High-speed trader Virtu Financial Inc.
pushes back critics in Washington who say the stock market is rigged against retail investors.
Virtu’s business of fulfilling the orders of individual investors is being scrutinized by lawmakers and regulators after the surge in stocks of meme stocks like AMC Entertainment Holdings Inc.
and GameStop Corp.
Last week, the new chairman of the Securities and Exchange Commission, Gary Gensler, said he had asked SEC officials to review changes to the rules for handling investor orders. The review will include a practice known as order flow payment, where brokers send many of their clients’ orders to trading companies in exchange for cash. Virtu’s shares were sold heavily after Mr. Gensler’s comments.
Subscribe to Newsletter
WSJ Investment Challenge
A five-part course by WSJ columnists that will introduce you to the basics of investing and will be delivered to your email inbox.
Payment for the flow of orders has existed for decades and was put to the test before. However, it received new attention after the wild volatility of GameStop stocks in January. At a congressional hearing in February, MP Sean Casten (D., Ill.) Described Robinhood Markets Inc.’s practice of sending orders to high-speed traders as a “channel to feed fish to sharks.”
Companies like Robinhood and Virtu say payment for order flow is misunderstood. They say the practice benefits retail investors because it results in better prices than what they would get on public exchanges like the New York Stock Exchange and the Nasdaq Stock Market.
Taken together, this saves investors billions of dollars annually, industry data shows.
Paying for the order flow has also enabled brokers to offer commission-free trading. If the practice were banned, it is unclear whether brokers like Robinhood could still allow investors to trade stocks and options with no commissions.
Douglas Cifu, Virtu’s chief executive, is one of the most vocal defenders of order flow payment. In March, annoyed by CNBC host Andrew Ross Sorkin’s comments on how high-speed traders were benefiting from investor orders, Mr. Cifu tweeted his phone number to Mr. Sorkin saying, “Let me know when you’d like to learn how Markets work. ”Shortly thereafter, the CEO went on the show to discuss payment for the flow of orders with Mr. Sorkin.
After the GameStop trading frenzy, the SEC is expected to take a fresh look at paying for order flow, a decades-old practice that is at the heart of how commission-free trading works. WSJ explains what it is and why critics say it is bad for investors. Image: Jacob Reynolds / WSJ
In an interview, Mr Cifu warned that banning the practice and requiring that orders from individual investors be sent to exchanges would harm retail investors. “Retail investors would have a much, much worse experience,” he told the Wall Street Journal.
Firms like Virtu, known in the trading business as wholesalers, make money with investors by executing their orders throughout the day and collecting a small spread between the buy and sell price of each stock. Under SEC rules, they cannot execute the trades at prices worse than the best available price on the exchanges – a benchmark known as the national best bid or ask price, or NBBO.
Since individuals tend to do small deals, wholesalers can trade against them, knowing they are unlikely to push stock prices up or down, just as institutional investors can move a stock through heavy buying or selling. This enables wholesalers to make more consistent profits when executing orders from retail investors than when trading on exchanges – a benefit brokers are willing to pay for in the form of payments for the order flow.
In the meantime, retail investors can benefit from the arrangement by getting prices better than the NBBO’s, often by a fraction of a penny per share.
The resulting savings for the investor are referred to as “price improvement”. In a report released Thursday, Virtu said standard analytics underestimate the degree to which retail investors benefit from wholesalers executing their orders.
With a broader measure of price improvement than what is commonly used, Virtu said it saved investors just over $ 3 billion on their stock trades in 2020 last year.
SHARE YOUR THOUGHTS
Is the stock market manipulated against small investors? Why or why not? Join the conversation below.
The difference was mainly due to the way Virtu calculated the savings if an investor made a trade on a larger scale than is publicly displayed on the exchanges. For example, suppose that 200 shares of Apple Inc.
are available on exchanges at the national best-offer price, and an investor buys 500 shares of Virtu’s stock at a slightly lower price.
In this scenario, Virtu’s methodology calculates the savings based on how much it would cost to buy all 500 shares based on market prices – not just at the national best offer, a price where only 200 shares are quoted, but at the higher price in which the remaining 300 shares would be filled.
Critics were not convinced of Virtus’ analysis and called it selfish. The payment for the order flow is fundamentally flawed because it represents a conflict of interest for brokers, said Tyler Gellasch, executive director of the Healthy Markets Association, a trading group for institutional investors.
“There is one simple question that every investor must ask himself and that is whether their broker is trying to get the best prices or to maximize their own profits,” said Gellasch.
SEC chairman Gary Gensler recently requested a verification of the payment for the order flow.
The Wall Street Journal
Virtu is the second largest wholesaler in the U.S. stock market by volume, handling between 25% and 30% of retail investor stock order flow, and paying more than $ 300 million for order flow last year, according to Bloomberg Intelligence.
Other large wholesalers are Citadel Securities, which have the largest market share, and Susquehanna International Group LLP. Virtu isn’t breaking out on how much it makes by trading retail investors, but the meme-share frenzy has helped the company’s stock jump 15% since the start of the year.
Mr. Cifu acknowledged that paying for the order flow poses a conflict of interest for brokers, but said the conflict is already being resolved by SEC rules. The regulator requires brokers to publicly disclose their order flow payment methods. Brokers also have a duty to seek the best execution possible for their clients and some have been fined for failing to comply with that obligation when routing orders.
The SEC review will eventually confirm that the retail stock market is performing well, Cifu predicted.
“I’m so confident of the value we, Citadel and Susquehanna, working with these retail brokers, have brought to the ecosystem,” he said, “that any sane person who looks at this and looks at the data will conclude: ‘Man, this is a great trading system. That is the envy of the world. ‘”
More about paying for the order flow
Current WSJ articles on commercial practice, selected by the editorial team
Write to Alexander Osipovich at email@example.com
Copyright © 2020 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8