The new head of the SEC, Gary Gensler is calling for a ban on the trading tactic called, "Payment for Order Flow," an innovation which was created by by Bernie Madoff.*
A quick summary of the technique, is that a company transfers the trades to a, "Market Maker," who generates profits from executing their own trades before the orders. (See here)
The advantage, at least for operators like Robin Hood, is that they can claim free trades, when actually the trader is paying more for buying, and getting less for selling securities.
In more enlightened days, the US banned this practice, calling it, "Front Running."
So the SEC is considering banning the practice, which is already banned in Canada and Great Britain, because it's too corrupt for them, and Robin Hood investors are completely losing their sh%$ over this:
A controversial practice that has brought in billions of dollars to brokers and high-frequency trading firms is in the crosshairs of the Securities and Exchange Commission, and could be eliminated entirely.
In an interview with Barron’s on Monday, SEC Chairman Gary Gensler said that a full ban of payment for order flow is “on the table.” Payment for order flow is a practice where brokers send trade orders to market makers that execute those trades in return for a portion of the profits.
Gensler says the practice has “an inherent conflict of interest.” Market makers make a small spread on each trade, but that’s not all they get, he said.
“They get the data, they get the first look, they get to match off buyers and sellers out of that order flow,” he said. “That may not be the most efficient markets for the 2020s.”
………
For most brokers, the practice is a relatively small part of their business model — often less than 10% of revenue. But for Robinhood Markets, which pioneered zero-commission trading, payment for order flow makes up about 80% of its revenue. Shares of Robinhood were already trading lower on the day, but fell further after the Barron’s report. In late afternoon trading on Monday, the stock was down 8%, at $43.03.
Whenever you hear about a financial innovation, hold on to your wallet.
*As Anna Russell would say, "I'm not making this up, you know."
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