John McCrank

NEW YORK, (Reuters) – The U.S. Securities and Exchange Commission’s head said Wednesday that the commission may offer the broadest reforms in the equities markets since nearly twenty years. These rules will curb a practice known as payment for order flow (PFOF), currently banned in Canada, Australia, and the UK.

What is PFOF?

Wholesale brokers receive most orders from retail brokerages rather than exchanges. This is because orders are usually executed at slightly higher prices than what’s available on the exchanges. Wholesalers are often willing to give rebates or pay customers in exchange for their orders.

Gensler stated that PFOF could be avoided by investors if there were more retail order execution competition. For retail investors, Gensler suggests sending auction orders.

WHAT IS THE COMMON TYPE OF PFOF

As retail trading volumes have increased, many US brokers are now able to disclose the practice in their quarterly regulatory filings.

Retail brokerages include Charles Schwab Corp. Robinhood Markets Inc (NASDAQ:) will accept PFOF from Fidelity, Public.com and others.

Robinhood derived approximately three quarters of its revenues from PFOF in the first quarter. The practice, it claims, allows Robinhood to provide commission-free trading.

Gensler indicated that even though PFOF is not accepted by many businesses, they still provide commission-free trading. Gensler also recommended lowering the disclosure time increments.

WHAT IS THE IMPACT OF IT?

SEC investigating whether PFOF encourages brokers to place customer orders at places that will maximize their revenues rather than those that provide the highest execution.

Gensler expressed concern that brokerages offering commission-free trading might encourage traders to trade more, even though it may be against the best interests of investors.

Is the REGULATORY SCRUTINY OF PFOF NEW

No. PFOF is a practice that has existed for many decades. The SEC has always focused on the disclosure of this activity. Increased scrutiny of PFOF is due to the recent growth of the practice, with commission-free models becoming the norm along with increased off-exchange trading.

IS COMMISSION FREE TRADING A BENEFIT TO ALL?

Robinhood was penalized $65,000,000 by the SEC for failing to inform its customers of PFOF received. Customers were then forced to pay more to trade.

Robinhood was told by regulators that certain wholesalers had informed Robinhood of a compromise between price improvement and PFOF. Robinhood then “explicitly” offered lower price improvements for customers in return for higher PFOF.

SEC stated that Robinhood’s customer costs “may have exceeded any savings they may have realized from zero commission trading.” Robinhood settled the case without admitting to or denial.