Federal Judge View Re: Broker Rebates From Exchanges: Securities Fraud?

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Class Action Lawsuit Against TD Ameritrade for taking Broker Rebates From Exchanges and HFT Firms “May Be Securities Fraud,” Says Federal Judge; PFOF is Under the Gun, Again

(Below re-published with permission from MarketsMuse.com)– Broker Rebates, Payment-for-Order-Flow and “Pay-to-Play” have become synonymous with new world order in which exchanges, dark-pool operators and high-frequency trading (“HFT”) firms, (the so-called “flashboys”) dominate the world of stock trading. While many Wall Street geniuses will argue “the genie is out of the bottle” when it comes to payment-for-order-flow, it doesn’t mean this practice is right-minded, no less legal-and it hasn’t stopped naysayers from arguing that customers’ best interests are clearly not part of the equation. A Federal judge in Nebraska seems to agree, based on his ruling last week that allows a class action lawsuit aimed at TD Ameritrade in connection with their receiving payment-for-order-flow rebates from high-frequency trading (“HFT”) (and not even sharing those rebates with customers!) to proceed. The plaintiff argument is that TD has violated best execution guidelines. Should anyone be shocked?! After all, the topic of payment-for-order-flow and barely-disclosed rebates paid to brokerages by exchanges and electronic market-making firms in consideration for routing orders to them has been a topic of spirited debate for more than several years.

Here’s the excerpt from WSJ reporting by Cezary Podkul:

Mom-and-pop investors who think their brokers are prioritizing high-frequency traders over them may soon have a chance to try to prove their case in court.

A federal judge in Nebraska this month ruled a class-action lawsuit could proceed against TD Ameritrade Holding Corp. AMTD -1.09% , one of the nation’s largest discount brokerages. In his ruling, the judge cited “serious and credible allegations of securities fraud” stemming from the company’s order routing practices.

Plaintiffs allege the discount brokerage prioritized its profits over their best interest on stock transactions

The TD Ameritrade customers who brought the suit alleged the company, which provides investing and trading services for 11 million client accounts, prioritized its profits over their best interests. They claim it did so by accepting incentives from stock exchanges and large electronic trading firms to route customer orders to them without ensuring the customers would get the best prices available – an obligation that along with related factors is known as “best execution.”

A spokeswoman for TD Ameritrade said the company disagrees with the judge and will appeal his ruling.

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The Great Rebate Debate..Broker Disclosure IS Front-Burner Topic

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Exchange rebates paid to brokers for routing orders to their respective venues and the general issue with regard to the now ubiquitous “payment-for-order-flow” model that extends throughout the electronic trading ecosystem has been a topic of discussion for many years now. It may be confusing, but is certainly not an unknown concern to the universe of informed buy-side investors. For those who may be still be uninformed as to how/where/why/when (and how much?!) broker-dealers are on the receiving end of rebates, suffice to suggest its time you get yourself up to speed; your bottom-line can depend on it.

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Image Courtesy of April 2014 Wall Street Journal

Courtesy of financial industry media outlet MarketsMedia’s all-star journalist Terry Flanagan most recent dissertation “Got Transparency?” it is one that deserves an accolade from altruists within the industry, if not a check under the hood or bottom of Terry’s car before he starts the engine.

“One aggravating factor is a lack of transparency. Many market participants do not know either the amount of the rebate or where it ends up.”

As Flanagan points out, “..In institutional equity trading, rebates have been a point of contention since the late 1990s, when Bill Clinton was U.S. President and the Dow Jones Industrial Average scaled 10,000 for the first time.

Supporters say exchanges paying rebates on order flow is a perfectly legitimate practice of rewarding customers and offering volume discounts. Helped by rebates, trading commissions have dropped substantially over the years; the biggest decline from 2005 to 2017 was 68% for the lowest-touch direct market access / algorithmic trades, according to Tabb Group research.

“Most buy-side firms operate with ‘all-in’ pricing models and aren’t provided granularity into fees by order, but the decisions on when and how to route to particular venues significantly impact execution performance…” according to Stino Milito, Co-Chief Operating Officer at Dash Financial Technologies.

On the other hand, critics say rebates create conflicts of interest, and shortchange end investors if brokers route in ways that disadvantages clients……Helped by rebates, trading commissions have dropped substantially over the years; the biggest decline from 2005 to 2017 was 68% for the lowest-touch direct market access / algorithmic trades, according to Tabb Group research.

 “There is absolutely crap disclosure about broker-dealer routing strategies,” according to Dave Weisberger of ViableMkts. “If you can’t get a high-level view of how brokers route and what the outcomes are, then how can you be talking about a transaction fee pilot, or making claims about what rebates do to destroy the market?

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To read the entirety of Terry Flanagan’s piece in the latest edition of MarketsMedia, click here

The Great Rebate Debate..Broker Disclosure IS Front-Burner Topic