Sen. Schumer Attacks The Maker/Taker Model
We would like to welcome back Senator Chuck Schumer to the market structure debate. Yesterday, Sen. Schumer sent a letter to the Chairman of the SEC on the subject of broker rebates otherwise known as the “maker/taker” model. It’s been a while since we have heard from the senior Senator from New York on a market structure issue. If we recall correctly, the last time he sent a letter to the SEC it was on flash orders back in 2009 (and they still have not be banned).
So what has caused Sen. Schumer to get out his pen again? Apparently, after he read the recently released Woodbine study on broker routing methods and found out that investors could be losing up to $5 billion as a result of “sub-optimal order routing decisions”, he wanted to find out what has been going on in those smart order routers for all these years. Sen Schumer wrote:
“I am writing in response to a new study indicating that brokerage customers are potentially paying billions of dollars per year in hidden costs due to conflicts of interest faced by their brokers. The study concludes that customers often do not receive the best available price on their trades, because brokers rout transactions to venues that provide the largest rebates or other incentives, not necessarily the best price. In the aftermath of the 2008 financial crisis and the 2010 Flash Crash, investors already question the integrity of our markets. It’s more important than ever to ensure that brokers put their clients first, and not pocket hidden rebates at the expense of their customers…These models create a conflict of interest, as brokers may be incentivized to execute trades on a particular venue even if that venue is not offering the best price.”
We must say that we were impressed with Sen. Schumer. We are so impressed that we are going to send him a free copy of our book Broken Markets when its released on June 3rd so that he can read about the many more conflicted practices that have been going on in the equity market in the past few years. Hopefully, Sen. Schumer will be angered enough after he reads the book to get his pen out again.
While Sen. Schumer has helped shine some light on the conflicted maker/taker model, we do have some issues with his solution. Sen.Schumer suggested:
“I respectfully urge the Commission to act as promptly as possible to ensure complete disclosure of all such payments and require brokers to pass these payments on to their customers, thus eliminating the potential for conflicts of interest.”
While this suggestion will certainly help to protect institutional and retail clients, it does nothing to address the HFT practice of rebate arbitrage. Of course, we are talking here about how proprietary high frequency traders currently enjoy getting paid up to 1/3 of a penny per share to “add liquidity” in stocks like Bank of America. These rebates have skewed asset prices and are responsible for countless artificial arbitrage trades. Rebates are used as an enticement by the exchanges to lure HFT clients to their exchange so that they could increase their market share and sell other market data related products. While HFT’s get the benefits of these rebates, they don’t have to supply any real obligations.
We would like to suggest to Sen. Schumer that he amend his letter to the SEC and rather than just calling for rebates to get passed on to clients, he should suggest an outright elimination of the maker/taker model. A flat fee of 1/10 of a penny per share, whether you add liquidity or take liquidity, should replace the maker/taker model. This fee should offset any revenues that the exchanges would be losing with the elimination of the maker/taker model. By adopting a flat fee model, the problem of fragmentation may finally start to get addressed.