A Wall Street insider debunks Robinhood’s payment for order flow myths

Payment for order flow and market concentration hurt prices for all investors, says a trading expert who worked at a top hedge fund.

Images of rolls of dollar bills.

A Wall Street expert says retail investors would be better off if trades moved to exchanges.

Photo illustration: Yulia Reznikov/Moment/Getty Images and Protocol

A Wall Street insider has published a report that could upend conventional thinking about payment for order flow, the controversial practice that helped Robinhood grow explosively on its way to an initial public offering.

After tracking the controversy over trading in GameStop this winter, Hitesh Mittal, the founder of BestEx Research, used his expertise from working at one of the world's largest hedge funds and consulting with institutional clients to analyze recent trades. His report, "The Good, the Bad and the Ugly of Payment for Order Flow," undermines claims made by market makers and Robinhood's defenders on Wall Street and Sand Hill Road, and could help critics seeking to build a case for banning the payments market makers send to retail brokers for directing trades to them, as market regulators in the U.K., Australia and Canada already have.

The main argument for payment for order flow, the system that Robinhood, Schwab and others use to subsidize the cost of trading so they can offer zero-commission trades, is that payment for order flow gives retail investors better prices, as market makers compete to do better than the price mandated by SEC rules known as the National Best Bid or Offer or NBBO. Bloomberg Intelligence estimates that investors received $3.7 billion in price improvement last year.

Mittal thinks it's not so simple. He says prices would be better if trades moved to exchanges. He likens the promises of price improvement to "getting a 30% discount on an item after the shopkeeper raises the price by 40%."

The analysis is timely: The SEC under new chair Gary Gensler is bringing greater scrutiny to trading and market structure after Robinhood temporarily froze buying in GameStop amid a social media-fueled run-up in the game retailer's stock. Robinhood's move brought attention to its close relationship with market maker Citadel Securities, which is a dominant player in handling trades from retail brokers. Gensler recently indicated to lawmakers that the agency would look at how to address the "inherent" conflict in payment for order flow and the current market structure.

Mittal, who was global head of trading at quantitative hedge fund AQR Capital before starting his own consultancy, doesn't work on behalf of retail investors; his firm's goal is to minimize execution costs for institutional investors, he said. But payment for order flow ends up affecting his clients as well. The dramatic increase in retail volume prodded him to write about the issues with payment for order flow.

Order, order

Payment for order flow happens when brokers send orders to market makers with the expectation that they can deliver better prices than what's available on the exchanges. Those small price differences get split three ways: The market maker takes some as profit, the broker gets a payment from the market maker, and the retail investor who placed the trade gets a slightly better price, or price improvement.

Defenders of payment for order flow generally make three interrelated claims:

  • It delivers better prices than exchanges, particularly for retail investors.
  • It doesn't benefit market makers beyond the profit they make on a trade.
  • It doesn't lead to market concentration and lessened competition.

Mittal's analysis, which examined aggregate trading data of all trades recorded on the public NYSE Trade and Quote system during December, undermines all three claims.

On pricing, his analysis shows that the top five market makers seem to get 24.5% price improvement for retail investors' trades, compared to the NBBO price on exchanges. That seems good for market makers, brokers and retail investors. But Mittal also found that those trades would get even better prices if the retail trades were all done through exchanges.

Mittal believes that under the current market structure, brokers can't change because those who don't take payment for order flow are at a competitive disadvantage — so only regulation can address the situation.

Mittal's analysis shows that overall spreads on trades would drop if all trades were moved to exchanges, which would mean both retail and institutional investors would get better pricing.

How does he show this?

First, it helps to understand what the NBBO is — and isn't. Despite the name, it doesn't actually capture the market's best pricing. The National Best Bid and Offer, which is the price that the SEC requires brokers to get on certain trades, is only based on trades of 100 shares or more on certain public exchanges. It also doesn't include trades with wholesalers, or on alternative trading systems.

Because of that, the 24.5% price improvement market makers get compared to exchanges is actually more like 15%, Mittal found. That's because certain prices on exchanges are already better than what's captured in the NBBO price.

Certain exchange trades aren't included in NBBO, such as hidden orders and odd lots, both of which get tighter spreads — meaning better prices. Hidden orders — which are limit orders placed with instructions not to publish them — make up 16.7% of daily volume in liquid stocks and 20.8% of illiquid stocks. Odd-lot orders of fewer than 100 shares are "extremely common," particularly for high-priced stocks.

There are also trades available on alternative trading systems that are priced at the NBBO midpoint — which is theoretically the best price available because there is no spread between buy and sell prices. Retail trades sent to market makers don't get these better prices.

Mittal calculates that if all retail trades were moved from market makers to exchanges, spreads between trades would drop by more than 25%.

