favor of higher kickbacks. And indeed, regulators last year fined Robinhood for doing exactly that. The infractions in question, however, occurred several years ago and there is no indication the company has played fast and loose with PFOF since then.

The most interesting recent development when it comes to PFOF, though, does not relate to Robinhood. Instead, it’s about how the old guard brokerages have come to rely on it as a revenue stream too. Annual reports show that Charles Schwab, eTrade and TD Ameritrade all pulled in record PFOF revenues in 2019—$135 million, $188 million and $492 million respectively.

None of this is surprising given the commission-free trade environment that Robinhood pioneered, and that the rest of the industry has since embraced. PFOF, that funny sounding acronym, appears poised to power the brokerage industry’s profits for years to come.

Jeff John Roberts

@jeffjohnroberts

jeff.roberts@fortune.com

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