A war of words is breaking out between two top U.S. online brokers over a heavily debated revenue source that has taken on newfound importance for the retail trading industry.
After a series of price-cutting moves from Charles Schwab Corp., E*TRADE Financial Corp. and TD Ameritrade Holding Corp., among others, that eliminated commission fees, payment for order flow is gaining renewed attention as a more stable revenue source.
 Charles Shwab CEO Walt Bettinger II recently took aim at rival Fidelity Investments for what he said was the company's decision to not tell "the whole story" about its payment-for-order-flow arrangements. |
The practice entails selling retail investors' stock orders to the biggest and fastest trading firms for execution. The involvement of those high-speed trading firms has made payment for order flow a lightning rod on Wall Street. Payment for order flow has been credited by its supporters for helping lower trading costs for end users, as it subsidizes at least part of the revenue lost when an online broker lowers commission fees. But critics say the practice may also create conflicts of interest in how brokers route their clients' orders.
That tension was recently on full display when Schwab CEO Walt Bettinger II took aim at Fidelity Investments over its statement that it does not accept payment for equity order flow. Bettinger specifically cited Fidelity's use of payment for order flow in options and its internalization of clients' stock trades that are then executed against institutional orders on an off-exchange trading venue that Fidelity controls.
"I have a lot of respect for Fidelity as an organization," Bettinger said Oct. 18 during the company's fall business update. "But I do think, as of late, they are not necessarily telling the whole story."
Privately held Fidelity fired back at Bettinger's remarks in a statement.
"Fidelity puts the interests of its customers first. Schwab is trying to distract from the issue and confuse investors," a Fidelity spokesperson said in an email. "Schwab gets paid at the expense of their customers on equity orders — Fidelity does not. Schwab has an opportunity to give their customers a better price and they do not."
After scrapping commission fees for most online trades and wiping out millions of dollars in revenue in the process, the major U.S. online brokers have been grappling with different ways to compensate for the decision. Some companies have detailed expense-cutting plans, while others may be considering M&A.
But the move to zero has also pushed analysts to focus on the role that payment for order flow will play at certain online brokers, including Schwab. The San Francisco-based online broker reported that it generated $139 million of order flow revenue in 2018, versus $114 million in 2017 and $103 million in 2016. That still represented a small slice of its $10.13 billion in annual net revenues during 2018, though.
Fidelity, which is the sole major U.S. online broker that does not accept payment for equity order flow, explained that it provides "retail investors with access to better prices" by internalizing their stock orders. The company's spokesperson added that Fidelity uses payment for order flow in the options markets because those are "structurally different than equities."
"Options orders require the use of specialized options brokers to facilitate price improvement, all options trades must occur on exchange and are subject to exchange pricing mechanisms," the spokesperson said. "As with equity trading, Fidelity seeks best execution for its customers in options and is supportive of efforts to make options execution quality and economics more transparent."