Mar. 15, 2023
Dear SEC, I am writing to comment on the Best Execution Proposal and the NMS Proposal, which have been referred to as “The Proposals.” As a concerned household investor, I am concerned with five key principles, including transparency, simplicity and fairness, choice and control, best execution, and better settlement and clearing. In this letter, I will focus on three of these principles - Transparency, Simplicity and Fairness, and Best Execution. Our comment letter is relevant to both proposals because it concerns Payment for Order Flow (Wholesaler PFOF) and exchange rebates (Exchange PFOF), collectively known as PFOF. While PFOF is primarily seen as an off-exchange inducement to route orders to wholesalers, exchange fee structures and rebates play a similar role in order routing decisions. We believe that these inducements should not exist and should be banned. The Commission and FINRA have recognized the problems that these inducements create, but they have not been addressed or solved. The acceptance of Payment for Order Flow (PFOF) by brokers results in inferior price improvement and is incompatible with the duty of best execution. Brokers who do not accept PFOF route orders differently and, as a result, see superior execution quality. The negative impact of this practice on individual investors is clear and tangible. Studies have shown that Robinhood, which relies heavily on PFOF, does not provide statistically significant price improvement relative to exchanges, even though PFOF accounts for around 70% of its revenue. This violates FINRA’s best execution guidance, which states that firms may not negotiate the terms of order routing arrangements in a way that reduces price improvement opportunities for customer orders. Payment for Order Flow (PFOF) is incompatible with the duty of best execution and should be banned. Research shows that brokers who accept Wholesaler PFOF receive less price improvement, while brokers who do not accept any kind of PFOF see superior execution quality. Rebates, which tend to increase transaction costs for demanders of liquidity, are also harmful to market quality and should be banned. The letter argues that the SEC should take a more comprehensive approach to addressing these issues and ban order routing inducements that are not related to execution quality. In the past decade, several studies have been conducted to investigate the negative impacts of Payment for Order Flow (PFOF) on markets. While there is a comprehensive analysis of the problems associated with Wholesaler PFOF, the issue of Exchange PFOF has received less attention. Exchange PFOF harms investors in the same way as Wholesaler PFOF by increasing costs, driving brokers to place non-marketable orders based on rebates rather than execution quality, and subsidizing high-speed trading firms at the expense of other participants. The Commission’s CAT analysis has quantified many criticisms of PFOF, and Public, a retail broker that does not accept Wholesaler PFOF, has argued that the market maker’s discretion in setting prices results in sub-optimal execution quality. These issues highlight the incompatibility of PFOF with the duty of best execution. banning PFOF and exchange rebates will not impact zero-commission trading. Many brokers offer zero-commission trading without accepting PFOF, and zero-commission trading exists in other countries where PFOF is banned. The section notes that the industry conflates zero-commission trading with zero-cost trading, which is misleading since there are material costs to trading in a zero-commission model that are hidden and implicit. If investors must bear costs for trading and investing, explicit costs are preferred over hidden costs. Countries such as the UK, Singapore, and the EU have taken steps to reduce or ban PFOF, citing conflicts of interest and the risk of compromising firms’ compliance with best execution. The passage also notes that other markets, such as Hong Kong, Japan, Australia, and Euronext, do not allow exchange rebates, unlike the US. The US could learn from other markets’ approaches to PFOF. Several publicly traded institutional asset managers have expressed their views on the issue of eliminating PFOF. T Rowe Price welcomed the idea of reducing or eliminating rebates, and Vanguard does not receive or take any form of payment for order flow. Capital Group has been a leader on this issue for years and strongly recommends eliminating rebates. These asset managers recognize the incompatibility of PFOF with their “client first” philosophy and believe that eliminating rebates will improve the overall market for long-term investors. if a ban on PFOF is not implemented, alternatives should be considered to reduce conflicts of interest, such as a universal fee and rebate cap. The letter argues that a rebate cap for wholesaler PFOF should be implemented alongside the access fee cap. The letter also calls for simpler and more transparent fee structures, citing the overwhelming complexity of current fee structures and the importance of promoting a level playing field among market participants. I urge the Commission to extend the principle of eliminating tiered fee structures from the OCR Proposal to the NMS Proposal. various firms are opposing The Proposals offered by The Commission because they threaten their earnings, despite having endorsed similar reforms in the past, including CEOs of Intercontinental Exchange and Citadel Securities, who have previously spoken out against payment for order flow (PFOF). Additionally, Virtu, a founding member of the Healthy Markets Association, has also been supportive of eliminating PFOF. The article notes that brokers and exchanges will likely argue that PFOF adds liquidity to the market and provides investors with the same prices as the best quotes on exchanges. These arguments are flawed and come from Bernie Madoff. it is time to ban payment for order flow (PFOF) as it distorts order routing and violates the principles of best execution. PFOF creates a warped system that benefits high-speed speculators and rent-seekers while preventing investors from interacting directly. The article claims that there are few reasons to preserve the current system and numerous compelling reasons to put an end to this unequal practice, including legal obligations to provide best execution. As a concerned household investor, I urge the SEC to take strong action to address the problems created by PFOF. It is critical to ensure that investors receive fair treatment and that the financial markets operate with integrity and transparency. Thank you for considering my comments. Concerned investor, Matthew Gatt