WASHINGTON/NEW YORK, March 28 (Reuters) – The Wall Street regulator is considering changes to stock market rules to increase competition for orders and improve transactions for retail investors, according to its top official Gary Gensler and industry leaders.
The U.S. Securities and Exchange Commission (SEC) is reviewing the practice of payment for order flow (PFOF), in which wholesale market participants pay brokers like TD Ameritrade (SCHW.N), Robinhood Markets ( HOOD.O) and E*Trade to route retail customer orders to them rather than exchanges. The SEC review could result in the biggest shake-up to U.S. stock market rules in more than a decade.
Robinhood derives approximately 75% of its revenue from PFOF. The trading app and others say the practice on average gives retail investors a slightly better deal than exchanges, allowing them to cut commissions and democratize investing. Read more
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Critics claim that paying for order flow can create conflicts of interest and also encourages brokers to add video game-like bells and whistles to their apps and websites that entice investors to trade more, which increases broker profits but is rarely the best investment strategy. Read more Britain, Canada and Australia have banned PFOF, and Gensler suggested in August that the SEC might go that route.
The PFOF came under renewed scrutiny last year when an army of retail investors went on a buying spree of “meme stocks” like GameStop and AMC, pressing hedge funds that had shorted the shares. Many bought the stocks using commission-free brokers like Robinhood that accept PFOF from a few powerful market makers.
The largest, Citadel Securities, claims to control 35-40% of all retail order flow in the United States. Virtu Financial controls about 25%, according to an analysis of SEC data by BestEx Research.
The SEC is investigating whether retail brokers send PFOF customer orders to the wholesaler who pays them the most, rather than to the venue that offers the best deal.
“When a party pays a platform for order flow, it may conflict with a retail client getting best execution,” SEC Chairman Gensler said in an interview. “They don’t get order-by-order competition.”
Some brokers, like Fidelity, claim they can get good stock prices for clients and offer free stock trades without accepting PFOF.
A Robinhood spokeswoman pointed to a study by two Massachusetts Institute of Technology professors that found Robinhood customers benefited from more than $8 billion in price improvements from 2020 to 2021 thanks to PFOF.
A spokesperson for TD Ameritrade said the current market structure is delivering “great results” for investors and the company supports efforts to improve it further.
A ban on PFOF is on the table, Gensler told Reuters, but he said the practice was also just a symptom of a wider problem: exchanges don’t compete on a level playing field. with the off-exchange market, where about 40% to 50% of trading takes place.
The national benchmark for measuring the best deal is flawed because it does not include such off-exchange transactions, he added.
“Here’s the focus on new market structure rules: how could we promote a more level playing field?” Gensler said.
The SEC is also considering making it easier for exchanges and market makers to compete for orders by allowing exchanges to offer prices below a penny and changing the definition of “best execution,” Gensler and other industry leaders.
Several executives said they doubted the SEC would actually ban PFOF. Virtu Financial CEO Doug Cifu said his company would be one of many to challenge such a decision in court.
“The PFOF and the rebates have really fostered incredible innovation and competition in the marketplace,” Cifu told Reuters, adding that if the SEC bans the practice “they’re looking at a very long fight.”
He and other industry executives have said the SEC should improve retail brokerage disclosures so retail investors are better informed about the pros and cons of the PFOF. Gensler said the SEC is also reviewing the disclosures.
“As long as it’s transparent and disclosed, I don’t see a conflict,” said Kirsten Wegner, CEO of the Modern Markets Initiative, which represents auto trading firms.
Investor advocates support better information and also want to boost the competitiveness of exchanges to improve the reliability of the national price benchmark, known as the National Best Bid and Offer (NBBO).
Current “best execution” rules require retail brokers to route client orders to a venue that offers the best quoted price on the exchange, or better, and market makers generally improve the best price by a fraction of a cent. .
Exchanges cannot offer quotes below a penny, but the SEC is considering allowing it. It is also considering a rule, similar to the one in Canada, requiring retail brokers to execute orders on an exchange unless the off-exchange price is significantly better, said Dave Lauer, CEO of financial platform Urvin Finance, and another knowledgeable industry source. of SEC thinking.
Wholesalers offer a 15% improvement on the NBBO spread, but moving retail flow to exchanges would reduce NBBO spreads by 25%, according to research by Hitesh Mittal, CEO of BestEx Research.
“Institutional investors and market makers would do better to compete with exchanges for retail feeds by closing the bid-offer spread,” he said.
Ty Gellasch, executive director of investor trading Healthy Markets, who also discussed the matter with the SEC, said he expects the agency to clarify that “best execution” requires brokers to obtain the best price available rather than a fractional price improvement.
“I expect him to say to the industry, ‘you have to give customers the best prices,'” he said.
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Reporting by Katanga Johnson in Washington and John McCrank in New York; Editing by Michelle Price and David Gregorio
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