May 19, 2022


Skillful Business Crafters

‘Extremely difficult’ for SEC to eliminate payment for order flow: Interactive Brokers founder

The U.S. Securities and Exchange Commission (SEC) has said it could eliminate the business model that helps brokerages charge no fees on stock trades, but the founder of one brokerage says he doubts the regulator will do so.

“I think that it would be extremely difficult for the SEC to ban payment for order flow,” Interactive Brokers (IBKR) Chairman and founder Thomas Peterffy told Yahoo Finance Wednesday.

Payment for order flow exploded as an industry practice just prior to the pandemic, when the growth of Robinhood (HOOD) spurred other major brokerages to lower commission fees to zero to draw in users.

In a PFOF model, a brokerage processes an investor’s order for a stock purchase and passes it on to a wholesaler, like Citadel Securities or Virtu Americas. These market makers then execute the transaction, in turn paying brokerage firms for routing the trade through them.

[Read: How do brokerage firms make money?]

When the market maker is able to purchase a stock at a lower price than the customer asked for, the cost savings are split by the brokerage and the market maker. The money pocketed by the brokerages (which it can use to finance its business) is called “payment for order flow.”

SEC Chair Gary Gensler has said he has not ruled out the possibility of a full ban on the model.

Interactive Brokers allows users to choose if they would like to pay to have the brokerage route the orders itself (through IBKR-PRO) or if it would like to get zero commission trades through a market maker that gives Interactive Brokers payment for order flow (through IBKR-LITE).

Peterffy said he is agnostic to what the SEC chooses to do on payment for order flow, but warned that eliminating the model would force market makers to merge with brokerages.

“That looks just like any other bank, and nothing will have changed,” Peterffy said, comparing the prospective consolidation to banks that have both sales and trading departments in-house.

Gamifying trades?

Payment for order flow has become enormously popular — and profitable — amid the retail investor frenzy augmented by the meme stock activity in early 2021. It has also sparked controversy, raising debate within the SEC over whether or not the model encourages brokerages to glorify risky stock betting.

“Payment for order flow and the incentives it creates may cause broker-dealers to find novel ways to increase customer trading,” SEC staff noted in a recent report about the explosion in meme stocks.

Robinhood, which drew scrutiny earlier in the year for dropping digital confetti on its app to celebrate trades, has since backed off of some of those practices amid criticism of the “gamification” of stock trading.

Peterffy said brokerages have always had an incentive to boost volume.

“Brokers for the last 200 years have always tried to get people to trade more, because they used to get commissions,” Peterffy said. “Now they get payment for order flow. It’s basically the same thing.”

Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.

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