Fred and Ethel Get POOR (Post Only Order Retail)
It’s been a long time since we checked in with our good friends – long-term investors Fred and Ethel. You may recall that in prior notes through the years, we featured sit-downs with the sage couple, as we brought them up to speed on modern market structure and how modern markets actually work. We have found them to be great students, as they learned about dark pools, VWAP, and even the NYSE Retail Liquidity Program.
They have consistently been incredulous as to how the SEC could allow our markets to get so complex, with structures that favor short term traders at their expense. Yesterday evening, before the World Series, we sat down with them and explained how they are finally going to get their very own Post Only Order for Retail – or POOR for short.
We tried to explain to them how it works, and why it is being proposed by NASDAQ. They would have none of it, however. Fred kicked Joe in the shin, yelling “I never asked for this; WTF is wrong with you!” And Ethel spit her tea on me. They then kicked us out of their home.
This morning, allow us to share with you details about this new proposed NASDAQ Order Type.
After admitting last month that post-only orders have been inefficient and detrimental to investors, we would have expected NASDAQ to begin cleaning up their order types and start eliminating orders that have been harmful to the market. But rather than eliminating post-only orders, Nasdaq seems to be doubling down by proposing a new Retail Post-Only Order type. This order type is even more baffling and unnecessary than the post-only order.
Basically, the retail post only order is an order designed for retail brokers to avoid access fees. Currently, if a retail broker receives a non-marketable order, they will send that order to an exchange to be posted and would receive a liquidity rebate when that order trades (marketable orders are usually sold to internalizing market makers). However, if that non-marketable order becomes marketable while it is being routed to an exchange, it is possible that the order might remove liquidity and the broker would incur an access fee. This fee ($0.003/share) would eat into a retail brokers profit margin. For example, the retail broker would incur a $1.50 fee for a 500 share order that takes liquidity from an exchange. Obviously, for retail brokers like Robin Hood who charge $0 for trades, this is not economically viable.
According to Nasdaq, retail brokers can now send these non-marketable orders to Nasdaq with the Retail Post Only order type. This means that if they became marketable while they were on the way to the exchange, then the order would not remove liquidity and instead the order would be cancelled. The Nasdaq Retail Post-only order would be preventing a retail client from receiving the fill they deserve because their broker doesn’t want to pay an access fee.
You might recall that Nasdaq already created a manipulative routing scheme last year called RTFY which attempted to circumvent these exchange access fees. The RTFY order routing option sends non-marketable orders which have become marketable to internalizing brokers first rather than accessing an exchange quote. This way the retail broker is guaranteed never to pay an access fee and they can continue to reap profits from payment for order flow even at $0 commission. We wrote an SEC comment letter against RTFY last year, but the SEC still approved it.
Nasdaq must have gotten even more tired of “giving” away business to market makers and found a new way for retail brokers to avoid access fees.
Here is how Nasdaq described why they are adding the retail post only order:
“Currently, if a firm does not want a retail customer order to remove liquidity from the Exchange upon entry, the firm can select the RTFY routing option, which routes the order to destinations in the System routing table instead of immediately removing liquidity from the Exchange order book. Some firms, however, prefer to use their own routing infrastructure in seeking execution of a customer order rather than allowing that order to remove liquidity from the Exchange upon entry or instructing the Exchange to make a routing determination. In cancelling the order for any reason instead of adjusting its price, the Retail Post-Only Order will therefore provide firms with an alternative for handing [sic] retail customer orders.”
How kind of Nasdaq to give their retail brokers a choice on ways to avoid executing their retail flow and to disadvantage their own clients. Of course, just like every other order type or fee change, Nasdaq claims that the proposal could help competition:
“By offering firms that handle retail order flow an additional choice, Nasdaq believes that the proposal could stimulate competition by attracting additional retail customer order flow to the Exchange.”
We believe that the retail post-only order type violates a broker’s best execution responsibility, as it cancels an order which would have received a fill had it been sent regular way. This order type is another example of how access fees and payment for order flow have distorted price discovery and sacrificed best execution. There are two guilty parties here:
- Nasdaq who designed an order that prevents executions.
- Retail brokers who choose a strategy which would lower their cost but hurt their clients’ execution.
There is also one other potential guilty party: the SEC. If they approve this order type, they will be going against their basic principle of protecting retail and institutional investors. We hope that the Commission can see through Nasdaq’s self-serving arguments and issues a rejection of this conflicted order type.