Payment For Order Flow & The SEC’s Plan To End It – Investment Watch


Via Lance Roberts

“Cost For Order Float” stays a competition between retail traders and Wall Boulevard. At the one hand, it creates the facility to have “loose buying and selling” for retail traders. Then again, it additionally creates a possibility for Wall Boulevard to “front-run” folks for benefit.

In monetary markets, “Cost For Order Float,” or “PFOF,” refers to a dealer’s repayment from 3rd events to steer how the dealer routes shopper orders for achievement.



Learn that once more.

For years, paying for order flows allowed companies to centralize consumers’ orders for any other company to execute. Such allowed smaller companies to make use of economies of scale of bigger companies. Such permits small companies to mix orders with better companies, offering higher execution high quality.

Over time, the decimalization of the buying and selling securities reduced the profitability of industry execution. Such driven Wall Boulevard towards fee for order go with the flow so to generate income and subsidize the transfer to 0 commissions.

Technological advances and knowledge research higher the velocity with which knowledge will get despatched and gained. Over the past decade, Wall Boulevard spent billions to determine tactics to make the most of the information and “recreation the gadget.”

Nowadays, Robinhood and others generate the majority in their revenues from fee for order go with the flow through promoting orders to the absolute best bidder. 

Take into accounts this moderately. If a company is promoting order go with the flow to the absolute best bidder, even if you’re paying “0 commissions,” you don’t seem to be essentially getting the most productive execution.

In different phrases, “loose” isn’t essentially “loose.”

The Fleecing Of Retail Traders

The problem of fee for order go with the flow isn’t a brand new factor. In 2004, Castle’s lawyer Jonathan G. Katz wrote a letter to the SEC creating a definitive argument the follow of marketing order go with the flow must be unlawful.

Payment For Order Flow, Payment For Order Flow & The SEC’s Plan To End It
Supply: www.sec.gov/regulations/thought/s70704/citadel04132004.pdf

Take into accounts that for a second.

  • In 2004, Castle argued that fee for order go with the flow must be unlawful to the SEC.
  • In 2020, Castle is the most important company within the fee for order go with the flow trade.

Castle made up our minds that “if you’ll be able to’t beat ’em, sign up for ’em” used to be the most productive recreation plan.

What came about between 2004 and 2020?

All over the waning days of fractional pricing, the smallest unfold used to be ⅛ of a greenback, or $0.125. Spreads for choices orders have been significantly wider. Investors found out “loose” trades value them rather slightly since they didn’t get the most productive transaction value.  

At that time, the SEC did step in to behavior a learn about. The outcome used to be a close to ban on fee for order go with the flow. The learn about discovered, amongst different issues, that the proliferation of choices exchanges narrowed spreads because of the extra festival for order execution.

In spite of everything, underneath drive from Wall Boulevard, the SEC acquiesced and allowed the follow to proceed mentioning:

“Whilst the fierce festival through higher multiple-listing produces speedy financial advantages to traders within the type of narrower quotes and efficient spreads. Via some measures those enhancements get muted with the unfold of fee for order go with the flow and internalization.” 

That call opened “Pandora’s field.”

No Such Factor As Unfastened Buying and selling

Higher Markets up to now wrote:

“As is apparent from the billions paid for, and created from, order flows, there is not any such factor as ‘loose buying and selling.’

Thus, the declare of ‘commission-free buying and selling’ is not more than a rhetorical ruse to draw new traders. Such distracts them from the billions of greenbacks in PFOF and different hidden prices that pop out of retail traders’ wallet.

Those intermediaries are steadily simply moving the traders’ visual in advance commissions into invisible after-the-fact de facto commissions.

Such permits the complexity of the fragmented order processing gadget that one may argue is designed essentially to cover the ones bills.” – Higher Markets

Such is why Wall Boulevard lobbies the SEC closely to seem the wrong way. In addition they proceed to obfuscate the “racket” underneath the guise of “developing marketplace liquidity.” Then again, liquidity would stay in an international with out fee for order go with the flow. Wall Boulevard would simply shift focal point again to market-making.

However, in the event you don’t suppose this can be a “giant deal,” you’re sorely misinformed.

“Brokerages corresponding to Charles Schwab Corp., TD Ameritrade, Robinhood Markets Inc., and E*Industry gathered just about $2.6 billion in bills for inventory and choice orders. The most important assets of the bills have been digital buying and selling companies corresponding to Castle Securities, Susquehanna World Staff LLP and Virtu Monetary Inc.” – WSJ

Payment For Order Flow, Payment For Order Flow & The SEC’s Plan To End It

“Such companies earn money through promoting stocks for rather greater than they’re keen to shop for them, and pocketing the associated fee distinction.”

So, precisely why would companies pay for order go with the flow?

