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The stock market has changed dramatically in recent years. It's becoming ever more complex, with many more exchanges where trades can be made. A recent study by professors at Notre Dame and Indiana University found that, increasingly, exchanges are paying big retail brokers to send trades their way. And they found that put some investors at a disadvantage. Today, the Senate Permanent Subcommittee on Investigations took a look at the issue. NPR's Jim Zarroli reports.
JIM ZARROLI, BYLINE: The hearing looked into what's known on Wall Street as the maker-taker pricing system. Simply put, there are a lot of new exchanges of all kinds, and they are hungry for business. So they pay big retail brokerage firms, like Scottrade and TD Ameritrade, to steer trades their way. Democratic Senator Carl Levin of Michigan.
SENATOR CARL LEVIN: This money, known as payment for order flow, can add up to untold millions. And almost every retail broker keeps these payments rather than passing them on to clients.
ZARROLI: But the payments to brokers vary a lot, depending on what kinds of trades are being executed. And in some cases, brokers have to pay fees. That means brokers have an incentive to carry out some kinds of trades before others. And some trades get executed last or not at all, says Robert Battalio, a Notre Dame finance professor. He says, this as a built-in conflict of interest, and it can hurt investors.
ROBERT BATTALIO: They're putting you at the back of the line at a price all the time. And so if the line doesn't fully exhaust, you go wanting.
ZARROLI: Battalio and his co-authors looked at four big retail brokerage firms. One of them, TD Ameritrade, sent senior vice president Steven Quirk to address the report. Quirk told the senators that his firm decides where to send orders based on the quality of the exchange. And only after that does it consider revenue opportunities.
BATTALIO: We strongly believe that compliance with best execution obligations and proper disclosure, brokers can effectively manage any conflict that may arise from payments.
ZARROLI: Republican Senator Ron Johnson of Wisconsin also took issue with the report. He told Battalio that the amount of money brokerage firms get for each trade under the maker-taker system is tiny.
SENATOR RON JOHNSON: You're concerned about a conflict of interest, where I might have to pay an additional 40 cents on a $2,000 trade. Is that what this is about, really?
BRAD KATSUYAMA: No, it's about the fact that you didn't get to trade, so your assumption that you trade is wrong.
JOHNSON: But I obviously have been able to trade.
KATSUYAMA: Maybe you have.
ZARROLI: Johnson also pointed out that stock trading has become a lot less expensive than it used to be for investors, partly because technology has driven down the cost. But Brad Katsuyama, CEO of IEX Group, responded that money wasn't the issue.
KATSUYAMA: You can try to minimize it by trying to, you know, relate, you know, how much its pennies, et cetera, people are holding for years. But this is a principle-based issue. And it comes down to, you know, the foundation of why the markets exist and people's trust in those markets.
ZARROLI: Katsuyama was the central character in "Flash Boys," Michael Lewis's book about high frequency trading. Katsuyama's view was echoed by the head of the New York Stock Exchange, Thomas Farley. He said, it was frustrating that individual investors aren't coming back into the stock market, even though the U.S. economy has improved. That may be because so many people were burned by Wall Street during the recession and no longer trust the markets. And he said, even the appearance of a conflict of interest can make the problem worse. Jim Zarroli, NPR News.
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