Securities Fraud Lawyers Blog
In light of the recent market volatility brought on by social media and the meme stock frenzy, the Securities and Exchange Commission (SEC) is beginning to investigate whether rule changes are in order for the market structures which foster these situations. During a speech on June 9th, 2021, newly appointed SEC chairman Gary Gensler spoke of the SEC’s role in protecting individual investors who trade securities via brokerages like Robinhood, which utilize high-speed trading platforms called wholesalers to execute these trades.
In the wake of chairman Gensler’s remarks, shares of Virtu Financial, Inc., the second largest wholesaler by volume in the United States, fell 7.7% on the heels of a surge in share price during the meme stock craze of 2021. [1]
One system which the SEC has pointed to as in need of review is that of payment for order flow. Payment for order flow has ushered in market volatility in meme stocks like GameStop and AMC, because this system powers a good deal of app-based securities trading. It allows individual investors to trade at the current market price without paying commission on their orders. A familiar example exists within the app-based platform, Robinhood.
When a Robinhood user makes a trade in the app, Robinhood may send the order to a wholesaler like Virtu or Citadel to fill rather than routing the order through a public exchange. The wholesaler then fills these investor orders, and ultimately profits because of the small size of individual investor orders and their lower relative power to move the market. This results in more consistent profits for the wholesaler than they could garner when dealing with a higher-powered institutional investor.
Proponents of payment for order flow tout data which has shown that this form of securities trading saves individual investors significant amounts of money over time by securing the investor a price that is better than the national best bid and offer (NBBO), and by removing some traditional barriers to investment, such as commissions. [2]
However, the SEC is questioning whether the practice raises transparency concerns and potential conflicts of interest. Because wholesalers commonly execute trades outside of public exchanges, they are not required to disclose their pre-trade prices. While wholesalers are required to execute trades at no worse than the NBBO set by public exchanges, SEC chairman Gensler has expressed doubt about the validity of NBBO as a benchmark for wholesalers, since such a substantial amount of trading occurs outside of these public exchanges.
Furthermore, experts in the field question the true intentions of wholesalers like Virtu and urge investors to consider whether these firms are acting in the interest of investors, or whether they are acting in the interest of increasing their own profits. Others contend that the system, which has recently attracted swaths of younger investors, encourages too much speculation amongst individual investors.
While payment for order flow is a longstanding practice in the United States, it is not even permitted in several other countries worldwide, including the United Kingdom and Australia. Chairman Gensler’s remarks have signaled his eagerness to move swiftly in re-evaluating not only how NBBO is calculated, but also the very rules behind individual investing via payment for order flow.
Proponents of the payment for order flow, including Virtu’s CEO, Douglas Cifu, are vocal in their belief that payment for order flow provides far greater value to individual investors than it does harm. However, the SEC’s review will help provide concrete direction and protection to smaller investors whose financial interests may be better served with improved regulation.
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