Payment for order flow

In financial markets, payment for order flow refers to the compensation that a broker receives, not from its client, but from a third party that wants to influence how the broker routes client orders for fulfillment.[1] It is a controversial practice that has been called a "kickback".[2] In general, market makers such as dealers and securities exchanges are willing to pay brokers for the right to fulfill small retail orders, since these can be matched more easily than large orders.[3] The payment can be in the form of a direct cash incentive, a non-monetary service, or a reciprocal arrangement between broker-dealers to route particular order classes to each other. Market orders are typically preferred.[4]


Payment for order flow was pioneered by Bernard Madoff. He described it as a way for market-makers to outsource the task of finding orders to fulfill, and compared it to retail arrangements in which a supplier pays for the rack on which its products are displayed.[2] Although the practice was uninvolved in Madoff's later fraud scheme, it has long been controversial.[5][6][7] The New York Stock Exchange opposed its use for years, but in February 2009 it sought permission from the U.S. Securities and Exchange Commission (SEC) to adopt the practice on its electronic exchange(s).[8] Payment for order flow has become less lucrative on a per share basis because of the decline in the tick size and the bid/ask spread. When stocks traded on 1/8 of a dollar, payments for order flow were much larger than they became after 2001 when the tick size in U.S. markets fell to one cent.[4][5] Larry Harris reported that in 1997, 24% of E-Trade's transaction revenue came from payment for order flow, but that by the second quarter of 2001 such payments accounted for only 15% of transaction revenue.[4]

A boom in payment for order flow was a key factor in the retail brokerage industry's move toward a zero-commission model in 2019, with startup Robinhood seeing an estimated threefold year-over-year increase in its routing revenue.[9]


The benign view is that in competitive markets, payment for order flow may allow smaller trading venues to compete more effectively with the NYSE.[10] Additionally, since retail orders have a lower chance of adverse selection for the market maker, they are less risky and thus cheaper to fill. These savings are passed on in part to the broker as payment for order flow, but also to the retail customer as price improvement: market makers often fill retail orders at a better price than the "best execution" available on public exchanges. The additional revenue for brokers allows them to cut trading fees, fueling the rise of low-cost and commission-free trading for retail investors.[11][12]

A more negative view is that exchanges and other market-makers who pay for order flow reduce liquidity on exchanges that do not pay for order flow and thus increase the bid–ask spread. As retail orders are internalized by broker-dealers and large institutional orders are shifted to dark pools, the remaining orders on public exchanges are mostly highly informed traders.[13][citation needed] This increases the risk of adverse selection for market makers, which is compensated by larger spreads.[11][14] This means that traders whose orders do not receive payment bear the cost to their detriment.[15][failed verification] Joel Seligman has noted that "Few practices are more likely to subvert quote competition" than payment for order flow.[10] John C. Coffee has described it as a "bribe".[16] He notes, however, that the SEC permits the practice because it sustained competitors to the NYSE and reduces the likelihood that NYSE specialists will obtain monopoly power.[17]


In the United States, accepting payment for order flow is only allowed if no other trading venue is quoting a better price on the National Market System. Moreover, the broker must inform its client in writing that it accepts payment for order flow:


  1. ^ U.S. Securities and Exchange Commission (2007-06-25). "Payment for Order Flow". Retrieved 2019-04-24. CS1 maint: discouraged parameter (link)
  2. ^ a b McMillan, Alex Frew (20 May 2020). "Q&A: Madoff talks trading". CNN Money. Archived from the original on 17 August 2020. Retrieved 3 September 2020. It was characterized as this bribe and kickback and something sinister, which was very easy to do. But if your girlfriend goes to buy stockings at a supermarket, the racks that display those stockings are usually paid for by the company that manufactured the stockings. CS1 maint: discouraged parameter (link)
  3. ^ Div. of Mkt. Reg., SEC, Market 2000: An Examination of Current Equity Market Developments, 22 (1994).
  4. ^ a b c Harris, Larry (2003). Trading and Exchanges: Market Microstructure for Practitioners. Oxford University Press. pp. 155, 518–519. ISBN 0195144708. Retrieved 2009-03-13. CS1 maint: discouraged parameter (link)
  5. ^ a b Farrell, Greg (December 23, 2008). "SEC inaction that helped fuel scheme". Financial Times. Retrieved April 5, 2009.
  6. ^ Frank, Allan Dodd (March 31, 2009). "Former NYSE Chairman Grasso Speaks, Part II". The Daily Beast. Retrieved April 5, 2009. CS1 maint: discouraged parameter (link)
  7. ^ Pellecchia, Ray (December 30, 2008). "'Payment for Order Flow': Madoff's Earlier Days". Seeking Alpha. Retrieved April 5, 2009. CS1 maint: discouraged parameter (link)
  8. ^ NYSE Alternext US, LLC (February 27, 2009). "Proposed Rule Change Amending Schedule of Fees and Charges for Exchange Services" (PDF). U.S. Securities and Exchange Commission. Retrieved April 5, 2009. CS1 maint: discouraged parameter (link)
  9. ^ A controversial part of Robinhood’s business tripled in sales thanks to high-frequency trading firms (April 18 2019)
  10. ^ a b Joel Seligman, "Rethinking Securities Markets", 57 Bus. Law. 665 (2001-2002)
  12. ^ Levine, Matt (December 20, 2019). "You'd Pay Not to See Your Stock Price". Bloomberg.
  13. ^ Degryse H, de Jong F, van Kervel V (June 13, 2014). "The Impact of Dark Trading and Visible Fragmentation on Market Quality". Review of Finance. 19 (4): 1587–1622.
  14. ^ Bartram SM, Fehle F, Shrider DG (February 4, 2008). "Does Adverse Selection Affect Bid-Ask Spreads for Options?". Journal of Futures Markets. 28 (5): 417–437.
  15. ^ Henriques, Diana B. (December 19, 2008). "Madoff Scheme Kept Rippling Outward, Across Borders". New York Times. Retrieved April 5, 2009. CS1 maint: discouraged parameter (link)
  16. ^ John C. Coffee, "Brokers and Bribery", N.Y.L.J. Sept. 27, 1990 at 5
  17. ^ John. C. Coffee and Hillary A. Sale, Securities Regulation, p. 29, 2009.
  18. ^ "Payment for Order Flow". U.S. Securities and Exchange Commission. Retrieved April 5, 2009. CS1 maint: discouraged parameter (link)
  19. ^ The notification on trade confirmations may read as follows "[Brokerage] receives remuneration for directing orders to particular broker/dealers or market centers for execution. Such remuneration is considered compensation to the firm and the source and amount of any compensation received by the firm in connection with your transaction will be disclosed upon request."