Payment for Order Flow (PFOF), has been around and active in the financial industry for quite some time. I can remember it going back as far as the 1990’s, but it may go back even farther than that.

What is PFOF?

Well, many investors think of it as a “kickback” in return for their orders being sent to a market maker for execution by their broker. Many other investors may not be aware of its existence or understand what it is. PFOF quite simply, is the compensation/payment, as much as 1 penny per share, that a broker receives from a market maker in exchange for the broker routing its clients’ orders to that particular market maker.

There are rules in place however, that cover payment for order flow. The U.S. Securities and Exchange Commission requires disclosure of PFOF to the public in Rule 606. The rule in general requires a broker to publish on a quarterly basis, order routing information which includes the identity of the venue(s) to which orders are routed, and whether or not there is an agreement in place for PFOF with that venue. There are also best execution requirements. A broker must be prepared to demonstrate a good reason for routing orders to particular venues for the sake of best execution for its customers. PFOF is widely practiced, and legal but also controversial.

Critics of the practice feel that it poses a conflict of interest by incentivising brokerages to boost their revenue rather than working to ensure good pricing for their customers. The SEC best execution requirement doesn’t necessarily mean “best price” since there are several factors taken into consideration such as price, speed and liquidity when it comes to execution quality. Those that defend PFOF say that retail investors benefit from the practice because of increased liquidity and the ability to get trades done. They also say that customers benefit from better pricing rather than what they would receive if orders were sent to exchanges.

What does the future hold for PFOF?

After decades of allowing the practice to continue, the SEC is now considering a full ban on the practice. SEC Chairman Gary Gensler recently stated that a full ban of the practice is on the table.

“I’m pro competition, and I’m not sure the payment for order flow system really is the best competitive landscape,” Gensler said at a recent Senate hearing.

When wholesalers manage to get a cheaper price in a stock than the customer was willing to pay, the savings are split between the wholesaler and the brokerage—who then can pass the cost savings on to the customer in the form of a better price. Wholesalers also get rebates from exchanges for providing liquidity, deepening their roles as middlemen in stock trades.

So what happens with all of the brokers that have been receiving PFOF over the years? Well, shares of app based retail brokerage Robinhood Markets Inc., which relied on PFOF for approximately three quarters of its revenue for the first quarter, closed down about 7% after the Chairman’s announcement. PFOF does make up a good portion of the revenue for many brokers in the financial industry. Can its prohibition have an impact on these brokers? Yes, but what remains to be seen is the level of impact it may have.

Why do wholesalers want to pay brokers for their order flow?

There are at least two reasons, one reason is that the more orders a wholesaler has coming into the trading desk, the more opportunity there is for that wholesaler to generate profits in the marketplace by trading against incoming orders. Another reason is, the more that wholesalers are able to trade with incoming order flow, the more exposure they have in the marketplace because their name is constantly being published in the quotations of stocks in the market.

As we all know, the whole idea behind being a market maker in the first place,  and participating in the marketplace by trading is to make money. Traditionally all firms, brokers and wholesalers alike, are always trying to find more and more ways of generating profits. PFOF is only one small part of that, and while PFOF has been practiced in the industry for many many years, and has afforded wholesalers the opportunity to make more profits from trading and gain exposure and has also afforded brokers the opportunity to increase their revenue on a monthly or quarterly basis by receiving payments from the wholesalers for their order flow, now all of that may soon come to a crashing end.


Sources: Reuters, Wikipedia, Yahoo Finance, U.S. Securities and Exchange Commission,

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Written by

Carmen Lelli

Regulatory Business Analyst, Itiviti

Carmen has over 34 years of experience in the Financial Industry, the past 17 of which have been devoted to the Laws and Regulations of the Financial Industry. He is specialized in SEC, FINRA and CAT (Consolidated Audit Trail).

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