FOR IMMEDIATE RELEASE: May 10, 2012
SCHUMER TO SEC: REFORM ‘MAKER - TAKER’ SYSTEM BY REQUIRING BROKER REBATES TO GO TO INVESTORS
New Study Reveals That Brokers Often Execute Trades On Venues That Offer the Largest Rebate, Not Best Price for Investor— Arrangement Costs Investors Up to $5 Billion Annually
Schumer Calls for SEC To Require Rebates To Go Straight to Investors & Be Fully Disclosed – Reforms Would Save Investors Billions & Eliminate This Major Conflict of Interest
Senator Considering Legislation If SEC Does Not Act
WASHINGTON, DC—U.S. Senator Charles E. Schumer (D-NY) called on the head of Securities and Exchange Commission (SEC) to swiftly address a major conflict of interest in securities trading that a new study reveals may be costing investors up to $5 billion per year. The study, released this week, reveals that the so-called “maker-taker” pricing system is causing brokers to make routing decisions that are often not in the investors’ best interest.
In response, Senator Schumer called on the SEC to require that rebates and other incentive payments—paid to brokers by exchanges and other trading venues in order to entice brokers to rout transactions to their market—be passed on to investors and fully disclosed. Schumer added that if the SEC fails to act, he would consider introducing legislation to mandate that all such rebates and incentive payments be passed on to customers.
“In the years following the financial crisis of 2008 and the Flash Crash of 2010, investors are already questioning the integrity of our markets. It’s more important than ever to ensure that brokers put their clients first, and not pocket hidden rebates at the expense of their customers,” Schumer wrote in a letter Thursday to SEC Chairman Mary Schapiro. “There should be no incentive for traders to profit at the expense of their investors, and I urge the SEC to require brokers to pass on any payments they receive from trading venues to their customers, and to fully disclose any potential conflicts they may face in routing customer trades.”
Schumer’s concerns come in light of a study by Woodbine Associates that examines the now widespread use of “maker-taker” and “payment for order flow” pricing. These models involve exchanges and other trading venues offering brokers incentives for routing trades to their venue. In a Concept Release on Equity Market Structure, issued over two years ago, the SEC asked for public comment on whether investors receive adequate and useful information about routing practices and execution quality. However, the SEC has not taken any action to address potential conflicts of interest in routing practices.
The Woodbine study shows that these pricing models not only create conflicts of interest, as brokers may be incentivized to execute trades on a particular venue even if that venue is not offering the best price, but that customers have lost up to $5 billion as a result of “sub-optimal order routing decisions.” Brokers are required to ensure that clients receive “best execution” on their trades, but there is flexibility in how that mandate is interpreted. This may allow brokers to put their own interests ahead of their clients’ by maximizing the rebates they receive from exchanges. Schumer is calling on the SEC to eliminate even the potential for a conflict of interest by requiring that all such compensation from trading venues be made fully transparent and be passed on to the investor.
Schumer also questioned whether other economic interests may create similar conflicts of interest. He called on the Commission to adopt robust and comprehensive disclosure standards to ensure complete transparency for investors with respect to the execution quality of their trades.
A copy of Senator Schumer’s letter appears below.
May 10, 2012
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549
I am writing in response to a new study indicating that brokerage customers are potentially paying billions of dollars per year in hidden costs due to conflicts of interest faced by their brokers. The study concludes that customers often do not receive the best available price on their trades, because brokers rout transactions to venues that provide the largest rebates or other incentives, not necessarily the best price. In the aftermath of the 2008 financial crisis and the 2010 Flash Crash, investors already question the integrity of our markets. It’s more important than ever to ensure that brokers put their clients first, and not pocket hidden rebates at the expense of their customers.
The study, by Woodbine Associates, examines the now-widespread practice of exchanges, electronic communications networks (ECNs) and other trading venues offering brokers rebates and other incentives for executing trades on their venues – the so-called “maker-taker” and “payment for order flow” pricing models being two prominent examples. These models create a conflict of interest, as brokers may be incentivized to execute trades on a particular venue even if that venue is not offering the best price. Brokers are, of course, required to ensure clients receive “best execution”, but there is flexibility in how that mandate is interpreted, leaving room for brokers to arguably put their own interests ahead of their clients by maximizing the rebates they receive from exchanges.
In its Concept Release on Equity Market Structure, the Commission requested public comment on several questions relating to order routing practices and exchange fee structures. However, the Commission has not taken any action to improve order routing practices or ensure that investors are protected from potential conflicts of interest created by exchange fee structures. The study finds that customers have lost up to $5 billion as a result of “sub-optimal order routing decisions”, showing that the time for such action is now.
I respectfully urge the Commission to act as promptly as possible to ensure complete disclosure of all such payments and require brokers to pass these payments on to their customers, thus eliminating the potential for conflicts of interest. Some disclosure is currently required, but it is not sufficient to ensure that customers are fully-informed about the payments received, and routing decisions made, by their brokers. If the Commission does not act, I will consider introducing legislation to address this problem.
In addition, the Commission should look closely at brokers’ routing practices and economic interests that may create conflicts of interest for brokers executing their customers’ trades. The Commission should adopt robust disclosure standards to ensure that customers receive complete transparency with respect to the execution of their orders, and full disclosure of any potential conflicts of interest.
Thank you for your attention to this important matter. I look forward to working with you to ensure investors are protected and their trust in our markets is rewarded.
Charles E. Schumer