It has never been easier for all Americans, regardless of financial means, to participate in the stock market. Due in large part to the prevalence of “commission-free trading” apps, retail investors accounted for nearly one-fifth of U.S. equity trading volume in 2020, double compared to a decade prior. We should all celebrate that more young people and those with modest means have access to trading markets that could help grow their wealth over the long term. Unfortunately, overzealous lawmakers and regulators in Washington, D.C. have put commission-free trading in their crosshairs. If they succeed, it could mean an end to the creative tools that have democratized investing for everyday people – an outcome that would benefit the few over the many.
The march toward commission-free trading began in earnest in 1975 when regulators abolished fixed trading commissions, but the practice stayed limited until the past decade. It wasn’t until Robinhood began offering no-commission trades in 2013 that the industry began to change its business model. In order to remain competitive in the market, the largest players in the trading world, like Charles Schwab, TD Ameritrade, and E*Trade all began offering zero commission-trading services in 2019. Thanks to free market competition and innovation, the new price for trading, seemingly overnight, became $0.
But how can companies offer trading services at zero cost? In order to remain a financially viable enterprise whilst also providing customers with $0 trades, trading platforms utilize a process known as Payment For Order Flow”(PFOF). Under this model, trading platforms such as Robinhood route customers’ orders to market makers who execute the trade, and in return, provide payment to the trading platform. It’s a win-win-win scenario: the market maker earns revenue between the bid and offer price; Robinhood makes money from the order flow payment; and consumers benefit from the absence of high-cost commissions.
PFOF has ushered in a new era in investing and leveled the playing field between retail investors and the big firms on Wall Street. No longer are potential investors locked out of the market due to high commission fees: they have access to individual stocks, crypto currencies, and ETFs all literally at their fingertips.
The choice to invest should be left to the investor. It may be true that retail investors are less informed than other professional traders, but raising barriers to retail investors would not create more informed investors. Some investors may choose riskier investments, while others opt for safer trades. However, investing should not just be reserved solely for the well-to-do.
Despite the clear benefits of PFOF, the process has attracted the ire of the Securities and Exchange Commission and some Democrats in Congress. Over the summer SEC Chair Gary Gensler, who has long been a critic of the practice, stated a ban on the use of PFOF was “on the table.” It’s rumored the SEC may move forward on its ban sometime in 2022. Over in Congress, a House committee advanced on a partisan vote a bill to study improvements to PFOF. While studies are usually helpful in determining whether improvements to a particular issue are warranted, the legislation contains a provision that would allow the SEC to ban PFOF before the completion of such a study. NTU was a proud opponent of that legislation when it came before the House Financial Services Committee last summer.
In response to the potential attacks on the mechanism that allows commission-free trading, Sen. Pat Toomey (R-Penn.) introduced legislation that would protect investors and PFOF. His bill, called the Investor Freedom Act, would prohibit the SEC from enacting a blanket ban on PFOF, thus preserving commission-free trading for all.
Making investing harder, more expensive, or less user-friendly is not in the best interest of retail investors.
The widespread adoption of commission-free trading has allowed consumers from all backgrounds and income groups to grow their wealth and has truly democratized investing. Ultimately, the decision to invest should be left to the consumer. While lawmakers may have valid concerns about young people investing, lowering barriers to entry is a positive development made possible in part by commission-free trading. Banning PFOF could undo this progress and make it more difficult for retail investors to participate in the stock market. Lawmakers should stand on the side of consumers, retail investors, and taxpayers by passing Toomey’s important legislation.
