NEW YORK & LONDON--(BUSINESS WIRE)--Market structure expert Larry Tabb, founder and CEO of capital markets research and consulting firm TABB Group, has written to US Senator Carl Levin, chairman of the Permanent Subcommittee on Investigations, disagreeing with conclusions Levin shared in his July 15th letter to SEC Chair Mary Jo White, asking that she ban payment 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. Furthermore, the limited disclosures currently required are not filed with the SEC and often disappear from broker web sites at the end of each quarter.”
In his August 11th-letter, Tabb explains banning this practice would be a serious mistake, that “we need more disclosure on payments for order flow arrangements; reports should be filed with the SEC; better archival mechanisms are needed; and current reporting requirements are not as informative as needed. However, I would pause between requiring more transparency and the attempt to ban the practice. While payment for order flow does introduce conflicts, banning the practice will only create more challenges and magnify conflicts of interest.”
He goes on to give three reasons why retail investors’ orders are valuable, that paring size, spreads and the herding nature of institutions, create an environment in which interacting with smaller retail investors is safer for a market maker than providing institutional liquidity.
Referring the senator to “US Equity Market Structure: Q1-2014 Market Metrics,” a July 2014 TABB report that aggregates and publishes price improvement statistics, he says while it’s in the best interest of retail brokers to obtain as much payment for their order flow, they also force wholesalers to actively compete on their price improvement statistics, adding that although this is not a perfect process, “it’s transparent, aboveboard and many retail investors receive a better price than offered in the market.”
Given the SEC’s desire to ensure retail investors obtain price improvement, TABB concludes, payment for order flow allows brokers to reduce retail commissions, invest in better client-facing technology and provide a better customer-facing environment. The process is transparent and regulated (although more rigorous reporting would absolutely be welcomed). It allows wholesalers to not only compete over who pays the broker the most, but to compete over the benefits provided to retail clients. While not perfect, it works without drastically layering on a new set of costs, conflicts, management challenges and potential under-the-table incentives. “Payment for order flow also provides retail brokers with investment capital to spawn innovation; it creates a market where wholesalers actively compete to provide top-tier execution; it levels the execution framework for individuals, given their inability to invest in professional trading technology; and most important, it provides a better execution experience for clients.”
A copy of Tabb’s letter, available on TabbFORUM, the global capital markets community for current issues, was sent to SEC Chair White.
About TABB Group
Based in New York and London, TABB Group is the research and consulting firm focused exclusively on capital markets, based on the interview-based, “first-person knowledge” research methodology developed by Larry Tabb.
