Rebate-pricing schemes are the most controversial at the moment, but Tabb cited a number of other distortions and non-transparent payment mechanisms, including exchange pricing tiers; the development of internalization and ATS platforms; payment for order flow relationships between wholesalers and retail brokers; and soft-dollar relationships where commissions are used by the buy side to receive services from brokers, including trading tools, research, and corporate access. "Each of these mechanisms leverages discrete payment channels to influence the routing of order flow."
Robert Battalio, professor of finance at Notre Dame's Mendoza College of Business, who co-authored a research paper, testified that, when given the choice, four of the largest online brokers (TD Ameritrade, E-Trade, Fidelity, and Scottrade) route orders in a way that focuses on liquidity rebates. "With the marketable stuff, they go to the wholesale brokers, and they always go to the high rebate exchange for the non-marketable orders."
Sen. Ron Johnson (R-WI) weighed in with his own trading example of wanting to buy 100 shares of a $20 stock, insisting that a 30-cent rebate on a $2,000 trade was miniscule. Drawing on his own experience, he said that retail brokers are paying lower prices to trade and have instant access. Government intervention, versus having free-market competition drive transparency, could have unintended consequences, he said.
Ultimately, the ethics of brokers seeking rebates became the focus of debate.
"If you look at the payments, there is a known conflict in the market, and we should address it," said Brad Katsuyama, CEO of IEX Trading. "The size of the conflict relative to the notional traded is not a reason to ignore the conflict." Katsuyama, a proponent of market reforms, was featured in the book Flash Boys, which criticized the routing of retail orders to wholesalers.
In terms of assessing whether going for the highest rebate was harmful to investors, he said, the exchange that pays the highest rebate would have the longest queue. "Where is the seller going to go? The seller is going to avoid the highest [take] fee. So getting in the line for the venue that pays the highest rebate exposes you to more competition and also makes you the least likely venue to get filled at, because the seller of the order is not incentivized to go there."
However, routing decisions that capture the highest rebates are not necessarily bad. Katsuyama said that routing decisions are also conditional upon what's happening in a stock. "There are times when you could be getting the highest rebate and also serving your client's interest."
Joseph Brennan, principal and head of the global equity index group at Vanguard Group, said it didn't accept payment for order flow or rebates to avoid conflicts. Vanguard executes $2 billion of trades a day and spends a lot of time monitoring brokers, he said, so removing maker-taker wouldn't make a difference.
When asked what would happen if he had a less conflicted environment, Brennan said it might make the review process of the data less complex.
As for next steps, Katsuyama said a proposed pilot study of eliminating rebates in certain stocks should be given a chance to prove that maker-taker doesn't harm the markets.Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio