The way the stock market works could be massively altered

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Wall Street’s top cop has voted for fundamental changes in the way millions of investors buy and sell stocks on a daily basis.

The Securities and Exchange Commission on Wednesday proposed a rule that would add competition to an invisible — but potentially costly — part of the stock trading system for retail investors. The changes have not yet been implemented – a vote in the spring could finalize the rules. But the agency is majority-controlled by Democrats and the proposal is expected to go through next year.

Today, when you buy or sell a stock in an app, the trade appears to be instantaneous. But beneath this simple buy/sell action lies a complex web of Wall Street players exploiting tiny price differentials to rake in vast amounts of money.

When you tap “Buy” or “Sell,” the broker like Robinhood or E*Trade routes your order to a company known as a wholesaler or market maker – middlemen firms who are there to get you the best price. Wholesalers pay brokers for the privilege of executing the trade.

This process is referred to as “payment for order flow”. To support free trade, brokers typically earn pennies from wholesalers on every transaction — but those pennies add up and make up the majority of broker earnings. The SEC said the top six wholesalers collectively paid $235 million to retail brokers for inventory order flow in the first quarter of 2022.

The order flow payment has come under intense scrutiny by regulators following the fallout from the January 2021 launch of meme stocks like GameStop. The SEC notes that wholesalers typically do business “without offering other market participants an opportunity to compete for a better price.”

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The changes proposed by the SEC would create more competition at the intermediary level to ensure retail investors are actually getting the best prices. Orders would be routed into auctions where commercial firms would have to compete to fill them.

SEC Chairman Gary Gensler has long criticized the way the current order flow payments market works, arguing that it lacks transparency and competition to the detriment of investors.

Gensler and other critics of the process say the brokers and market makers have conflicts of interest and that being paid for the flow of orders hurts everyday investors while amassing vast wealth for Wall Street firms.

“Today’s markets are not as fair and competitive as they can be for individual investors — everyday small investors,” Gensler said. “This is partly because there isn’t a level playing field between the different parts of the market: wholesalers, dark pools and lighted exchanges.”

Gensler noted that ordinary people don’t have the same advantages as larger, cashier investors, who can often fill orders at the best possible price.

“Markets have become increasingly out of sight, particularly for retail investors,” Gensler said. “Therefore, today’s proposal aims to create more competition in the market for retail orders.”

– CNN’s Allison Morrow contributed to this report