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Order Flow: Too Hot to Handle

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Some brokerages receive "order flow payments" in exchange for routing trades to certain exchanges. This practice is a major money-maker for brokers, but some worry it comes at the expense of clients.

The term “order flow payment” essentially means that investment firms get compensated by exchanges for preferentially directing orders to those exchanges. According to the Securities and Exchange Commission, those payments amount to “perhaps a penny or more per share.”

A number of brokerages engage in Order Flow. It is not only a hot subject, but a sensitive topic, as well.

I am a client of Ameritrade, which advertises “Order execution striving to save you time and money.” After a recent trade, I’m wondering if it is Ameritrade’s money that is being protected, not my own. Others question this too.

On Oct.15 of last year, I made a fairly large trade at Ameritrade for 2,790 shares of JNJ (Johnson & Johnson). The market was down and I had money. After figuring out how much my husband and I needed in reserve, I purchased JNJ. It has a 2.8% dividend and is a market performer.

While executing the trade through Ameritrade, I decided to watch the price per share on NASDAQ, where JNJ trades. My reason for this was that I noticed previously my Ameritrade executions did not always appear to me to be favorable for the current market price. Of course, if Ameritrade can make a few cents per share when I and others buy or sell it would be a profit center for the company.

What happened next depends on who is interpreting the events. For me, I thought my trade was not executed as favorably as it could have been. Ameritrade, however, says that is not the case.

Either way, in my exchange with representatives of the company, I thought there was what I would call “double talk.” For example, one representative said to me through Ameritrade mail,

When you submit a buy order and get it executed the only thing you pay is the price of the stock plus the commission. You do not pay for order flow or for anything else.”

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When I questioned this same person further regarding order flow, I was surprised at his response. Now, he seemed to be giving me a different reply than earlier:

My reply did not say whether or not your order was routed to a particular market maker or not, nor whether we receive payments for our order flow to that market maker. All I said was that you did not pay anything to have your order routed, and you never do.”

My interpretation is that order flow might have occurred, potentially causing my trade to be routed in a manner that was less favorable to me, the customer. The company claims differently using figures I was cited over the phone.

OK, so I am a peanut and what does it matter? Should I even bother being concerned about losing a few cents a share to order flow when I make a trade with a brokerage firm? Well, if you add up all us tasty treats (yes, you too), it makes a lot of difference. In fact, in 2013, we little guys appear to have provided 30% of Ameritrade’s profit according to one report.

This begs the question, “Should something should be done?”

In fact, it is. This so-called payment for order flow is being investigated by the SEC. If it results in litigation, this would mean that brokerage companies that use it would have to be more transparent about it to their customers, give it up altogether, or lessen any percentage return they are now receiving. This would not be a welcome scenario for them and that makes the subject a sensitive one, a “hot potato.”

While the issue is being resolved, there is at least one way to get around it for the individual trader at Ameritrade. It is summarized below from the Ameritrade website.

How do I . . . enable my account to direct route orders?

Click the "Account Services" tab. Under the "Update an existing account" section, select the "Direct Routing Signup" link. Read the Terms of Use and acknowledge acceptance of these terms to activate direct routing functionality.”

You must be a client of Ameritrade’s for this to work, i.e. you must be able to sign in.

For those that trade elsewhere, there might be a similar fix on your brokerage webpage or if not, perhaps asking your broker might be helpful. Besides, you will look smart and get that person’s attention!

In a nutshell, payment for order flow is alive and well. The SEC is addressing the problem as this is written. In the meantime, an individual investor can ferret out what might help. The broker’s website may be of assistance, but if not, a broker conversation may be in order.

For Further Reading:

Trade Execution: What Every Investor Should Know

Bad Boy Brokers

Contain Expenses to Increase Returns

This information and content is offered for educational purposes only by MyMoneyMD, LLC. MyMoneyMD, LLC is not acting as a Registered Investment Advisor, Investment Counsel, Tax Advisor, or Legal Advisor.


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