Last month, another market structure related class action lawsuit was filed.  As far as we can tell, this case has not yet been reported in the press. The target of the lawsuit is the online retail broker TD Ameritrade and the subject is payment for order flow and order routing practices.  The case, brought by the NJ-based law firm Lite Depalma Greenberg LLC, centers around whether TD Ameritrade provided best execution for their clients.

Here are some of the key points raised by Lite, Depalma, Greenberg case:

 -Rather than route its clients’ non-directed, non-marketable orders to

the venue(s) which would provide the best execution, TD Ameritrade instead sent

such orders to the venues which would provide the highest liquidity rebates,

payments made by the venues to TD Ameritrade relating to the number and size of

orders that were routed.

 

– Rather than route its clients’ non-directed, marketable orders to the

venue(s) which would provide the best execution, TD Ameritrade instead sent such

orders to the venues which would pay the Company for order flow, payments made

by the venues to TD Ameritrade relating to the number and size of marketable

orders that were routed.

 

– As a result of this self-interested order routing, TD Ameritrade failed

to provide best execution for its clients, causing them material harm in the form of

economic loss due to their orders going unfilled, underfilled, or filled at a

suboptimal price.

 

The case points out that in 2011, TD Ameritrade suddenly shifted their order routing practices:

 

 – In the fourth quarter of 2010, according to TD Ameritrade’s Rule 606

Report, the Company routed 62% of limit orders to Citadel Execution Services and

22% of such orders to Citigroup. Both of these venues paid, on average, less than

15 mills per share, where a mill is equal to one-tenth of a penny. That same

quarter, the Company routed 8% of limit orders to Direct Edge, a venue that paid

32 mills. Thus, at that time, TD Ameritrade routed 84% or more of its limit orders

to venues that paid less than half of the highest liquidity rebate available.

 

 – Sensing an opportunity for additional profit, however, TD Ameritrade

radically modified its routing behavior beginning in 2011, and began routing limit

orders to the venues that would maximize their rebates. By the fourth quarter of

2012, TD Ameritrade was directing all of its nonmarketable limit orders to Direct

Edge, which was paying the highest rebate for adding liquidity available at the

time.

 

 – TD Ameritrade’s most recent 606 Report demonstrates that the

Company’s practice of routing orders to the venues which pay the most for order

flow or the highest rebates for the addition of liquidity has continued, and will

likely continue, unabated.

 

– Direct Edge, to which TD Ameritrade routed roughly half of its clients’ limit

orders in the first quarter of 2014, paid a staggering 35 mills per share (or 35 cents

per hundred shares traded) in liquidity rebates.

 

 – All told, TD Ameritrade Holding Corporation “earned” routing

revenue of $236 million in 2013, $184 million in 2012, and $185 million in 2011,

in the form of liquidity rebates and payments for order flow. These amounts are in

addition to the commissions which TD Ameritrade’s clients paid the Company for

its broker-dealer services.

 

The lawsuit also references the Battalio Study that we featured last year in a note :

 

 -The Battalio Study authors conclude that their results indicate an

impact of limit order routing decisions on some measures of limit order execution

quality, such that “routing decisions based primarily on rebates/fees appear to be

inconsistent with best execution. There is a significant opportunity cost associated

with routing all nonmarketable limit orders to a single venue offering the highest

liquidity rebates.”