In theory, the practice could help investors, assuming payments are passed along to them. However, the SEC found scant evidence that this is happening in the options market.
Going with the Flow
Rather, payment for order flow has had an impact on where an order was routed, according to the study. But the SEC found little impact on the difference between prices to buy and sell options, and little change in effective spreads – where the trades actually occur. However, they noted it may be a bit early to try and discern patterns.
Firms are obligated to seek the best possible executions for their customers’ orders, irrespective of payment for order flow or other order routing inducements.
Payment for order flow refers to the practice of paying brokers to route customer orders to a particular market or specialist for execution.
Most Pay To “Play”
The study found that the vast majority (80%) of the 24 brokers included in the study currently accept payment for passing along customer orders. Only four of the firms refuse to accept such payments.
In the absence of paying for order flow, brokers generally route orders to the exchange that has the largest market share in a particular option.
While paying for order flow isn’t illegal, the SEC has expressed concerns about the potential for conflicts of interest between those of the broker and their customer.
One firm cited by the SEC had taken in more than $6 million for order flow, while another six had collected more than $2 million. In total, the survey found that over a ten-month period, specialists paid more than $33 million to attract broker business.
The report noted that in March 2000 specialists paid brokers for 14% of the retail options orders sent to them, but by August brokers were being paid for over three-fourths of the options orders sent through them. From November 1999 through last September, the study found that some $33 million was paid to brokers as an inducement.