Would The SEC Really Ban PFOF? PreMarket Prep Weighs In

Benzinga's PreMarket Prep airs every morning from 8-9 a.m. ET. During that fast-paced, highly informative hour, traders and investors tune in to get the major news of the day, the catalysts behind those moves and the corresponding price action for the upcoming session.

On any given day, the show will cover at least 20 stocks determined by co-hosts Joel Elconin and Dennis Dick along with producer Spencer Israel.

The PreMarket Prep team not only does critical analysis on a variety of issues every day, but the hosts also educate their audience on other important topics regarding the markets.

On Monday, SEC Chairman Gary Gensler said a ban of the payment for order flow model "is on the table." The possibility of this coming to fruition and the changes needed to do so along with the pros and cons were discussed in detail on Tuesday's PreMarket Prep.

Payment For Order Flow: PFOF is the compensation a broker receives for routing trades for trade execution: “Payment for order flow is a method of transferring some of the trading profits from market making to the brokers that route customer orders to specialists for execution.”

What Is It And Who Uses It: Falling commissions over the years has led to commission-free trading, and brokerage firms have had to change their business models in order to remain competitive and profitable.

In lieu of charging commissions, firms sell their “order flow” to market-makers /wholesalers (such as Citadel and Virtu Financial VIRT that take the other side of the trade (on most occasions) in an attempt to immediately flip for a small profit.

Any major brokerage firm that doesn't charge commission for stocks employs this practice. The most notable of late is Robinhood Markets Inc. HOOD. The upstart company built a successful brokerage and forged the way for free commission based on the PFOF practice.

See Also: Why Zero-Commission Trades Aren't Really 'Free'

Click here to listen to the full discussion on the PreMarket Prep Podcast now.

PreMarket Prep Take: In all likelihood, a ban on PFOF isn't going to happen for a variety of reasons. The most important being, turning the clock back on commission-free trading will create an uproar from new and old market participants alike.

If PFOF was abolished, would there even be enough market-makers (mainly major Wall Street firms who have abolished their market-making operations) to process the huge amount of volume traded on a daily basis?

Dennis Dick, a market structure expert who vehemently opposed PFOF, has conceded to the forces that be. Back in 2016, Dick consulted with the SEC on the nuances of PFOF to no avail.

“I do not think you are going to see a ban PFOF," Dick said. "Overall it would be a benefit for the market long-term, but in the short-term, it could create a real liquidity issue. You would need several market-makers to come in to make markets and I do not see that happening.”

He emphasized that going back to commission-based trading would be very difficult.

The full discussion on this topic from Tuesday’s show can be found here: