Massachusetts on Tuesday entered the debate over sales practices in the US stock market as it launched an investigation into whether paying rebates on bids and offers hurts investors.
William Galvin, the state’s secretary of the commonwealth, said it had sent letters to retail brokerages Charles Schwab, Scottrade, TD Ameritrade, Fidelity, E* Trade, Edward Jones and Morgan Stanley inquiring about routing orders to exchanges that pay rebates.
“Institutional brokers are responsible for placing millions of dollars of average investors’ life savings in their employers’ pension plans, as well as in mutual funds and variable annuities,” Mr Galvin said. “If financial rebates or kickbacks create a conflict that results in less than the best deal for the investors, this practice must stop.”
Rebates are part of a two-way system known as “maker-taker” whereby equity exchanges pay brokers to provide prices on their platforms. Exchanges also charge brokers and market makers for accepting, or taking, bids and offers on their venues. The difference between the two is revenue for the exchanges.
The level of both fees and rebates have to be approved by the Securities and Exchange Commission.
Critics of maker-taker have long argued that the system creates the potential for conflicts of interest that would drive brokers to post orders to venues with the highest rebates, which may not ultimately be in the best interest for investors.
Others say that eliminating rebates could cost investors, as brokers would have to widen the difference, or spread, between quoting a buying and selling price for a share.
Some market participants have said that a new administration in Washington that has promised reform of financial regulation and staff changes at the SEC could create an opportunity to revisit the maker-taker model.
In a press release announcing the investigation, Mr Galvin cited a recent editorial in the New York Times by Jonathan Macey, a professor at Yale Law School, and David Swensen, Yale’s chief investment officer, arguing that brokers pick exchanges that pay “kickbacks at a price disadvantage to investors”.
Mr Galvin said his office was looking into whether brokers were meeting their obligation to get the best prices for customers.
Morgan Stanley, Fidelity, Edward Jones, TD Ameritrade and Scottrade declined to comment while officials for E* Trade and Charles Schwab were not immediately available to comment.
A few years ago, Jeffrey Sprecher, the head of Intercontinental Exchange, which owns the New York Stock Exchange, raised the idea of eliminating maker-taker. In a recent blueprint for revitalising markets, Adena Friedman, Nasdaq chief executive, argued for “an intelligent rebate/fee structure”, but also cautioned on “policies that would eliminate or significantly reduce rebates in the context of less liquid stocks where incentivisation of market making is most impactful”.
IEX, which became an exchange last year, opposes rebates while Bats Global Markets, owned by the Chicago Board Options Exchange, recently unveiled a flat-fee model for one of its venues in response to industry demand.
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