The recent GameStop saga is “prompting calls for regulators to reconsider a decades-old practice in the U.S. stock market” in which trading firms pay brokerages for the right to execute online investor orders. This according to a recent article in The Wall Street Journal.
The practice, called “payment for order flow” has long been controversial, the article reports, adding “some say it warps the incentives of brokers and encourages them to maximize their revenue at the expense of customers.” Many brokers and trading firms argue, however, that the practice is misunderstood and sees to it that investors enjoy seamless executions and good trade prices.
The article reports, “Payment for order flow helped set the stage for the manic trading in GameStop,” whose shares surged from $18 per share at the beginning of the year to a record close at $347.51 on January 27th.
How? Because the practice allowed the U.S. brokerage industry to move to zero-commission trades in late 2019: “No longer needing to pay a fee on stock transactions and empowered by easy-to-use trading apps like Robinhood, individual investors poured into stocks and options at record levels last year,” more recently piling into stocks like GameStop.
The article quotes the president of advocacy group Better Markets Dennis Kelleher, who said, “Payment for order flow, at the end of the day, is legalized bribery that appears to incentivize brokers to violate rules.” But eliminating the practice would “create its own difficulties,” the article notes, by making it more difficult for brokerages to offer their customers zero-commission trades.