Stock exchange pricing model comes under fire at Senate hearing
WASHINGTON (Reuters) - The pricing model used by U.S. stock exchanges to attract liquidity came under fire on Tuesday, as a top Wall Street executive called for ending the practice and two U.S. senators raised concerns about the potential conflicts it creates.
In a Senate hearing, an official from Intercontinental Exchange's (ICE.N) New York Stock Exchange expressed support for ending the "maker-taker" model used to reward brokers who make offers to buy or sell stocks on exchanges.
"We are seeking support for the elimination of maker-taker pricing," said NYSE President Thomas Farley. "Broad adoption of this policy would reduce the conflicts inherent in such pricing schema."
A top official at Vanguard also called for revisiting the practice, saying it has become too conflict-ridden.
Tuesday's hearing before the Senate Permanent Subcommittee on Investigations comes shortly after author Michael Lewis released a book that raised questions about payment for order flow and accused high-speed traders of rigging markets.
Earlier this month, Securities and Exchange Commission Chair Mary Jo White announced a series of proposed reforms to address high-speed trading, trading in anonymous "dark pool" venues and potential conflicts that may influence how brokerages route customer orders.
White also asked exchanges to review order types, an issue Farley said his exchange will address in part through a six-month moratorium on permitting any "new or novel" order types.
But while White outlined a proposal to enhance disclosures surrounding how brokerages route institutional orders, she did not explicitly propose maker-taker reforms.
STUDY RAISES QUESTIONS
In the maker-taker model, brokerages earn rebates by sending in resting orders to bring more liquidity, but must pay fees if they take away liquidity through orders that can be executed immediately.
In addition, large market makers like KCG Holdings (KCG.N), Citadel LLC, Citigroup (C.N) and UBS AG UBSN.VX, typically pay cash fees in the neighborhood of 30 cents per hundred shares for orders.
The maker-taker model came under scrutiny last year after researchers from the University of Notre Dame and Indiana University released a study suggesting that payment-for-order-flow practices may create conflicts and prevent customers from receiving the best price in the shortest possible time frame.
The study looked at four discount brokerages that accept payments for order flow: TD Ameritrade (AMTD.N), E*Trade, Scottrade [SCTRD.UL] and Fidelity Investments.
It found the firms tend to route "limit orders" to the exchanges that pay the highest rebate fees - a conflict that may prevent orders from being filled and violate best execution rules.
The Senate panel's chairman, Democrat Carl Levin of Michigan, and its ranking member, Republican John McCain of Arizona, both said they were troubled by the findings, and McCain called for more transparency on the payments to brokers.
McCain also called for changes to rules which he claimed force firms to take the "bait" of high-speed traders who dangle great prices in front of investors, and then rush ahead to buy it first and sell it higher.
On Wednesday, a U.S. Senate Banking Committee panel will also be holding a hearing on high-frequency trading. Virginia Democrat Mark Warner, the panel’s new chairman, told Reuters in an interview Tuesday he plans to focus mostly on how high-speed trading could be impacting smaller companies.
Not all experts on Tuesday were enthused about eliminating maker-taker pricing, showing how it could be difficult to pursue changes to the model.
BATS Global Markets exchange CEO Joe Ratterman said maker-taker pricing encourages liquidity makers to "post tighter bid-offer spreads" that benefit all investors and urged regulators to focus on enhancing disclosures to manage conflicts.
Steven Quirk, a senior vice president at TD Ameritrade, whose firm was highlighted in the study, questioned the study's findings, and stressed that his brokerage follows best execution requirements.
But Levin pressed Quirk on why TD Ameritrade disclosures often showed it had sent most of its non-marketable orders to the exchanges with the highest rebates.
"Your subjective judgment as to which market provided best execution contends that millions of customer orders virtually always led you to route orders to the markets that paid you the most?" Levin asked.
When Quirk interjected that it wasn't "always," Levin quipped: "I said virtually always."
"Virtually, yeah," Quirk replied.
Republican Senator Ron Johnson of Wisconsin expressed skepticism about the gravity of the conflict problem, and questioned the research of Robert Battalio, an author of the study.
"If I am doing a $2,000 trade, you're concerned about a conflict of interest where I might have to pay an additional 40 cents? Is that what this is about?" Johnson asked.
"No, it's about the fact that you didn't get to trade," Battalio shot back. "Your assumption that you trade is wrong."