They’re keen to pay for order go with the flow from on-line brokerages as a result of they’re much less more likely to lose cash buying and selling in opposition to person traders than on an alternate, the place buyers have a tendency to be better and extra refined.” – WSJ

The SEC’s Plan To Repair It?

As soon as once more, the SEC is having a look at solving the fee for order go with the flow follow.

At this time, there isn’t a degree enjoying box amongst other portions of the marketplace: wholesalers, darkish swimming pools, and lit exchanges. It’s no longer transparent, given the present marketplace segmentation, focus, and loss of a degree enjoying box, that our present nationwide marketplace gadget is as honest and aggressive as imaginable for traders.” – SEC Chairman, Gary Gensler

The Wall Boulevard Magazine went into extra element about what used to be recently getting thought to be:

Chairman Gary Gensler directed SEC body of workers closing 12 months to discover tactics to make the inventory marketplace extra environment friendly for small traders and public firms. Whilst sides of the trouble are in various phases of construction, one concept that has won traction is to require brokerages to ship maximum person traders’ orders to be routed into auctions the place buying and selling companies compete to execute them.

Probably the most consequential alternate being mentioned would have an effect on the way in which trades are treated after an investor puts a so-called marketplace order with a dealer to shop for or promote a inventory. Marketplace orders, which account for almost all of person traders’ trades, don’t specify a minimal or most value the investor is keen to pay.

Mr. Gensler has stated he needs to make sure that agents execute orders at the most productive imaginable value for traders—the absolute best value for when an investor is promoting, or the bottom value if they’re purchasing.” – WSJ

The SEC is thinking about an “public sale marketplace” that might power companies to compete with each and every different to fill an person investor’s industry. That fluctuate would have an effect on how companies like Castle Securities and Robinhood Markets procedure retail industry orders.

Now you’ll be able to remember that “loose trades” weren’t that “loose” in spite of everything.

The Different Downside Of “Unfastened Trades”

The opposite “loose buying and selling” downside is that it additionally ends up in deficient investor results. As famous lately through the CEO of the funding app “Stash:”

“All of the manner that buying and selling is occurring at the moment out there and the way fee for order go with the flow is operating. It’s using a on line casino impact the place on a regular basis American citizens who don’t know the way to industry and don’t have monetary schooling provided to them in class and from their folks are actively buying and selling. And I wish to know how marketplace construction will alternate to make it concerning the retail buyer. The institutional consumers and the hedge price range, they’ll be OK, however I wish to be sure that we’re protective retail traders.

Cost order go with the flow has had a spiral impact the place it simply made it in reality, in reality simple to industry and actively industry. I believe that it does receive advantages the marketplace makers and the top frequency buying and selling companies. While, what I wish to see is extra retail consumers fascinated about the long run and making an investment slowly.”

As we famous up to now, a lot of research turn out extra widespread buying and selling ends up in worse efficiency over the years. Such is because of the emotional errors traders make, essentially of shopping for top and promoting low, but additionally tax problems and buying and selling prices related to widespread buying and selling.

The issue with loose buying and selling is that people have a tendency to overreact to excellent or dangerous information. This emotional response reasons illogical funding selections. This tendency to overreact can grow to be much more vital all through private uncertainty or when the financial system is horrible.

A complete box of research researches this tendency to make illogical monetary selections. It paperwork and labels our money-losing thoughts methods like “recency bias” and “overconfidence.”

Whilst the explanations for underperformance are many, commission-free buying and selling exacerbates that development through taking away the “brake pedal” from the rushing automotive.

The Go back Of Commissions

As Higher Markets concluded:

There is not any explanation why for the markets these days to be so fragmented rather than to function a wealth extraction mechanism that strikes cash from buy-side wallet to sell-side companies, intermediaries, and their associates.

Then again, it isn’t simply Robinhood and a few hedge price range however a collaboration of each Wall Boulevard participant.

I’m a company believer in “loose markets.”

Then again, for “loose markets” to paintings successfully, they will have to even be “honest markets.”

Our present capital marketplace gadget is also “loose,” however it’s not “honest” in some ways. Banning fee for order go with the flow is a superb get started.

Sure, such would imply that companies offering transaction services and products must price a fee for execution. However such would probably have the knock-off impact of “slowing issues down” and offering higher investor results.



Then again, whilst this used to be an workout in figuring out fee for order go with the flow and that “loose buying and selling isn’t loose,” not anything will most likely alternate. As is at all times the case, there may be an excessive amount of cash, energy, and political drive from Wall Boulevard at the SEC.

We aren’t protecting our breath that the rest will alternate for the simpler anytime quickly.

However possibly it’s price figuring out that paying a small fee for “honest execution” wasn’t so dangerous.





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