Last January’s GameStop saga focused the world of retail trading on issues of market plumbing — the nuts and bolts of how brokers execute orders to buy and sell stocks and derivatives — like few previous episodes.
Eighteen months later, U.S. Securities and Exchange Chairman Gary Gensler is launching an effort to comprehensively overhaul this market structure for the first time in nearly 2 decades, in a Wednesday speech to Piper Sandler’s Global Exchange Conference.
Americans were outraged that stock brokers like Robinhood Markets Inc.
temporarily blocked users from buying shares of GameStop Corp.
and other so-called meme stocks, and many blamed financial arrangements between brokers and market makers like Citadel Securities and Virtu Financial Inc.
as the culprit.
Such market makers now execute more than 90% of retail orders, Gensler said, and they typically pay stock brokers for the privilege of executing these orders, on which they make a small profit on the spread between the price at which they’ll buy and sell a security. Add those small profits up — Citadel Securities reportedly posted a record revenue total of $7 billion last year.
In fact, brokers restricted trading in order to manage risk and obligations to the clearinghouse that guarantees retail traders orders will be executed even if their broker goes bankrupt.
There’s no evidence that payment for order flow was the reason brokers restricted trades, but the episode underscored the appearance of a conflict of interest between retail brokers’ clients and the market makers that are their main source of revenue.
“Payment for order flow can raise real issues around conflicts of interest,” Gensler said. “Certain principal trading firms seeking to attract Robinhood’s order flow [said] that there was a tradeoff between payment for order flow and price improvement for customers.”
To remedy these potential conflicts, Gensler said he has asked staff to recommend rules that could require retail brokers to submit retail orders to an auction process, whereby each market maker would transparently compete for a retail trade based on the best price offered.
“I’ve got a client that’s 330 million Americans, and all the folks on the Reddit posts, those are our clients and they’re not getting the full benefit of full and fair competition when they put a retail market order in right now,” Gensler said during a press conference following the speech, referring to the active community of retail traders on the social-media website.
“American retail investors enjoy one of the most efficient, low cost investing environments in history. Robinhood’s model of commission-free, no account minimums investing has saved investors billions,” Dan Gallagher, chief legal officer at Robinhood said in a statement. “We look forward to reviewing the Commission’s eventual rule proposal and engaging with the SEC during a meaningful notice and comment rulemaking process.”
The regulator also proposed a series of other reforms, including setting a marketwide minimum pricing increment— called tick size—that all market makers and exchanges would adhere to. As it stands now, stock exchanges like the New York Stock Exchange can price stocks to the penny, while market makers can offer prices in much smaller increments, providing them a pricing advantage.
Furthermore, Gensler suggested changing the method by which the National Best Bid and Offer prices — used as a benchmark for brokers who are required to find the best price for their customers — by creating a separate measure for trades of fewer than 100 shares, order sizes typically associated with retail traders.
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