The chief of the US financial regulator proposed a new set of rules to reform the way retail brokers enable free share trading via a practice called ‘payment for order flow’ (PFOF).
PFOF is where some retail brokers, including Robinhood Markets Inc (NASDAQ:HOOD), Charles Schwab (NYSE:SCHW) Corp, E*Trade and TD Ameritrade (NASDAQ:AMTD), sell their customers’ orders for a profit to giant Wall Street market makers such as Citadel Securities and Virtu Financial.
Securities and Exchange Commission chair Gary Gensler said his staff are looking at ways of making the process more transparent and fair, suggesting investors could get better prices without PFOF.
While some brokers who offer free trading do not use PFOF, the SEC’s moves are seen as a response yet to last year’s meme stock frenzy where retail investors ganged up against hedge funds to send shares in GameStop Corp (NYSE:GME), AMC Entertainment and others up hundreds of percent.
In the first quarter of 2022, Robinhood made around three-quarters of its turnover from PFOF, with Bloomberg calculating that in total brokers earned US$3.8bn from PFOF last year and US$2.8bn in 2020.
“Right now, there isn’t a level playing field among different parts of the market: wholesalers, dark pools, and lit exchanges,” Genslersaid at an online event in New York.
“It’s not clear, given the current market segmentation, concentration, and lack of a level playing field, that our current national market system is as fair and competitive as possible for investors.”
One of Gensler’s proposals is to send trade orders to an auction mechanism to help retail traders get better prices for their orders, similar to techniques used in the options market.
Other proposed measures including harmonisation of the size of trade execution across market participants, increasing competition for trade orders, strengthening the national best bid and offer (NBBO), improving disclosure of the quality of order execution, and creating another best execution standard.