Gary Gensler, chairman of the United States Securities and Exchange Commission.
Melissa Lyttle / Bloomberg
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A controversial practice that has contributed billions of dollars to brokers and high-frequency trading companies is in the spotlight of the Securities and Exchange Commission and could be completely eliminated.
In an interview with De Barron on Monday, SEC President Gary Gensler said “a total ban on order flow payments is on the table.” Order flow payment is a practice in which brokers send trade orders to market makers who perform these operations in exchange for a portion of the profits.
Gensler says the practice has “an inherent conflict of interest.” Market makers make a small difference in every trade, but that’s not all they get, he said.
“They get the data, they get the first glance, they get to match buyers and sellers of that order flow,” he said. “This may not be the most efficient market for the 2020s.”
He did not say whether the agency has found cases where conflicts of interest caused harm to investors. SEC staff is reviewing the practice and could submit proposals in the coming months.
Gensler has mentioned several times that the UK, Australia and Canada prohibit the payment of order flow. Asked if he raised these examples because there could also be a ban in the United States, he replied, “I’m raising this because it’s on the table. That is very clear. “
It is not the only one raised by the SEC.
“Also on the table is how we can move more from this market to transparency,” he said. “Transparency benefits the competition and efficiency of markets. Transparency benefits investors. “
Order payment is part of a larger problem with the market structure that Gensler is trying to address. He points out that approximately half of the operations are carried out in dark pools or are internalized by companies that keep these businesses out of the stock exchanges. Even some of the transactions that are made in exchanges are opaque, and the exchanges are paid through discounts similar to the payment for the order flow. Opaque markets where different investors have processed their trading orders differently have the potential for abuse.
“It provides an opportunity for the market maker to do more and ultimately for the investing public to get a little less when they sell, or have to pay more when they buy,” he said. “I think it also affects companies that raise money,” he added, because it could be a barrier to “fair, orderly and efficient markets.”
Changes in order flow payment can take place as part of a larger remodel of how transactions are processed and tracked.
There has been a boom in retail in the last two years, with millions of new investors signing up brokerage applications to trade stocks, options and cryptocurrencies for the first time. The boom has been driven in part by a shift in the way brokers make money in trading clients. Most brokers no longer charge for early transactions. They make money from operations by sending orders to market makers, such as high-frequency marketing companies. The manufacturer of the market executes the trade and obtains profits from the difference between the prices of the offer and the prices demanded, and returns part of the profit to the broker.
For most brokers, the practice is a relatively small part of their business model, often less than 10% of revenue. But for
Robinhood Markets
(ticker: HOOD), which pioneered zero-commission trading, paying the flow of orders accounts for about 80% of its revenue.
Shares of Robinhood were already trading lower on the day, but fell further after De Barron report. On Monday afternoon, shares fell 8% to $ 43.03. .
The company has told investors who have filed securities that the SEC’s focus on paying for order flow is a risk factor. But company executives have downplayed the possibility of it being banned. “Our internal view is that we don’t expect payment for the order flow to be banned,” CFO Jason Warnick said in Robinhood’s latest profit call. He added that “we believe that order flow payment is such a small revenue stream (it’s 2 to 2 and a half cents for every $ 100 traded) that it’s not a terribly difficult revenue stream to replace for us. “.
But the SEC has found that all these fractions of cents add up. In fact, the agency resolved complaints with Robinhood last year about how it negotiated payment of the order flow and its disclosures to customers. The agency said Robinhood made deals between 2015 and 2018 with market makers that gave the company a much higher percentage of the spread, while other brokers generally returned more of the spread to customers.
The SEC order said Robinhood had negotiated an 80/20 split, with the company receiving 80% and investors 20%, while other brokers tended to have a division closer to 20/80. And the regulator said Robinhood’s commercial execution was so bad for consumers that it far outweighed the benefit they got from not having to pay a commission. To settle the allegations, Robinhood agreed to pay $ 65 million, but neither admitted nor denied the findings. The company has also said it has changed its payment to order flow practices.
Advocates of order flow payment say it’s a way to make money that intermediaries don’t really harm consumers and allow apps to charge zero commissions. It’s one of the main reasons why more people have never started investing, said Warnick of Robinhood.
“Never before has investment in this country been cheaper,” he said.
He also noted that other brokers had historically accepted payment of the order flow in addition to commissions, while Robinhood has never charged commissions.
Any change in practice would be clearly controversial.
“We will definitely stand up for our customers and make sure we don’t put barriers that have been removed and keep people out,” Warnick said.
Robinhood declined to comment further Monday.
Write to Avi Salzman at [email protected]