Payments to Brokers for Orders Probed, May Be Banned : Stocks: Critics say the practice violates trading ethics; proponents say it saves investors money.

Are stockbrokers hurting their customers when they divert investors’ orders to markets that offer the brokers cash fees?

The big stock exchanges think so. They are losing business to outfits that pay for orders, and they want the practice outlawed.

But market makers in the National Assn. of Securities Dealers’ over-the-counter stock market say the fee system is just another way of gaining a competitive edge.

A congressional subcommittee, examining the role of the securities markets going into the next century, is trying to sort this out.

At issue is the practice whereby some off-exchange securities firms and regional exchanges pay stockbrokers for routing customers’ orders to them.

The payment typically amounts to a penny or two per share, but it can also come in the form of “soft dollar” inducements such as discounts on trading fees, or free services such as research or computer time.

The cost of paying for orders is recouped through increased volume of trades and by making money off the spread, or difference between the price the seller asks for a stock and what the buyer is willing to pay.

The New York Stock Exchange and the American Stock Exchange strenuously oppose paying for order flow.

“Cash payments for orders puts the interests of intermediaries ahead of the interest of investors,” and allows the intermediary as well as the customer’s brokerage firm “to benefit at the expense of the investor,” NYSE President Richard Grasso told the House telecommunications and finance subcommittee last week.

“We believe that all forms of payment for order flow should be banned,” he said.

But Bernard Madoff, who heads a very profitable off-exchange securities firm that pays brokers for trades, claimed his operation “saved investors $64 million in 1992 alone.”

He also said that 99% of his company’s business was conducted with NYSE members.