Thursday, August 21, 2014

Market Expert Shuns Potential Ban on Payment for Order Flow

[This story previously appeared in Securities Regulation Daily.]

By Amy Leisinger, J.D.

Larry Tabb, founder and CEO of capital markets research and consulting firm TABB Group, has submitted a letter to Sen. Carl Levin (D-Mich.), disagreeing with the senator’s request to SEC Chair Mary Jo White that the Commission consider banning payment for order flow to reduce conflicts of interest. In his letter and an accompanying press release, Tabb suggests that any attempt to proscribe this practice would be a “serious mistake” and that lawmakers and regulators should consider unintended consequences. According to Tabb, enhanced disclosure and reporting obligations concerning payment for order flow would be more appropriate than a total prohibition.

Tabb’s conclusions. In response to Sen. Levin’s concerns that these payments create an incentive for brokers to maximize their own profits at the expense of best execution and that consumers are unaware that “the fractions of a cent received by retail brokers per-share add up to a multi-million-dollar conflict of interest,” Tabb agrees that enhanced disclosure on payment for order flow arrangements, together with more informative reports to the SEC, may be necessary. However, he states, “[w]hile payment for order flow does introduce conflicts, banning the practice will only create more challenges and magnify conflicts of interest,” he explains.

Payment for order flow is a legitimate practice governed by the SEC, and order prices must meet national best bid offer requirements while order executions are required to meet the most advantageous price to the client. Further, according to Tabb, retail flow is valuable, and banning the practice of payment for order flow changes not the value of the flow but only how it can be gathered. When a retail order is routed to an exchange, the order will likely trade at either the best bid or best offer, and the investor will either receive the least and or pay the most, respectively, Tabb explains. “Payment for order flow is the tool that helps wholesalers give a portion of that benefit back to investors and retail brokers,” he reasons. Banning these payments would force brokers to either deal in trades directly (raising costs) or to send a valuable asset in the form of an order flow stream to another who would not pay for it (losing revenue), he opines.

While acknowledging that it is, in fact, in the best interests of the retail brokers to obtain as much as they can from their order flow, Tabb notes that brokers also force wholesalers to actively compete on their price improvement statistics. In addition, he states, payment for order flow allows for reductions in commissions and investments in innovation to better serve customers. The process is not perfect, Tabb concludes, but it is “transparent and aboveboard” and allows most investors to get a better price than that available in the market.

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