TABB Forum published op-ed authored by S3 CEO Mark Davies.

26 March 2021

When it comes to payment for order flow, the quality of trade executions is still very opaque – despite the fact that SEC Rule 605 reports show how well market centers perform. These reports do not help the average investor decide how and where to trade, writes Mark Davies, Founder and CEO of S3. And the only way for investors to know the quality of a trade is for this information to be publicly available. The SEC and Congress should focus on increasing transparency, not on banning PFOF or restricting other business models, Mr. Davies explains.

You know that house at Halloween who gives away the full-size candy bars? Do you suppose they buy those from the gas station for $1.19?  Probably not.  More likely, they buy them at Costco.  I bet they even use coupons.  With that, they can get the price to about $0.30 per bar.

Is your first reaction, “oh, they’re giving away junk candy – it only costs $0.30”?  Of course not – it’s the same candy bar as the one you can buy at the gas station!

But this is exactly the thought process being applied to the stock market these days.  Why?  Because everyone knows how much retail brokers are paid via Payment For Order Flow (PFOF), but no one knows the quality of their executions.

SEC Rule 606(a) is the reason we all know how much PFOF brokers are receiving – it requires disclosure of the financial arrangements between brokers and the destinations that they route orders to.  As a result, popular sentiment seems to be that if retail firms are getting paid to route their order flow to a certain destination, then they must be getting bad executions for their clients.

There are many factors that come into play when determining quality of execution – size of the order, the specific stocks being traded, the time the execution occurs, and the limit price on the order are just a few of the things that affect execution quality.  The notion that firms receiving more PFOF are delivering an inferior service to investors without understanding the quality of execution is absurd.

With the chocolate, the quality is printed right on the wrapper – there’s nutritional information, ingredients, and a best-before date.  But the quality of trade executions is still very opaque – sure, there are SEC Rule 605 reports that show how well market centers perform, but this doesn’t help the average investor decide how and where to trade.  The only way for investors to know the quality of a trade is for this information to be publicly available.

This is where the SEC and Congress should focus – increasing transparency, not on banning PFOF or restricting other business models.  Transparency of quality, in tandem with the existing disclosures, is the only way to determine if conflicts of interest exist.  Without this transparency, good quality efficient businesses are punished, and that’s not in anyone’s best interest.

 

Mark Davies is the co-founder and CEO of S3, a full-service regulatory compliance and trade analytics software company.  He is a member of several industry groups that focus on market structure and compliance issues, co-chair of the FIF 606 committee, and an advocate for giving away full-size candy bars at Halloween.