Making a market

That 25% price improvement of moving trades to exchanges would be even bigger if you accounted for private information that market makers have, Mittal said.

Big market makers with private information have an immense advantage — raising the risks of market concentration, MIttal says. That's because they're seeing more of the trading happening — both retail trades coming direct to them and public trades on exchanges — and know who is behind those trades.

Big market makers on exchanges also know where their own trades are coming from, whereas other market makers don't since trades are anonymous on public exchanges. So market makers have a better "picture of the supply and demand in a stock," Mittal said. They can use information to get the best execution not only for their off-exchange market making, but also they can "price stocks more accurately than other" market makers on exchanges, jumping in when they expect the price to move their way, and backing off when they expect prices to move against them, he said.

Beyond retail order flow, market makers also have private information from electronic liquidity providers that large wholesalers provide to institutional brokers.

Mittal believes the spread improvement could be even higher than that 25% he calculated if there was a "level playing field" of trading on exchanges. "We think the spread improvement would be even bigger," Mittal said. "The reason we think it'd be bigger especially in illiquid stocks is because if wholesalers get 50% of the volume they have a lot of information about that stock that other market makers do not.'

Another example of private information: Brokers send retail limit orders to market makers but market makers don't execute them; they send them to exchanges, he noted. Brokers get exchange rebates on these trades, since exchanges typically provide rebates on limit orders and charge for market orders.

It's a strange practice since market makers do not trade against non-marketable limit orders, since there would be no spread. But market makers benefit from this additional private information. Mittal believes this is done for "optics" reasons, because brokers don't want to answer questions about when and why they send orders to market makers.

It takes concentration

The private information market makers get from order flow doesn't just have short-term benefits. Over time, it can erode the competitiveness of the market, Mittal writes — a dynamic where having more information gives leading market makers an edge, compounding as they take more share.

As the number of market makers decline, spreads increase, which means worse prices for investors. That market concentration effect isn't included in Mittal's calculations.

The five largest wholesalers had retail volume equal to 47% of the volume during regular trading on all 16 exchanges in December — and this doesn't include odd lots, which aren't reported by market makers. Citadel had 50% of the top five's volume and Virtu had 26%.

The concentration is even higher for certain stocks. In the highest traded Russell 2000 stocks, Citadel traded 69% to 188% of the volume of these stocks on exchanges during December.

Big implications

Some industry analysts praised the report.

"The BestEx report advances our understanding of the impacts of captive retail order flows executed by a concentrated group of wholesale market makers in the dark," said Paul Rowady, director of research at Alphacution Research Conservatory.

Mittal says he wants to "represent both sides," despite the implicit critique of the industry. "There is nothing evil about allowing retail market order flow to go to wholesalers," he writes, and he notes that without payment for order flow, a "lack of revenue for retail brokers would likely lead to increased commissions charged to retail investors."

Robinhood is expected to file a prospectus soon for its initial public offering. That S-1 will likely reveal just how dependent the company is on payment for order flow, though other required regulatory disclosures already suggest it's taking in considerable sums and growing quickly.

Brokers aren't really to blame for how they route trades because they face a prisoner's dilemma, Mittal said. If only one broker sent its trades to exchanges, other brokers would still get the benefit of better prices. Because you can't coordinate in a competitive market, the only way for all trades to move to exchanges would be through regulation, he said.

That's the conclusion regulators already reached in other countries, though the U.S. is a larger market. With billions on the line, Mittal's analysis promises to add fuel to an already explosive debate.


A pro-China disinformation campaign is targeting rare earth miners

It’s uncommon for cyber criminals to target private industry. But a new operation has cast doubt on miners looking to gain a foothold in the West in an apparent attempt to protect China’s upper hand in a market that has become increasingly vital.

It is very uncommon for coordinated disinformation operations to target private industry, rather than governments or civil society, a cybersecurity expert says.

Photo: Goh Seng Chong/Bloomberg via Getty Images

Just when we thought the renewable energy supply chains couldn’t get more fraught, a sophisticated disinformation campaign has taken to social media to further complicate things.

Known as Dragonbridge, the campaign has existed for at least three years, but in the last few months it has shifted its focus to target several mining companies “with negative messaging in response to potential or planned rare earths production activities.” It was initially uncovered by cybersecurity firm Mandiant and peddles narratives in the Chinese interest via its network of thousands of fake social media accounts.

Keep Reading Show less
Lisa Martine Jenkins

Lisa Martine Jenkins is a senior reporter at Protocol covering climate. Lisa previously wrote for Morning Consult, Chemical Watch and the Associated Press. Lisa is currently based in Brooklyn, and is originally from the Bay Area. Find her on Twitter ( @l_m_j_) or reach out via email (

Some of the most astounding tech-enabled advances of the next decade, from cutting-edge medical research to urban traffic control and factory floor optimization, will be enabled by a device often smaller than a thumbnail: the memory chip.

