Payment for order flow

Payment for order flow (PFOF) is the compensation that a stockbroker receives from a market maker in exchange for the broker routing its clients' trades to that market maker. The market maker profits from the spread (the difference between purchase price and sale price) and rebates a portion of this profit to the routing broker as PFOF. Some of this benefit may be passed on to the retail customer as price improvement, often measured in fractions of a cent per share. PFOF was a key factor in the elimination of most brokerage commissions primarily in the United States and parts of Europe (see analysis below). PFOF is a controversial practice that has been called a "kickback" by its critics. It is criticized for culminating in conflict of interests and reducing market transparency. On the other hand, policymakers supportive of PFOF and several people in finance who have a favorable view of the practice have defended it for funding new investment apps, low-cost trading, and more efficient execution.

Legality and usage

United States In the United States, accepting PFOF is allowed only if no other exchange is quoting a better price on the National Market System. The broker must disclose to the client that it accepts PFOF. Transactions must be executed at the best execution, which could mean the best price available or the speediest execution available. Market makers including Citadel LLC, Virtu Financial, and Susquehanna International Group pay PFOF. Brokers in the United States that accept PFOF include Robinhood Markets, E-Trade, Ally Financial, Webull, TradeStation, tastytrade, and Charles Schwab Corporation, while brokers that do not receive PFOF include Interactive Brokers (pro accounts that are charged commissions), Merrill Edge, Fidelity Investments, and The Vanguard Group.

Within organizations At the brokerage level, PFOF has fundamentally restructured how firms generate revenue. Rather than charging clients directly, brokers monetize the act of routing, essentially selling access to their customer base to market makers. In some cases, PFOF accounted for over 60% of a brokerage's revenue. Lexology Robinhood is the most extreme example (see below).

On the market maker side, firms like Citadel Securities and Virtu Financial use a process called internalization where wholesalers typically execute orders in house in an internalization process, which fills orders with the firm's own inventory of stocks, allowing wholesalers to make money through spreads. Essentially, instead of sending your order to a public exchange to find a counterparty, the market maker itself takes the other side of your trade, pocketing the spread. In 2014, broker-dealer Robinhood Markets introduced no-commission retail stock trades funded by PFOF. In 2021, transaction-based revenues (primarily PFOF) were responsible for over 77% of Robinhood's net revenue, with its $1.4 billion in transaction-based revenues split across options (49%), crypto assets (30%), and equities (21%). Other retail brokerages followed Robinhood's footsteps, and in 2020, PFOF received by stockbrokers totaled $2.5 billion. A 2014 investigation by the United States Senate Homeland Security Permanent Subcommittee on Investigations, led by Carl Levin, conducted hearings focused on the conflicts of interest inherent in PFOF. At the hearings, an executive for TD Ameritrade said that it routes orders to wherever it can get the highest payment. In January 2021, after the GameStop short squeeze, officials again questioned whether retail traders were getting the best possible prices on their orders. Brokers sold their orders in bulk to market makers that executed the trades, a practice that came under scrutiny during the GameStop short squeeze and subsequent meme stock events. Certain platforms, such as Public.com, announced that they would abandon PFOF and add Safety Labels to stocks rather than halt trading.

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