Feedback About Madoff and Payment for Order Flow

By: Ray Pellecchia

File Under: Miscellaneous, NYSE

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There was an unusually high number of comments and e-mails (OK, it was about 15, but that's more than we usually get!) in response to The Madoff Scandal and Payment for Order Flow, and the Seeking Alpha version of that post, 'Payment for Order Flow': Madoff's Earlier Days. Having the piece run on SA generated some additional feedback, which increases the value of the conversation. Today, I'm going to highlight three of the comments.

From Exchanges:

Thank you for a wonderful article. I have said it in the past and I will say it again, the SEC should be rebuilt from the ground up or delisted. It is undeniably the single biggest impediment to fair trade I have seen in my 21 years on the street. If I misplaced a ticket, or a timestamp was off, I received a letter of admonition after 3,000 dollars in legal fees, but they repeatedly ignored documented missives detailing the Madoff Ponzi scheme, OMG. Worst of all they allow for outright bribery in the form of PFOF. It is a disgrace.
-- David R. Palmer

David -- We might soon get a better understanding of what happened: WSJ.com is carrying an Associated Press article reporting that the SEC's inspector general will testify about the matter on Monday before the House Financial Services Committee. Here's a link to the article.

From Seeking Alpha:

It is rhetorically easy to smear Madoff's market activities with his clearly fraudulent money managing. But we will have to wait for more information to know if there really was a connection.
I had personal experience with several different brokers who passed on the order flow payments to their customers, and the firms themselves had computer systems that sought the best price, order flow payment or not (since anyway it did not go to them).
I think that the NYSE specialist system is pretty good overall, but it has also suffered from abuses from time to time to time again.
-- mplaut

The question is are we better off with a fragmented market or should we have a central market place?
With fragmented markets,dark pools, ECN, ATS, OMS, internalization... other exchanges that trade the same security can regulators oversee all these venues. One thing is certain that the upfront commissions which appear on customers confirmations have come down, but the question is do customers realize that other costs are incurred. How many customers know what payment for order flow means, even though the back of their confirmation acknowledges that fact.
I would hope that when the oversight committee meets that someone asks the SEC commissioner if he feels 100% confident that the regulators can regulate today's fragmented market. Additionally I would like to hear the SEC comment on the benefits of payment of order flow to investors.
-- capitalstructureman

mplaut -- Agreed, we need to learn more before reaching any conclusions. My purpose was to raise questions. It will be interesting to learn the answers, just as I'm surprised to hear that you had brokers who passed along payments for order flow to customers. Also agreed: any system is susceptible to abuse; I think it's beneficial to discuss these issues so we can better understand how to prevent violations of trust and encourage compliance with the rules and the law.

capitalstructureman -- All good questions: Where does the balance of competition versus fragmentation net out? Are we better off today? Do customers know enough about how their trades are handled? Can this new marketplace be regulated effectively? The answers will impact the public's confidence and participation in our financial markets. Again, much more to follow on these issues.

Happy New Year, folks. A little historical trivia to start your year off right:

Today in NYSE History (NYSE.com)
02 Jan. 1929 -- Members began wearing identification badges on the trading floor.

I just realized that this year will mark the 80th anniversary of the Great Crash of 1929. How timely, given the events of last year! Much more to come on that, I'm sure.

BTW, in the spirit of transparency and because these posts can travel far and wide (I wish!), I'm adding an explicit disclosure statement to each post, which will echo what's already stated in our "About" and "Authors" pages.

Disclosure: The author is vice president of Corporate Communications at NYSE Euronext and owns shares of the company.