Bulletins

Gensler has payment for order flow in his sights

The SEC chair is proposing major changes to the U.S. equities markets, which could potentially mean big changes to the business models of major Wall Street firms and online brokers like Robinhood.

Gary Gensler speaking during a House Subcommittee hearing

Gary Gensler, chairman of the U.S. Securities and Exchange Commission, wants to make big changes to U.S. markets.

Photo: Al Drago/Bloomberg via Getty Images

On Wednesday, SEC Chair Gary Gensler suggested the need for auctions to ensure the best prices for stock trading, in what would be a major change to the way U.S. equities markets operate.


The idea, along with several other big changes that the SEC is considering, could mean retail equities orders executing in auctions instead of directly with wholesalers that currently control the vast majority of retail order execution.

"I've asked staff to make recommendations for the Commission's consideration around: How do we enhance order by order competition? Now this may be through open and transparent auctions, or other means," Gensler said. "It may be segment investors get the midpoint or better, and then there might be this auction mechanism."

Gensler said the market needs greater "order by order competition" — better prices for each individual trade. This auction system could address that. He noted that U.S. options markets have an auction system and that could be used to help guide changes.

Currently, retail orders are executed mainly by wholesalers, while stock exchanges such as the NYSE or Nasdaq handle large institutional orders. Analysts have argued that this segmentation results in worse prices for both retail and institutional trading.

"The vast majority of retail marketable orders are flowing to wholesalers — 90% plus to a small handful of wholesalers that pay for order flow," Gensler said. "And what's more, this segmentation means that institutional investors, such as pension funds and others, don't get to interact directly with that order flow. This segmentation, which isolates retail market orders, may not benefit the retail public as much as orders being exposed to order by order competition."

Meanwhile, information about what trades are getting better prices is not always clear. Gensler suggested that more disclosure is needed — particularly from brokers, who currently do not need to disclose as much information about pricing quality as wholesalers and exchanges in so-called Rule 605 forms.

Gensler, in a speech at a Piper Sandler conference, also discussed several other areas that he is interested in changing in financial markets. In particular, he reiterated his view that payment for order flow is a conflict of interest, and said he has asked his staff for a proposal to address this.

"Payment for order flow can distort routing decisions — certain principal trading firms seeking to attract Robinhood's order flow told them that there was a trade-off between payment order flow and price improvement for customers," Gensler said.

He also noted that not all brokers pay for order flow and that some with zero commission do not — perhaps seeking to address criticisms that banning PFOF would result in the end of zero-commission trading.

Gensler also suggested potential changes to rules limiting tick sizes to a penny, which are in effect with stock exchanges and disadvantages them compared to wholesalers, which can offer sub-penny pricing. He also suggested potential changes to the National Best Bid and Offer, a system that firms use to measure their pricing for customers. Odd lots of less than 100 shares are not included in the NBBO, he noted, but now make up 55% of trading as of March 2022 — compared to 15% in 2014. That's the result of more retail trading and larger stock share prices.

Robinhood Chief Legal Officer Dan Gallagher criticized the SEC's potential changes before Gensler spoke Wednesday, an indicator of much more debate to come on these issues.

The SEC could begin proposing these various rules this fall, according to the Wall Street Journal, and public comment would follow.

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