Magazine article Modern Trader

Payment for Order Flow Back in Limelight

Magazine article Modern Trader

Payment for Order Flow Back in Limelight

Article excerpt

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ISE HOLDS OUT

Like a bad penny that won't go away, payment for order flow is back and lame-duck Securities and Exchange Commission (SEC) Chairman Harvey Pitt is seeking to end the practice as one of his last acts as head of the regulator.

Pitt sent a letter late January to the heads of all five U.S. options exchanges asking for an explanation of policies on payment for order flow and the internalization of order flow by member firms. Pitt says the practice where exchanges collect fees from options specialists and market makers, and then pay brokerages to direct business to them, as well as internalization, creates a conflict of interest that compromises a broker's fiduciary obligation to customers.

The four main options exchanges at the time dropped the practice in 2001, but competitive pressure from the International Securities Exchange (ISE) has led the Pacific Exchange (PCX) and the Philadelphia Stock Exchange (PHLX) to return to the practice.

Currently the SEC requires that upon opening a new account and on an annual basis, firms must inform their customers in writing whether they receive payment for order flow, and if the firms do, they must describe in detail what type of payments they accept.

Currently three U.S. options exchanges, ISE, PCX and PHLX, sponsor payment-for-order-flow programs, though PCX and PHLX both say they would support a broad ban of the practice. Meyer S. Frucher, chairman and CEO of PHLX, acknowledges his exchange only initiated its program to remain competitive. …

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