Brokers could be required to tell investors exactly where they sent a stock order to be filled under a measure the U.S. Securities and Exchange Commission (SEC) is weighing to address complaints that the decisions sometimes aren’t in clients’ best interests.
The proposal could give investors more insight into whether they are getting the best price when they buy and sell large numbers of shares, according to three people familiar with the matter. Brokers entrusted with orders in the U.S. stock market can choose from dozens of exchanges and private venues. Some money managers such as T. Rowe Price Group Inc. have told regulators that incentives offered by exchanges for attracting orders can put a broker’s financial interest at odds with the customer’s.
The SEC faces pressure to overhaul trading after Michael Lewis’s “Flash Boys” book made the claim that high-frequency traders hurt other investors by learning which shares investors plan to buy, purchasing them, and selling them back at a higher price. The SEC has said it’s reviewing every aspect of how stocks are traded, and regulators are trying to identify changes that could be implemented quickly, the people said.
“We’ve actually started this conversation about what can we do right now,” SEC Commissioner Kara M. Stein said in an interview. “All five commissioners are very focused on these issues and are committed to making sure the market is fair and efficient and promoting capital formation.”
There is a lot of “low-hanging fruit” that should be considered, said Stein, who declined to discuss specific steps. Commissioners expect the SEC’s staff to present them potential policy options “in the near term,” Commissioner Luis A. Aguilar said in an interview.
Florence Harmon, an SEC spokeswoman, declined to comment.
Brokers can face a conflict of interest as they select where to send customer orders. Brokers can either capture a rebate or pay a fee to an exchange depending on the type of order used, while private venues known as dark pools charge lower fees but don’t have to disclose how they treat customers.
Requiring brokers to report every step they took to fill a customer’s order could help investors defend against the predatory traders described by Lewis, said Andy Brooks, head of U.S. equity trading at Baltimore-based T. Rowe Price. While large investors can demand such reporting, regulators could require “a very detailed and comprehensive template” that would allow investors to compare the brokers they use, he said.
“It’s where you went and didn’t get an execution that begs the question of why did you go there?” Brooks said in an interview. “Why is a broker sending an order to a venue where you get no execution?”
More disclosure of where orders are sent probably isn’t going to change the “nature of the way things take place,” said Keith Ross, CEO of Glenview, Illinois-based PDQ ATS Inc., a dark pool that has marketed itself as a haven from high-frequency traders. Institutional money managers should know how their orders are being handled by brokers, Ross said in a phone interview.
“I would argue that is why they get paid their exorbitant fees for managing money, which is greater than the fractions of pennies we are talking about here for the high-frequency folks,” Ross said.
Greater transparency is one idea being weighed by the SEC’s Division of Trading and Markets, the people said. Regulators could decide to publicly encourage more uniform order-routing notices instead of imposing a new requirement on brokers, the people said.
While improved disclosure is helpful, the SEC should experiment with altering the economic incentives that affect how orders are handled, Brooks said. T. Rowe has joined the New York Stock Exchange, Royal Bank of Canada, and IEX Group Inc. in lobbying regulators to ban the “maker-taker” system, which pays rebates to large brokers to attract trades.
Brokerages often put their own self-interest in front of their clients’ under maker-taker, according to a study by Robert Battalio and Shane Corwin of the University of Notre Dame and Robert Jennings of Indiana University.
“Simply saying to brokers ‘Give us more disclosure’” isn’t enough, Brooks said. “The effort needs to be more robust than that if we are really going to go after this,” he said.