The Securities and Exchange Commission (SEC) sent out subpoenas for records to brokerage companies in an effort to determine how retail client orders are routed, executed and filled. The regular’s enforcement division will investigate whether or not retail clients are getting the best price possible, the National Best Bid Price (NBBO). The NBBO is the lowest bid and ask an order is executed at to ensure orders are filled at the best price at a given time.
Effective order execution is also in question. These brokerages, primarily those that offer discount services such as TD Ameritrade and Fidelity, essentially sell orders to the highest bidder. Exchanges offer the brokerages rebates for order flow, and the highest bidder (i.e. rebates) may not guarantee the lowest price on “limit orders.” It is speculated that these brokerages could receive in excess of $100 million per year by selling their orders.
Pressure on the SEC has accumulated in the weeks following the growing controversy over high frequency trading (HFT) and payment-for-order-flow schemes that resurfaced in Micheal Lewis’ book “Flash Boys.” There are no regulations against such schemes as long as rebates are disclosed and orders receive the best possible price in the shortest possible time frame.
Dark pools have come into question in regards to payment-for-over-flow and order execution. These pools are made up of anonymous liquidity from various market participants that want their order size kept private. Over 40 percent of all equity trading volume is done in dark pools, and brokers are likely sending their retail client orders to scoop up rebates. The problem? Dark pools do not guarantee the order is executed at the best possible price. Brokerages are considering closing down their dark pool activity, including Goldman Sachs and their Sigma-X dark pool.
Brokerages, though, have seen this kind of probe before. Scottrade and Morgan Stanley has seen against taken against their practices by the SEC for improper disclosures and other routing violations. E-Trade did disclose last year that it would partake in a self-imposed probe on how prices and executes orders to one of its affiliates.