SEC Proposal Requires Brokers to Disclose ‘Order Flow’ Fees

Stockbrokers who are paid to steer orders to firms that trade stocks through off-exchange trading systems such as Nasdaq should be required to disclose the payments to investors, federal regulators proposed Wednesday.

The rule was suggested by the staff of the Securities and Exchange Commission as a way to help investors get the best deals when trading stocks.

The SEC voted Wednesday to ask the public what it thinks about the idea.

Commissioners also voted to set in motion a plan to cut the number of days required to complete stock transactions from five business days to three, to eliminate uncertainty during market crises.

The stockbroker fees, known as payment or inducement to order flow, have received a lot of attention on both Wall Street and Capitol Hill.

Payments usually consist of a penny or two per share, but they can also come in the form of so-called soft dollar inducements, such as discounts on trading fees or rebates.

Big stock exchanges, such as the New York Stock Exchange, have decried payment for order flow as an evil that denies investors the best possible price and amounts to “commercial bribery.” They claim that trading on auction markets gives the best deal for investors.

In testimony before a House subcommittee last spring, NYSE Chairman William H. Donaldson urged Congress to outlaw cash payments, even though the Big Board offers rebates to brokers who route their retail orders through an automated trading system it operates.

The exchanges have been steadily losing business to the Nasdaq electronic stock market and other off-exchange trading systems that pay brokers for orders.

SEC Chairman Arthur Levitt said cash payments determine how an estimated 15% to 20% of the orders for exchange-listed stocks are routed.

The SEC proposal would require brokers to disclose cash and non-cash payments on the confirmation slips customers receive after a transaction is completed.

The SEC also approved a rule advocated by federal and industry reformers requiring market participants to conclude securities transactions within three business days, rather than the current five. It will go into effect June 1, 1995.

There is concern that a delay in clearing a transaction poses a risk that one of the parties might renege before it is completed. If enough deals fell through, it could cause panic.

Levitt, former chairman of the American Stock Exchange, said speeding up the process will eliminate the uncertainty he saw during the massive selloff of the 1987 stock market crash, which he called intolerable.

“Lowering that uncertainty by limiting the time frame, I think that has got to be done,” said Levitt, acknowledging that the shift will be costly in the short term for securities firms, especially at small firms outside New York.

One of the four SEC commissioners, Richard Roberts, agreed to vote for the measure “reluctantly,” although he said he was not convinced that the risks eliminated by faster settlement outweigh the costs accompanying such an extensive overhaul of the industry.