By Jeff Bacidore, Founder and President, The Bacidore Group LLC
A few weeks back, the issue of payment for order flow came to the fore (again) due to an article in the Wall Street Journal suggesting the SEC was considering a large overhaul to how retail orders are handled.[1] Specifically, the article suggested that the SEC may require all retail orders to be executed in auctions, allowing participants to compete for the orders on the basis of price. The proposal has not been put forth and details are not public. Therefore, to use a phrase heard commonly in Supreme Court nomination hearings, I will not be commenting on hypotheticals. And, to use a phrase uttered by Snoop Dog, I am somewhat brain-boggled that the SEC still has not addressed critical issue that is necessary under any retail reform, namely the one-size-fits-all tick size regime.
Reducing the tick size on tick-constrained stocks would arguably reduce one of the inefficiencies in retail executions, namely their inflated bid-ask spreads. Given that quoted prices form the basis for retail executions – whether those done by wholesalers or by the few that manage to somehow sneak their way onto an exchange – reducing the tick size on tick-constrained stocks would lead to significant savings. Furthermore, as pointed out by Phil Macintosh and others, reforming tick sizes would lead to significant benefits to the broader market as well.[2] (In fact, Phil Mackintosh alone has provided so much evidence on the benefits of tick size reform that if you tried to download it all to your phone, your phone would literally get heavier).
So, why hasn’t the SEC moved forward with such an obvious reform? I suspect the primary reason is that it is bundling it into a much broader reform, potentially including auctions. For me, the wait is a bit disappointing as I suspect a lot of ground could be made up right now by taking simple actions, instead of having to wait for reform to come someday. Plus, such reform is required regardless of whether what broader action the SEC chooses to pursue. If the SEC decides to go through with auctions, they need tick size reform. If they decide to do something more straightforward, like an on-exchange requirement, they need tick size reform for market participants to offer sub-penny price improvement like that provided by wholesalers. (The SEC could even couple it with a “retail only” quote if it wants to retain the price- and size-improvements afforded to retail orders by wholesalers via order flow partitioning). In fact, even if the SEC has no intention of addressing PFOF or simply needs more time for broader reform, tick size reform would be useful now.
And one more thing. Doing tick size reform first would allow researchers to tease out the incremental impact of tick size reduction in isolation, uncontaminated by other contemporaneous reforms. Should the SEC decide to move forward on a PFOF ban, with or without an auction requirement, we would be able to assess that change incrementally, without having it obscured by a simultaneous tick size change (and without the need to, God forbid, do another “pilot program” with multiple stock groups representing all the various permutations of rule changes. That would really “tick” me off. Ok, I’m done).
References:
[1] See Kiernan and Osipovich, “SEC Closes In on Rules That Could Reshape How Stock Market Operates”, Wall Street Journal, June 6, 2022. [2] See for example “The Tick-Constrained Stock Problem”, Mackintosh (2022).
