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At Senate Hearing, Brokerage Firms Called Out for Conflicts
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At Senate Hearing, Brokerage Firms Called Out for Conflicts

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At Senate Hearing, Brokerage Firms Called Out for Conflicts

WASHINGTON – TD Ameritrade, a brokerage firm that handles vast numbers of stock trades for average investors, promises to execute those orders on the best possible terms.

But in practice, TD Ameritrade routes a large number of the customer orders to the exchanges that pay it the most, Steven Quirk, an executive at the firm, said at a Senate hearing on Tuesday.

Mr. Quirk was one of several witnesses called before the Senate Permanent Subcommittee on Investigations to discuss potential conflicts of interest in today’s highly fragmented market where upstarts like high-frequency trading firms have been blamed for distorting prices and taking advantage of small investors. Lawmakers zeroed in on payments that brokerage firms like TD Ameritrade accept for routing customer orders to particular exchanges or trading firms.

The issue has divided the stock exchange sector. The president of the New York Stock Exchange, Thomas W. Farley, asserted on Tuesday that a system called maker-taker payments, in which exchanges pay rebates to brokerage firms for orders, created “inherent” conflicts. But the chief executive of the BATS Global Markets exchange company, Joseph P. Ratterman, played down that concern, saying the conflicts could be managed.

But when Mr. Quirk was questioned, the talk was less hypothetical. Senator Carl Levin, Democrat of Michigan, who leads the panel, pointed to data from the fourth quarter of 2012 that showed that TD Ameritrade directed all nonmarketable customer orders — meaning, orders that could not immediately be consummated based on the market price — to one trading venue, Direct Edge. It so happened that Direct Edge paid the highest rebate.

“Your subjective judgment as to which market provided best execution for tens of millions of customer orders a year allowed you to route all of the orders to the market that paid you the most,” Mr. Levin said. “I find that to be a frankly pretty incredible coincidence.”

Mr. Quirk estimated that TD Ameritrade received $80 million last year from such “maker-taker” rebates. He added that in the two years after the quarter that Mr. Levin cited, some of the exchanges to which TD Ameritrade routed orders “would not be the exchanges which were paying the highest rebate.”

But Mr. Levin pointed to different data from the first quarter of this year that showed that TD Ameritrade routed its nonmarketable orders to two markets that paid the highest rebates available. “So, again, your subjective judgment as to which market provided best execution for tens of millions of customer orders virtually always led you to route orders to the markets that paid you the most?” Mr. Levin asked.

“No, not always led us …” Mr. Quirk began.

“I said ‘virtually always,’ ” Mr. Levin responded.

After a short pause, Mr. Quirk said, “Virtually, yeah.”

The heated back-and-forth came near the end of a hearing that spent a lot of time in the weeds of market jargon.
Bradley Katsuyama, chief of IEX Group, at a Senate hearing on high-speed trading.Doug Mills/The New York TimesBradley Katsuyama, chief of IEX Group, at a Senate hearing on high-speed trading.

Regulators at the S.E.C. are reviewing questions of fairness in the stock market and considering recommendations for new rules. Mr. Levin said on Tuesday that “there are steps which must be taken either by regulators or by Congress to deal with conflicts” in the market, though it is not clear that the hearing will lead to any new legislation.

Several witnesses offered only modest recommendations for new policies.

Bradley Katsuyama, the chief executive of the stock trading upstart IEX Group, who made waves this year by proclaiming on CNBC that the markets were “rigged,” tempered his earlier critique. Mr. Katsuyama, who rocketed to prominence after being featured in “Flash Boys,” a recent book by Michael Lewis, is now trying to gain legitimacy for IEX by registering it as a full-fledged exchange.

To achieve that goal, Mr. Katsuyama needs the support of the Securities and Exchange Commission, and he appeared on Tuesday to be fashioning a new role for himself as a more conservative reformer.

“We want to emphasize the point that IEX was created within the current regulatory framework, which shows that the spirit of the rules governing our market allow for different types of solutions to emerge if participants are properly incentivized to create them,” Mr. Katsuyama said.

Senator John McCain, Republican of Arizona and the ranking member of the panel, asked Mr. Katsuyama whether it was accurate to describe the market as “rigged.”

Mr. Katsuyama said that term was “a word that can be used to describe” the disadvantages that certain investors suffer in the market, but he stopped short of endorsing it.

“What it did was, it gave our critics and people who are part of the problem a reason to talk about something else,” Mr. Katsuyama said. “It was a distraction, which was unfortunate.”

The panel’s focus on these issues is already shaping a broader debate on Wall Street. Last week, TD Ameritrade said that it would start to disclose on a quarterly basis information about the payments it receives for routing customer orders to particular exchanges.

But Mr. McCain was not convinced that the stock market was as fair as some of the witnesses on Tuesday suggested. He challenged Joseph P. Brennan, the head of the global equity index group at the Vanguard Group, the mutual fund giant, who noted that Vanguard’s stock funds remained popular with customers.

Mr. McCain said this reminded him of a story about a man in a small town who played poker even though he knew it was crooked, because “it’s the only game in town.”

“Mr. Brennan,” Mr. McCain added, “I don’t accept your allegation that everything is fine.”

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