The Securities and Exchange Commission is aiming to shake up the mechanics of US stock trading in the wake of last year’s meme-stock frenzy, and some experts in the markets say changes could lead to a shift back to retail investors paying commissions to make trades.
SEC Chairman Gary Gensler in a speech this week outlined six areas of market structure where rules could be updated to foster greater efficiencies, particularly for retail investors. Gensler is proposing the agency consider sending retail stock orders to auctions under which trading firms would compete to execute the transactions to ensure investors receive the best prices.
Such a move could alter the payment for order flow system, or PFOF, under which brokerage firms including Robinhood, TDAmeritrade, and E-Trade are compensated for sending customers’ orders to market makers rather than sending them directly to an exchange. Among the biggest market makers are Citadel Securities and Virtu Financial. PFOF supports zero-commission trading at online brokers that serve amateur investors.
A significant PFOF change “may reset the entire playing field and cost individual investors more money because we’ll have to go back to some sort of commission model,” Sean Bonner, CEO of Guild Financial, a self-direct investment app that focuses on active and retired members of the military, told Insider. Guild, an early-stage business, doesn’t use the payment for order flow system.
“I can guarantee you that commission model will be much higher than the rebates paying the payment for order flow — much higher, by a factor of 10s to 100s,” said Bonner, who has more than 20 years of experience on Wall Street from floor trading to working as a mutual fund manager. “Retail investors are saving billions of dollars a year on the current payment for order flow model.”
Major wholesalers such as Citadel, Virtu, G1X and Two Sigma provided $6.1 billion in price improvements in 2020 and 2021 combined, said BrokerChooser, based on its analysis. Zero-commission trading in recent years has fueled a boom in activity among individual investors who no longer had to pay their brokers as much as $6.95 for each trade.
Proposed changes to shake up rules in the US stock market was met with criticism from Robinhood’s chief legal officer Dan Gallagher this week. “It is a really good climate for retail, so to go in and muck with it right now, to me, is a little worrisome,” Gallagher said at a conference in New York, according to The Wall Street Journal. Retail traders are benefitting from zero-commission transactions and fast execution of trades, he said.
Following last year’s meme-stock frenzy, Gensler last year asked the SEC to review rules related to equity-market structure, including payment for order flow. PFOF is banned in some countries. Gensler isn’t proposing a ban but such a move would make it “almost inevitable” that retail investors return to a commission-based system, Kerim Derhalli, founder and CEO of investment app Invstr, told Insider.
“I don’t think anyone is going to be willing to provide brokerage services on their own without having some form of revenue associated with it,” he said. The Invstr app has 3 million users worldwide and the company doesn’t use the PFOF system. “If we return to a commission structure then you could argue that might discourage people from trading as frequently as they have been trading. You could, on the other hand, argue that if people start trading less, and investing more, they’ll be better off,” over the long term, he said.
“What would seem to be a simple solution would be [for Gensler] to say, ‘We’re going to make PFOF illegal and … retail trading needs to go through the exchange where it’s transparent and the prices are transparent and people can have confidence in the system,” said Derhalli. Bonner at Guild said overall he sees a ban on PFOF hurting retailer traders. “To be honest, a lot of brokers would hope that they get rid of this payment for order flow model and get back to charging for commissions because there’s a lot more revenue for the brokers in that.”
Gary Gensler is trying to level the playing field for small investors. He’s expected to outline a proposal for new rules to help them – possibly in a speech later today. The idea is to make sure those investors get the best deal when buying or selling stocks. When you make a trade, you may go through a broker. Some are paid to send their orders to wholesalers – who may not give you the best price.
Dennis Kelleher of the investor advocacy group Better Markets said the SEC is thinking about creating auctions. “Which should drive down the cost for retail investors and therefore give them the best price available,” he said. But the plumbing of trading is complicated. And if you divert the flow of buy and sell orders, some small investors could get hurt. Jaret Seiberg with the investment bank Cowen said those deals between brokers and wholesalers paved the way for free trading.
“If you start dismantling the system it’s not clear that you’re going to be able to still provide free access to trading,” he said. Investors advocates said at least with a commission you know what you’re paying upfront. There’s plenty of time for this debate. Any new rules would have to go through a long, public process.
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