The House Financial Services Committee’s second hearing on GameStop’s hype in January again focused on the practice that led to commission-free trading apps and boomed individual investor trading.
In a practice known as payment-for-order flow, large commercial businesses like Citadel Securities and Virtu Financial pay retail brokerage firms like Robinhood to execute orders. The rise in retail has made companies that have long acted relatively anonymous, central to the American stock market.
The deal can be lucrative: businesses are essentially making small profits, measured in penny increments on such deals, but the huge user base of commission-free brokerage firms means those tiny profits can add up quickly.
Citadel Securities, a large wholesale brokerage firm that trades a range of stocks including bonds, stocks, and derivatives, claims it does 47 percent of all retail trades in US-listed stocks.
However, the flow of payments for orders is “a flawed and conflicted practice,” said Sal Arnuk, co-founder of a smaller company that trades stocks for institutional investors such as pension funds.
Other witnesses called to testify at the hearing agreed that the practice should be revised. The system “pulls trading away from transparent exchanges and poses significant risks to the markets,” said Dennis Kelleher, president of Better Markets, an advocacy group that drives reforms to the financial system.
However, Michael Piwowar, former commissioner for the Securities and Exchange Commission and now executive director of the Milken Institute Center for Financial Markets, said the elimination of the flow of payments on orders would change the circumstances that led to a boom in retail.
“We will return to commission-based trading,” said Piwowar, should the practice of payment transactions be banned for the flow of orders.