As Adam Prussin reports in the current issue of The Pomerantz Monitor, stock trading in the United States stock market has not only failed to recover since the 2008 financial crisis, it has continued to fall. The New York Times reports that in April the average daily trades in American stocks on all exchanges stood at nearly half of its peak in 2008: 6.5 billion compared with 12.1 billion shares. In contrast, trading returned to normal within two years after the market declines of 1987 and 2001.
Declining trading leads to declining trading commissions, which have apparently led to fierce competition between trading venues for the action that remains. The latest weapon in these trading wars is rebates: exchanges are now paying brokers for sending trades to them. NASDAQ, for example, reportedly paid out $306 million in rebates in the first quarter of this year, or nearly half of its revenue. These rebates go to the brokers, not the customers. That’s not good, because the lure of potentially significant rebates can entice brokers to place the trade on an exchange that does not offer the best price.
Stockbrokers are legally required to seek out the best prices for clients who pay them to buy and sell shares; but that “best execution” rule is riddled with loopholes. For example, a broker may send the first 100 shares of an order to the exchange with the best price, but the rest of the shares to the exchange where the broker will receive a larger rebate.
A new study using industry data reveals that such rebates could be costing mutual funds, pension funds and ordinary investors as much as $5 billion a year. The study, released in early May, was written by Woodbine Associates, a financial consulting firm that does business with players on all sides of the issue. Woodbine said the report was done independently, without support from industry participants.
The study estimates that investors lost an average of four-tenths of a cent on each of the 1.37 trillion shares traded last year because of orders being sent to exchanges that were not offering the best final price. This conclusion comes in the wake of a 2010 report by two former chief economists at the SEC, who concluded that “in other contexts, these payments would be recognized as illegal kickbacks.”