September 22, 2000

Public Interest Comment on Disclosure of Order Routing and Execution Practices

  • Jerry Ellig

    Research Professor, George Washington University Regulatory Studies Center
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The SEC is seeking comment on enhancing disclosure of order routing and execution practices

Summary

The Securities and Exchange Commission has proposed a pair of information disclosure rules that would (1) require market centers to make public an array of statistics measuring the quality of trade executions, and (2) require brokers to disclose how they route customer orders and whether they receive payment for routing orders to particular dealers or market centers.

The SEC proposes to require greater disclosure regarding order flow because it fears that payment for order flow prevents investors from getting the best possible prices and contributes to "market fragmentation" that makes prices in the major stock markets less accurate. However, our analysis reveals that these concerns are unfounded. Firms receiving payment for order flow offer their customers lower trading commissions, greater price certainty, faster executions, and other benefits that could offset any higher spreads that these customers pay.

Furthermore, payment for order flow is part of a pricing strategy that moves the trades of smaller and less-informed investors to dealers and stock markets that can handle these trades at lower total cost to the customer. There is no evidence that this market segmentation reduces the ability of stock prices to incorporate relevant information. If it succeeds in discouraging payment for order flow, the SEC will force smaller and less-informed investors to subsidize the trading costs of larger and better-informed investors, thereby harming the very investors disclosure is intended to protect.

Mandatory disclosure is only desirable if its benefits exceed its costs. This occurs if the mandate remedies a "market failure," but the SEC provides no evidence of market failure. The markets for retail brokerage and order execution are highly competitive. Brokers, dealers, and market centers already have strong incentives to disclose any information whose value to customers exceeds its costs.