The GameStop saga, the subsequent media coverage, and the high-profile congressional hearings have brought retail trade executions in spotlight. Many small investors got visibility into the nuances of how their orders are handled, something they had not thought about much before.

Two terms were oft-repeated – “Best Execution” and much maligned “Payment for Order Flow (PFOF)”. Listening to the media coverage and various testimonies, one got a perception that Best Execution and PFOF cannot co-exist, which means one comes at the expense of the other. That is not entirely true, as I will explain in a moment.

First: What is Best Execution? In very simple terms, it is a trade execution that a client gets, after his or her broker has made efforts to search for the best price in the fragmented US market including liquidity outside the exchanges.

When a retail broker sends a customer order directly to a pre-determined market maker, by-passing the entire US liquidity scattered elsewhere, did retail customer get best execution? No, he did not. There was no search for better prices, the cornerstone of best execution. All the claims retail industry participants made about delivering best execution on public forums recently, were inaccurate. They can claim they provide good execution, but not best execution.

Second: PFOF – What is it? Why it exists? Why US Regulators allow it?

PFOF is the cash payment that retail brokers receive for delivering the retail orders directly to one of the predetermined market makers. Retail order normally gets a nominal price improvement or PI ( a term used to measure how much the price was better compared to the best quote displayed on the exchanges) in the execution. PFOF, and PI to a large extent, are predetermined arrangement between retail broker and market maker and are not decided in real-time or on per order basis. That is, the retail orders are handled at a bulk level through a predetermined PFOF arrangement. Unlike other modern market system, where terms of trade are decided in real-time and on per order basis, retail trading seems to be working based on an archaic model.

So why does PFOF exists at all?

To get to the answer, we need to look at the genesis of a retail order.

By construction, retail orders are small and “uninformed” in a variety of ways (For example, lack of access to information, lack of directional insight into the immediate market move, etc. etc.). It is sufficient to say that such construction of retail orders has value for many market participants, including market makers.

To such market participants, executable retail order holds two sets of values:

• 1) Market value of the security.
• 2) Value of the order being “uninformed.”

Because retail order has these attributes, the real execution price should lie between the best bid and ask displayed on the exchanges. The industry practices have mostly chosen to break the compensation for that value into two pieces, PFOF and PI. The broker gets the PFOF and the investor gets the PI.

Retail brokers make an argument that PFOF helps keep upfront commission low (zero commission) and invest in services for their clients. This is mostly correct.

But what about delivering the order directly to a market maker? How can that be defended? Well, the involved parties argue that the retail order would loose most of its value if comingled on a platform, like an exchange, along with other “informed” flow. Hence, a siloed and direct delivery helps market maker provide PFOF. It helps them to help the investor.

So, why have Regulators allowed PFOF?

In my view, they understand that the retail orders deserve the compensation and would not disallow the practice until a better and durable solution is proposed that serves retail investors better.

So, retail brokers have good intentions and market makers are offering a good deal. Then why is there a stigma around current order handling practices and PFOF in particular? The reasons are simple:

• 1) Lack of Transparency with respect to the PFOF arrangement
• 2) Lack of use of modern trade execution technology by retail brokers
• 3) Current retail order handling model does not pass the test of free and fair market.

If the above three are addressed, we can preserve the current compensation for retail orders on a defendable–long term basis. There should be no stigma attached to a practice if intention of participants (retail brokers and market makers) is good. There should be no unnecessary demand on regulators for making more rules when free market competition and technology can solve the problem.

Regulators have shown wisdom by not yielding to the demands of banning PFOF, or tweaking Reg NMS, unless the free market has run out of solutions. The participants making such demands may be lacking the desired credibility to move the needle on regulation.

Whether a retail broker gets a PFOF or not should entirely be based on their competitive strategy and business model. The market and retail broker will decide how they organize their offering. And the retail broker can seek PI only or PFOF only or any combination of both for itself and the customer.

So, what is the solution to destigmatize the retail order handling practices and build a durable model which works only with one objective – deliver the best deal for a retail order, in real-time, searching the entire US market?

Current regulatory environment, combined with technological innovation, makes it possible to deliver the desired outcome.

We can have an integrated price search and trading platform, that makes possible for all the participants in the US market, not just the PFOF market makers, to compete for retail orders. Retail brokers can control, ON PER ORDER BASIS, their preference of PI, PFOF or any combination of the two. The integrated platform will identify the best outcome for retail order with full transparency.

RTX Technologies LLC is executing this vision and we are deep into building our platform. The system is simple, elegant, and inclusive. It will provide every participant in the US market an opportunity to compete, in a free, fair, and transparent manner, for retail orders. Retail orders would get the BEST, and not just a good deal.

RTX is entering the marketplace with a constructive and innovative technological solution for an important problem that has implications for small investor participation in the US market. We have no biases, and we see a potential partner in every market participant.

We have no conflicts and only one agenda – create and deliver the best trade outcome for every single retail order, in real-time, based on the wishes of the owner of the order. We will have fully protected intellectual property to help us deliver that outcome. Our argument is deeply rooted in the idea of delivering free and fair competition in a transparent manner for retail orders.