For anyone who has not yet read Michael Lewis’s new book, “Flash Boys”, I recommend that you do.
Over the past few years, a dirty little secret of many broker/dealers has been their selling of their client order executions to the highest bidder. TD Ameritrade is just one of the many. Over the past 4 years, TD has been selling off some of its traditional business lines (like custodian/brokerage/back office services in support of Investment Counsel firms like our own) to focus on more “profitable areas”, to wit: areas where they can use and abuse unsuspecting customers without anyone questioning their practices. Here is a sampling from Lewis to explain:
“By the summer of 2013, the world’s financial markets were designed to maximize the number of collisions between ordinary investors and high-frequency traders–at the expense of ordinary investors, and for the benefit of high frequency exchanges, Wall Street[and Bay Street] banks, and online brokerage firms. Around those collisions an entire ecosystem had arisen.
Brad had heard many firsthand accounts about the nature of that ecosystem. One came from a man named Chris Nagy, who, until 2012, had been responsible for selling the order flow for TD Ameritrade. Every year, people from the banks and high frequency trading firms would fly to Omaha, where TD Ameritrade was based, and negotiate with Nagy. “Most of the deals tend to be handshake deals,” Nagy said. “You go out to a steak dinner. “We’ll pay you two cents a share. Everything is good.” The negotiations were always done face-to-face, because no one involved wanted to leave a paper trail. “The payment for the order flow is as off-the-record as possible.” said Nagy. “They never have an email or even a phone call. You had to fly down to meet with us.” For its part, TD Ameritrade was required to publish how much per share they were making from the practice but not the total amounts, which were buried on its income statements on a line labeled “Other Revenue.” “So you can see the income, but you can’t see the deals.”
In his years selling order flow, Nagy noticed a couple of things…the rapid growth in the number of stock markets, and in high-frequency trading–raised the value of a stock market customers’ order. “It caused the value of our flow to triple, at least.” Nagy said. The other thing he couldn’t help but notice was that not all of the online brokers appreciated the value of what they were selling. TD Ameritrade was able to sell the right to execute its customers’ orders to high-frequency trading firms for hundreds of millions a year.”…what Nagy did know was that the simple retail stock market order was, from the point of view of the high-frequency traders, easy kill.” (p 179)
Every customer should be asking their broker/dealers for information on how they are selling their best interests to the highest bidder. While many people are now focused on how customer orders are being routed around different exchanges, few have yet grasped the pivotal and lucrative roll that many account custodian/brokers are playing in the abuse of trust of vulnerable customers by selling their order flows.
Clandestine meetings, hand-shakes, winks and nods. It is a despicable display of the corrupt cartels that investment banks have become. Outrage, law suits and customer demands for change are needed to expose a host of many indefensible practices to the light of day.
