3. Payment for order flow and the zero commission

Costs 3: Where your order really goes

This is the mechanism that has generated the most noise in the past decade and, at the same time, the worst explained. It boils down to a single sentence: there are firms willing to pay your broker for the right to execute your orders. It sounds like a scandal, but to judge it you have to understand why they pay, what each of you receives in return, and why regulators of equal seriousness have reached opposite conclusions.

Who pays whom, exactly

Payment for order flow is a payment that a wholesaler — that is, a proprietary trading firm executing large volumes of retail orders — hands to a broker in exchange for having those orders routed to it. The money travels from the wholesaler to the broker, and its size is expressed in cents per hundred shares or as a fraction of the amount traded. In the United States, a small group of firms, Citadel Securities and Virtu among them, takes in most of that flow.

Note what this implies. Your broker is not paid for representing you, it is paid for handing you over. And the wholesaler is not buying a service: it is buying the right to be your counterparty. None of it happens in secret; it is in the contracts, in the public routing reports and in the income statement. But it changes the nature of the relationship most people believe they have with their broker.

Why retail flow is worth money

The key is adverse selection. A market maker earns the difference between the price at which it buys and the price at which it sells, and it loses when its counterparty knows something it does not. If the seller is a fund that has spotted a problem at the company, the price will move against the market maker immediately afterwards.

Retail flow has a statistical property of enormous value: it is uninformed. A private investor buying two hundred shares is not doing so because they know something the market does not, but because the salary has come in, they have read an article or they have decided to rebalance. In aggregate, their orders do not anticipate the movement of the price, so the market maker can quote tighter: its risk of ending up on the wrong side is far lower. It is not paying for the chance to deceive you, it is paying to trade against somebody who is almost certain to do it no harm. The economic logic is sound.

Price improvement is real, and still not enough

Out of that comes price improvement: the wholesaler executes better than the best available public price because it can afford to. The numbers make it plain. A share is quoted at 20.00 bid and 20.04 offered, with the midpoint at 20.02. On the market you would pay 20.04; if the wholesaler fills you at 20.03, you have saved a cent a share, and that saving is real money that would show up in any audit.

And even so, look at the whole sum. Against the midpoint, which is the theoretically fair price at that instant, you are still paying a cent. The wholesaler keeps half the spread minus what it has given back to you, and out of that difference it pays your broker and funds its own profit. The improvement is genuine and the result may still not be the best one available, because the bar it is measured against is a low one. Both statements are compatible, and anybody who defends only one of them is simplifying.

The case made by those who defend it

It is worth setting out properly, because it is not a weak argument:

• The commissions really did disappear. The explicit cost of trading for an American private investor went from between five and ten dollars a trade to zero. For small portfolios, that saving comfortably exceeds the cents lost in the spread.
• Aggregate price improvement is substantial. Wholesalers execute inside the published spread as a matter of routine, something a private investor cannot manage alone in the book.
• Access widened. With no minimums and no commissions, investing small amounts stopped being absurd.
• The alternative is not free. Ban the payment and the broker recovers that revenue by another route, and it is not proven that the net outcome for the small client improves.

The underlying criticism is not weak either: the broker decides where the order goes guided by who pays it most, not by who executes best, and those two criteria coincide only by accident. The serious argument is not whether the payment is wicked, but whether competition between wholesalers is enough to keep the conflict from ending in a worse price.

What the regulators have decided

Jurisdictions have answered differently, and the map matters:

• United Kingdom. The regulator banned the practice in equities in 2012, as incompatible with the rules on inducements and with the duty to act in the client's best interest.
• European Union. The review approved in 2024 bans payment for order flow. There was a transitional period for the member states where it was already permitted — only Germany took it up — but it expired on June 30, 2026, so that from July 1, 2026 the ban applies without exception across the whole Union.
• United States. It remains permitted and subject to disclosure obligations. In 2022 the regulator proposed putting retail orders through competitive auctions before they could be internalized, but the proposal went nowhere.

A real case: Robinhood's 65 million

In December 2020, the SEC settled with Robinhood for 65 million dollars. The charge was not taking payment for the flow, which was legal, but concealing it: the firm presented itself as a match for its competitors on execution prices while leaving out that payment for order flow was its main source of revenue. The order concluded that, even after netting off the saving from paying no commissions, clients had received worse prices to the tune of more than 34 million dollars.

That is the figure to hold on to. It does not say that the zero commission is a fraud: the saving was real and it is netted off in the calculation. It says that, once netted off, a negative balance remained. Free did not mean cheap, it meant the price had moved somewhere you were not looking.