In the aftermath of last year’s meme stock mania, the top US securities regulator has suggested rule changes to overhaul how Wall Street handles stock trades from tiny investors.
To increase competition, the plan, announced on Wednesday by US Securities and Exchange Commission Chair Gary Gensler, would require trading firms to compete directly for the execution of trades from retail investors.
The Wall Street watchdog is to investigate the contentious payment for order flow (PFOF) system, in which wholesale market makers pay some brokers for orders, including as TD Ameritrade, Robinhood Markets, and E*Trade.
PFOF first gained widespread attention during the GameStop stock frenzy last year, when it emerged that commission-free brokers were selling their orders, raising questions about whether small traders were getting the best price.
On Wednesday, I requested staff to take a holistic, crossmarket look at how we may update our rules and achieve improved efficiencies in our equities markets, particularly for retail investors,’ Gensler said to an industry conference.
According to him, the new SEC guidelines will require market makers to publish more information about their costs and trade timing for the benefit of investors.
On the Reddit community WallStreetBets, where the meme stock fever began, reaction to the plan was tepid, with some expressing reservations that the planned adjustment would benefit traders.
Many believed that if the new law is passed, free trading applications like Robinhood, which rely heavily on PFOF, would transition to a commission-based trading model.
‘Investors get free trading because brokers get paid for order flow. There’s a good chance we are going to be back to per trade commissions if this happens,’ commented u/attorneyatslaw.
‘It’s a double edged sword. It would be a more transparent practice, but at a cost that is likely to take the ‘fun’ factor out of what got so many new investors involved recently,’ remarked u/GalaxyFiveOhOh.
Dan Gallagher, Robinhood’s chief legal, compliance and corporate affairs officer, told DailyMail.com in a statement: ‘We look forward to reviewing the Commission’s eventual rule proposal and engaging with the SEC during a meaningful notice and comment rulemaking process.’
‘American retail investors enjoy one of the most efficient, low cost investing environments in history,’ remarked Gallagher.
‘Robinhood’s model of commission-free, no account minimums investing has saved investors billions. And our modern and intuitive mobile-first platform has also helped usher in a new era of retail investor participation, notably by younger and more diverse customers,’ he added.
Gensler’s revelation, which is the most significant change in US equities market laws in over a decade, will almost certainly result in formal recommendations this fall. The public can then comment on them before the SEC votes on whether or not to approve them.
The proposed modifications would substantially disrupt wholesalers’ business models. They may also have an impact on brokers’ ability to offer regular investors commission-free trading.
Last year, PFOF was investigated by the SEC after an army of retail investors went on a purchasing spree of’meme stocks,’ such as GameStop and AMC, pressuring hedge funds that had shorted the shares.
Many investors used commission-free brokers like Robinhood to buy stock.
The new rules would improve order-by-order competition, including the possibility of ‘open and transparent’ auctions, with the goal of giving better prices to investors.
They would include an agency-specific definition of “best execution” for stocks and other securities, ensuring that broker-dealers and investors benefit from more clarity on the procedural norms brokers must follow when managing and executing customer orders.
To benefit investors, they would force broker dealers and market centers to reveal additional data about order execution quality, such as a monthly summary of price improvement and other information, according to Gensler.
The guidelines would also aim to reduce the minimum pricing increment, or tick size, to better correspond with off-exchange activity and harmonize the tick size to guarantee that all trading takes place in the smallest increment possible.
The proposed rule changes will include an SEC definition of ‘best execution’ requirements that would force retail brokers to send their customers’ orders to auctions, run by exchanges or off-exchange trading venues, which would allow market participants to compete to trade against the orders, the sources said.
Customers’ orders can already be transferred to a wholesale broker for execution if the wholesale broker equals or beats the best pricing available on US exchanges.
Large market-makers frequently enhance the best price by a fraction of a penny. According to Gensler, this approach reduces competition for retail orders.
PFOF consumer orders would have to be sent to the wholesaler who gives the best deal, not the one who pays the most.
Wholesalers’ business models would be drastically altered as a result of this, since they would be able to make more money by fulfilling retail investor orders internally rather than interacting with other sophisticated trading firms or major investors on public exchanges.
Customers’ orders can now be transmitted directly to a wholesale broker for execution, as long as the wholesale broker matches or beats the best available pricing on US exchanges.
Large market-makers frequently enhance the best price by a fraction of a penny. According to Gensler, this paradigm restricts retail order competitiveness.
Under the new standards, retail brokers would be obligated to transmit PFOF customer orders to the wholesaler who offers the best bargain, rather than the one who pays the highest price.
This would significantly disrupt wholesalers’ business models, as they can make more money by executing retail customer orders internally rather than on public exchanges, where they might be dealing with other sophisticated trading firms or institutional investors.
Investor advocates want to boost exchanges’ competitiveness to improve the reliability of the national pricing benchmark, known as the National Best Bid and Offer (NBBO).