Retail And Regulators: Could PayPal's Bid To Become A Leading Online Brokerage Fall Under SEC Scrutiny?

PayPal recently shocked the world of retail investing after it was revealed that the company is looking at rolling out its own stock trading platform. But as the US Securities and Exchange Commission (SEC) moves to tighten the screw on modern brokerages, are PayPal’s PYPL plans destined for disappointment? 

There’s little doubt that venturing into the world of stock trading represents a significant opportunity for PayPal. The retail investment landscape has accelerated at an exponential rate across 2020 as the Covid-19 pandemic swept around the world. 

(Image: Financial Times)

As we can see from the chart above, trading volumes across the US have soared to new levels in the wake of the pandemic. The availability of government stimulus packages coupled with social distancing measures allowed investors more time and resources to embrace trading. 

Late 2019 also saw the arrival of payment for order flow operating models among online brokerages. This controversial approach meant that platforms could offer ‘zero-commission’ stock purchases for users whilst selling order requests to third party market makers. 

The news of PayPal’s future arrival sent shockwaves across the ecosystem, with Robinhood suffering a 7% fall as investors became fearful of the arrival of a major competitor. However, in light of recent regulatory concerns, it seems as though the biggest hurdles to PayPal’s success won’t come from an industry rival at all, but from regulators that are intent on bringing greater control to the investing landscape.

Arresting the Payment for Order Flow Boom

Robinhood is an example of a wildly successful retail brokerage that shot to prominence after pioneering a payment for order flow operating model that removed the need for platforms to take commissions from stock purchases. 

Soon, many more brokerages adopted the model, and the retail investing ecosystem began to boom as investors believed they were finding value in picking zero-commission brokerages to execute trades. 

(Image: Nasdaq)

As we can see from the table above, every major brokerage appeared to experience a significant rise in daily trading averages in the wake of the arrival of payment for order flow investing - with Charles Schwab, Robinhood and TD Ameritrade experiencing the most significant growth. 

However, the SEC has recently confirmed that it’s considering implementing a ban on the controversial practice - with SEC chairman Gary Gensler claiming that outlawing payment for order flow is “on the table.”

Although it’s unclear how PayPal is set to adapt its model to compete with rivals whilst offering its new investing services, it’s likely that the company will be looking to a similar payment for order flow approach in order to keep up with its competitors. Recently, the payment giants recruited industry stalwart Rich Hagen, who became CEO of a previously unreported division of PayPal called Invest at PayPal. Hagen’s current job description at the company is to “explore opportunities” in the consumer investment business, indicating that PayPal is yet to decide how to operate its new investment platform. 

Winning Over the SEC

For investors who may be getting excited about the prospect of utilizing PayPal for investing in the future, it’s unlikely that we’ll see any services released by the payments company in the short term. 

“The regulatory approval process for PayPal's own subsidiary brokerage company could take at least eight months,” noted Maxim Manturov, head of investment research at Freedom Finance Europe. “The US Securities and Exchange Commission (SEC) has already expressed concern about the growing popularity of securities markets accompanying the explosion in retail investing via applications. These reservations may also slow the approval process if PayPal decides to partner with an existing brokerage firm instead.”

Furthermore, it seems as though PayPal will have its work cut out in wooing the SEC into offering the firm the same concessions it afforded the established online brokerages across the US today. 

Not only is the field of retail investment extraordinarily competitive following a prosperous past 18 months, but PayPal will also be entering the landscape at a time when the SEC is actively looking to address some significant concerns regarding the safety of investors at the hands of trading platforms. 

The Securities and Exchange Commission has been vocal in its concerns about the rising levels of ‘gamification’ that securities markets have been indulging in over the past months. The gamification of retail investing has been compared to a casino by Warren Buffett and attributed to the rise of short squeezes that could be seen in the rally on GameStop GME and AMC AMC stocks over the course of the past year. 

Prominent retail brokerage, Robinhood, has been at the forefront of accusations that the platform’s using gamification methods to encourage more investors to trade stocks, and recently removed its confetti celebrations displayed on the app when a user’s first purchase takes place. 

It appears that PayPal may be set to enter into a highly volatile retail investment landscape, with regulators primed to curb what it deems to be reckless industry practices. However, with an eight-month approval process, PayPal will have plenty of time to refine its model to suit any changes imposed by the SEC. 

As a company with almost 400 million users globally, it’s clear that PayPal is well-positioned to adapt quickly in the face of regulatory changes - meaning that it may thrive in adapting quicker than its rivals in a retail ecosystem that may soon change significantly.