Wall Street pushes back as SEC targets business practice that generates billions
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5 min read . Updated: 08 Nov 2021, 07:48 PM IST - Virtu and Robinhood are among firms that say payment for order flow allows for commission-free trading
Wall Street is fighting back as Securities and Exchange Commission Chairman Gary Gensler considers policy changes that threaten to upend a lucrative business model.
Trading firms and brokers have ramped up their lobbying efforts and campaign donations to Republicans seeking to win control of Congress in next year’s midterm elections. They’ve become especially vocal about Mr. Gensler’s scrutiny of payment for order flow, whereby some brokerages sell their clients’ stock and option orders to high-speed trading firms that execute the trades.
At stake, the industry says, is a yearslong trend toward commission-free trading that has encouraged millions of Americans to invest in the stock market. Mr. Gensler says payment for order flow obscures trading costs to investors and has singled out the practice in a broader campaign to make capital markets more efficient, competitive and transparent. He acknowledges the effort could ding profits for the financial industry.
The SEC hasn’t issued a formal proposal to change stock-market rules, but Mr. Gensler has instructed staff to start working on one.
One of the loudest detractors to the potential policy shift has been Doug Cifu, chief executive of Virtu Financial Inc., a high-speed trading firm and market maker. Payment for order flow is central to Virtu’s business, as well as to some brokerages such as Robinhood Markets Inc., which use the revenue to replace once-ubiquitous trading commissions.
Firms like Virtu profit from the difference between the buying and selling prices of the shares being transacted. They say they execute trades at a slightly better price than stock exchanges. This, combined with the move toward zero-commission trading by many retail brokerages, saves investors money, the companies say.
Mr. Cifu took the train last month from New York to Washington for a security traders’ conference. At a downtown hotel, he gave a presentation called “Myth Busting," in which he sought to rebut some of the SEC’s concerns about payment for order flow.
“The narrative was so skewed and so polluted by the politics…that I just felt like there wouldn’t be a fair hearing in the world of public opinion," Mr. Cifu said in an interview. “I felt like they misrepresented—not intentionally—but they misrepresented the facts in the marketplace."
Mr. Cifu has spoken with all five SEC commissioners, including Mr. Gensler, to defend payment for order flow. He also has sought to persuade roughly two dozen lawmakers who oversee the SEC that the practice is good for investors.
The SEC chairman has suggested that when brokerages send investors’ orders to private trading firms rather than exchanges, it undermines the quality of prices displayed to the public and reduces competition. He often notes that the largest firm that pays brokerages for orders, Citadel Securities, has said it executes half of retail trading volume.
“I think companies and investors alike benefit if we can increase competition, lower costs, and bring more transactions out of the dark," Mr. Gensler told the Senate Banking Committee in a September hearing. The SEC declined to comment on Mr. Cifu’s statements.
Mr. Cifu, a longtime Democrat, participated in a fundraiser this year for Senate Majority Leader Chuck Schumer (D., N.Y.). The executive believes he can be a more-effective advocate in a Washington controlled by Democrats than Citadel Securities founder Ken Griffin, even though Virtu is smaller. Mr. Schumer’s office didn’t respond to a request for comment.
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Mr. Griffin, one of the largest donors to Republican campaigns, has kept a comparatively low public profile but he, too, met with Mr. Gensler in June as Citadel Securities was circulating a 20-page lobbying document with recommendations to improve the stock market’s plumbing.
Mr. Griffin has made $3.1 million in campaign donations to conservative groups and Republican candidates ahead of the 2022 midterm elections, according to the Federal Election Commission. At a similar point ahead of the 2018 midterms, Mr. Griffin had donated about $1.7 million.
Retail brokerages that sell their clients’ orders to market makers also have sought to defend the model, which generates billions of dollars in revenue. Robinhood, the upstart brokerage, has spent $2.1 million lobbying the House and Senate so far this year, up from $275,000 in all of 2020, according to congressional lobbying disclosures.
Its chief legal officer, former Republican SEC Commissioner Daniel Gallagher said the SEC’s initiatives amount to the “nanny state" telling customers on Robinhood’s app, “You’re too stupid to be in these markets."
Charles Schwab, one of the largest retail brokers, has been circulating a policy document estimating current stock-market rules allowing brokers to route customers’ orders to high-frequency traders will save individual investors $120 billion over a decade.
“We have to be really careful not to destroy the good in search of the perfect," Charles Schwab CEO Walter Bettinger said at an industry conference on Nov. 2, adding that individual investors have never enjoyed lower costs or better accessibility.
Payment for order flow accounted for 72% of Robinhood’s revenue last year, according to the company. Schwab’s order-flow revenue rose to $621 million in 2020 from $135 million in 2019.
Critics of payment for order flow say the benchmarks that brokers use to estimate savings are flawed because they are measured off public exchange prices. When trading activity is diverted to firms like Citadel Securities and Virtu, there is less activity on exchanges, making prices less accurate, critics say.
“Yes, when a broker uses payment for order flow, you do see price improvement, but you see price improvement off a really lousy price," Rep. Jim Himes (D., Conn.), a former Goldman Sachs banker, said during a hearing last month.
Past efforts by the SEC to change rules for the companies that execute stock trades have sparked bitter legal battles, which the agency has sometimes lost. Mr. Gallagher told Barron’s in September that Robinhood would “seriously consider" suing the SEC to stop it from banning payment for order flow.
Republican lawmakers have been receptive to the industry’s appeals. Sen. Pat Toomey (R., Pa.), the top Republican on the Senate Banking Committee, introduced a bill last month to prohibit the SEC from ending the practice.
“New innovations—such as zero commission trading and user-friendly mobile apps—have allowed more Americans to participate in the stock market than ever before," Mr. Toomey said in a statement. “Such technologies have been made possible in part by payment for order flow."
This story has been published from a wire agency feed without modifications to the text
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