While vast amounts of data are created, stored and processed every moment — by some estimates, 2.5 quintillion bytes daily — the insights in that code are unlocked by the memory chips that hold it and transfer it. “Memory will propel the next 10 years into the most transformative years in human history,” said Sanjay Mehrotra, president and CEO of Micron Technology.

Keep Reading Show less
James Daly
James Daly has a deep knowledge of creating brand voice identity, including understanding various audiences and targeting messaging accordingly. He enjoys commissioning, editing, writing, and business development, particularly in launching new ventures and building passionate audiences. Daly has led teams large and small to multiple awards and quantifiable success through a strategy built on teamwork, passion, fact-checking, intelligence, analytics, and audience growth while meeting budget goals and production deadlines in fast-paced environments. Daly is the Editorial Director of 2030 Media and a contributor at Wired.

Ripple’s CEO threatens to leave the US if it loses SEC case

CEO Brad Garlinghouse said a few countries have reached out to Ripple about relocating.

"There's no doubt that if the SEC doesn't win their case against us that that is good for crypto in the United States,” Brad Garlinghouse told Protocol.

Photo: Stephen McCarthy/Sportsfile for Collision via Getty Images

Ripple CEO Brad Garlinghouse said the crypto company will move to another country if it loses in its legal battle with the SEC.

Garlinghouse said he’s confident that Ripple will prevail against the federal regulator, which accused the company of failing to register roughly $1.4 billion in XRP tokens as securities.

Keep Reading Show less
Benjamin Pimentel

Benjamin Pimentel ( @benpimentel) covers crypto and fintech from San Francisco. He has reported on many of the biggest tech stories over the past 20 years for the San Francisco Chronicle, Dow Jones MarketWatch and Business Insider, from the dot-com crash, the rise of cloud computing, social networking and AI to the impact of the Great Recession and the COVID crisis on Silicon Valley and beyond. He can be reached at or via Google Voice at (925) 307-9342.


The Supreme Court’s EPA ruling is bad news for tech regulation, too

The justices just gave themselves a lot of discretion to smack down agency rules.

The ruling could also endanger work on competition issues by the FTC and net neutrality by the FCC.

Photo: Geoff Livingston/Getty Images

The Supreme Court’s decision last week gutting the Environmental Protection Agency’s ability to regulate greenhouse gas emissions didn’t just signal the conservative justices’ dislike of the Clean Air Act at a moment of climate crisis. It also served as a warning for anyone that would like to see more regulation of Big Tech.

At the heart of Chief Justice John Roberts’ decision in West Virginia v. EPA was a codification of the “major questions doctrine,” which, he wrote, requires “clear congressional authorization” when agencies want to regulate on areas of great “economic and political significance.”

Keep Reading Show less
Ben Brody

Ben Brody (@ BenBrodyDC) is a senior reporter at Protocol focusing on how Congress, courts and agencies affect the online world we live in. He formerly covered tech policy and lobbying (including antitrust, Section 230 and privacy) at Bloomberg News, where he previously reported on the influence industry, government ethics and the 2016 presidential election. Before that, Ben covered business news at CNNMoney and AdAge, and all manner of stories in and around New York. He still loves appearing on the New York news radio he grew up with.


Microsoft and Google are still using emotion AI, but with limits

Microsoft said accessibility goals overrode problems with emotion recognition and Google offers off-the-shelf emotion recognition technology amid growing concern over the controversial AI.

Emotion recognition is a well-established field of computer vision research; however, AI-based technologies used in an attempt to assess people’s emotional states have moved beyond the research phase.

Photo: Microsoft

Microsoft said last month it would no longer provide general use of an AI-based cloud software feature used to infer people’s emotions. However, despite its own admission that emotion recognition technology creates “risks,” it turns out the company will retain its emotion recognition capability in an app used by people with vision loss.

In fact, amid growing concerns over development and use of controversial emotion recognition in everyday software, both Microsoft and Google continue to incorporate the AI-based features in their products.

“The Seeing AI person channel enables you to recognize people and to get a description of them, including an estimate of their age and also their emotion,” said Saqib Shaikh, a software engineering manager and project lead for Seeing AI at Microsoft who helped build the app, in a tutorial about the product in a 2017 Microsoft video.

Keep Reading Show less
Kate Kaye

Kate Kaye is an award-winning multimedia reporter digging deep and telling print, digital and audio stories. She covers AI and data for Protocol. Her reporting on AI and tech ethics issues has been published in OneZero, Fast Company, MIT Technology Review, CityLab, Ad Age and Digiday and heard on NPR. Kate is the creator of and is the author of "Campaign '08: A Turning Point for Digital Media," a book about how the 2008 presidential campaigns used digital media and data.

Latest Stories