Apex Clearing Corporation is readying itself for a crackdown on payment for order flow (PFOF). The clearing firm has apparently been reading the writing on the wall for some time now. Thanks to its impressive senses, it now stands to lead a broad shift toward a new method of clearing trades.
PFOF has been a hot topic of debate over the last two years. The model involves brokerages selling trades in bulk to market makers. Those market makers then take the trades to a clearing house and return the proceeds. Robinhood (NASDAQ:HOOD) ended up changing the entire e-trading industry by implementing PFOF and creating fee-free retail trading. Since the company launched its platform, other companies have also implemented PFOF to keep their market share intact.
While revolutionary in the grand scheme of retail investing, PFOF is quite controversial. PFOF skeptics argue that the practice violates “best execution” requirements enforced by the Financial Industry Regulatory Authority (FINRA). Market makers can execute trades in a way that nets more of a profit for them, rather than executing them in a way that minimizes the bid-ask spread for retail investors. These critics call the model a kickback for brokerages as well, and they have reason to label it as such. A significant portion of Robinhood’s revenue comes solely from PFOF.
PFOF is coming under intense scrutiny especially following the controversies surrounding the meme-stock boom of early 2021. After Robinhood froze trading of certain stocks that many hedge funds were shorting, some accused the company of bending its knee to Citadel Securities. Citadel Securities is a sister company to Citadel LLC, a hedge fund that had to spend billions to bail out peer firms that were collapsing as GameStop (NYSE:GME) shares skyrocketed.
Apex Clearing Corporation Gets Ahead of the Curve, Announces PFOF Alternative
Earlier in the week, Securities and Exchange Commission (SEC) Chair Gary Gensler talked about the SEC’s interest in curbing PFOF. He discussed implementing an auction structure for clearing, similar to a model that exists in the options market. The changes could be painful for companies that will have to rush to catch up if such a model becomes the PFOF replacement. Apex Clearing Corporation, as it turns out, is already leading the charge. It is the company providing this idea to the government body.
Apex clears trades for several sizable brokerages, including SoFi (NASDAQ:SOFI) and Webull. It’s one of the larger players in the retail trading market. And now, it stands to grow its stake in the industry as it looks to roll out a PFOF alternative.
Apex has noticed the scrutiny the PFOF model has come under in the last couple of years. Anticipating aggressive action from the SEC, Apex has been preparing its own solution by way of the auction model. Apex is actually the source that provided the SEC with this idea in the first place.
Under the potential new model, clearing firms and market makers alike would compete to buy retail investors’ trades. Apex says that this model would create greater competition, which would in turn lead to better execution of investors’ trades. It would cut down on the monopolization of execution and disincentivize poorer execution.
Apex is ready to roll out its new model, giving it a head start if the SEC were to ban or limit the scope of PFOF. All the company needs is SEC approval.
On the date of publication, Brenden Rearick did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.