But that’s not what is happening. Instead, brokers routinely take kickbacks, euphemistically referred to as “rebates,” for routing orders to a particular exchange. As a result, the brokers produce worse outcomes for their institutional investor clients — and therefore, for individual pension beneficiaries, mutual fund investors and insurance policy holders — and ill-gotten gains for the brokers.
Although the harm suffered on each trade is minuscule — fractions of a cent per share — the aggregate kickbacks amount to billions of dollars a year. The diffuse harm to individuals and the concentrated benefit to Wall Street create yet another way in which the system is rigged, justifiably eroding public confidence in the fairness of the financial system.
This is how it works: The likelihood of executing a trade at the best price depends on the length of the queue to buy or sell and the incentives to trade. Longer queues lead to longer delays to execute a trade. Delays typically lead to worse outcomes. Quite simply, it makes no sense to wait on a longer line to receive a worse execution.
And yet, brokers choose longer queues hundreds of thousands, if not millions, of times a day. Publicly available trade and quote data show that the queues to buy or sell stock are considerably longer on exchanges that offer kickbacks. Even though the queues decrease the likelihood of getting a trade completed and impair the price performance after the trade is executed, brokers still direct trades to these places because of the kickbacks they receive.
