Payment for order flow: designed by Madoff, adopted by brokers everywhere

It has long been illegal for a brokerage to front run their customers’ trades; but outrageously, today it is not considered illegal for brokerages to sell their client trades to market makers (HFT) who profit by front-running those orders with rapid speed computers and unfair co-location advantages they purchase off of public stock exchanges. Ironically these skim-scams were deployed early on by fraudster-extraordinaire Bernie Madoff and have been widely adopted since he went to jail.

Now most broker/dealers (Charles Schwab, TD Ameritrade, E*Trade, Scottrade, Fidelity, to name just a few) sell their customer orders to the highest-paying HFT abuser, ripping off 100’s of millions in profits from the savings of unsuspecting customers even while assuring that the theft is in our own best interests for ‘liquidity’.  Meanwhile it has been proven time and again that HFT ‘liquidity’  vanishes as soon as selling pressures mount and markets enter stress.

Repulsive.  This  business model has spread unhampered for years now because we, the people, have allowed it and revolving door regulators have been paid to cooperate with perpetrators while meeting dominant front-runners like Citadel and Virtu in regular behind door, off-record consultations.  The public should be outraged at this systemic theft.  If they refused to use abusing brokers the practice would end, because without complacent retail flows, HFT firms would be out of sitting ducks to shoot at.

Today, at long last, former U.S. Stock Exchange Official, John C. Marchisi published an honest confession about these policies.  There will be more to come.  See Theft of opportunity, the impact of regulation NMS on the retail investor:

“…payment for order flow as a legalized policy and practice, results in the complete and total destruction of opportunity for the retail investor to succeed in the marketplace. The practice is both inequitable and predatory. Moreover, when combined with certain rules and exemptions known on the street as the “Madoff Exemptions”, irreversible damage is being done on a daily basis to the industry’s reputation as a whole.

…I would say it can be argued that this policy is responsible for spawning a new form of insider trading, as the purchasers of these orders then possess both an advanced, and privileged knowledge of the competition’s intent, which is then exploited for profit. Insider trading has previously been defined as using non-public information to gain advantage in anticipation of what the public might do once the information is released. How is it that now removing the need for any anticipation, and gaining that same advantage through the knowledge of instead the actual intent of the public in real-time, any less malicious and damaging?

As an industry tasked with conducting a fair and orderly market, originally designed to provide equal opportunity for all participants, herein currently lie massive failures, which need to be reassessed immediately…you can ask yourself, why is order flow the target of such fierce competition? Well the simple answer is that given the current rules, retail order flow is an all but a sure thing in regards to using it to turn a profit, a new gold rush of sorts.

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