Senator Carl Levin (D-MI) urged the SEC to immediately initiate action to eliminate maker-taker and payment for order flow because of rampant conflicts of interest inherent in both of these constructs. In a letter to SEC Chair Mary Jo White, Senator Levin emphasized that these conflicts of interest erode public confidence in the financial markets and have the potential to harm investors.
Under the maker-taker system, exchanges and other trading venues pay rebates to brokers for certain types of orders and charge fees for other types of orders. The system creates a conflict of interest for stock brokers who have a legal duty to seek best execution of customer orders. Maker-taker creates an incentive for brokers to route customer orders to venues that offer brokers the highest rebate, noted Senator Levin, or conversely, away from venues that charge brokers the highest fee, even when those venues may not offer best execution. He noted that academic and market research into order routing decisions suggests that the conflict is resulting in real harm to investors.
For example, a recent study by Professor Robert Battalio at the University of Notre Dame's Mendoza College of Business found that the order routing practices of four prominent retail brokers appeared consistent with the objective of harvesting rebates and does not appear to be consistent with the brokers' legal obligation of obtaining best execution. Professor Battalio recently testified before Senator Levin’s Investigations Subcommittee that a routing strategy designed to maximize rebate income can result in customer orders being routed to an exchange where they are as much as 25 percent less likely to be executed.
Best execution for customers should always drive broker routing decisions, emphasized the Senator, who added that does not appear to be the case in practice. In his view, eliminating maker-taker pricing would improve confidence in U.S. equity markets and reassure investors that they can rely on their brokers to provide best execution of their trades, without having to question whether a broker might instead be seeking to maximize its own profits at the customer's expense.
A similar conflict exists in the practice of wholesale brokers paying retail brokers for order flow. Such payments create another incentive for brokers to maximize their own profits at the expense of best execution of customer orders In addition, while retail brokers must disclose the amount they receive per-share from wholesale brokers for order flow, the aggregate totals of such payments are typically not disclosed. As a result, in most cases, 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. Moreover, the limited disclosures currently required arc not filed with the SEC and often disappear from broker web sites at the end of each quarter.
Chair Levin observed that the U.K. Financial Services Authority (FSA) recently raised concerns about payments for order flow, noting that the practice creates a clear conflict of interest between the clients of the firm and the firm itself. Among other things, the FSA questioned why, if a wholesaler broker offers the best possible execution for a customer order, there should be a need for payments to retail brokers, stating that it is difficult to see how a firm could provide any justification that payment for order flow benefits the client directly. He added that the argument that the client obtains a benefit because the firm obtains a benefit is tenuous at best.