Larry Tabb, founder and CEO of the Tabb Group, has a bone to pick with US Senator Carl Levin over high frequency trading (HFT).

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HFT issues: Eliminating payment for order flow

Tabb said that eliminating payment for order flow, a contentious issue in HFT, would in fact create more challenges and magnify conflicts of interest. Levin has proposed eliminating the little known and often undisclosed practice of stock brokerage firms accepting cash payments from trading venues for investor stock orders.

Jeff Specher, chairman of the ICE derivatives exchange, which purchased the New York Stock Exchange in 2013, vocally called for the elimination of payments for order flow years ago but has been silent on the issue lately.

Dan Collins, editor of Futures Magazine, noted that “payment for order flow has been a bane of the equity and equity options world for more than a decade. It is widely disliked by the competing options exchanges but all have appeared afraid to act unilaterally for fear of losing market share.”

Brokerage firms and high frequency traders have the potential to direct business away from trading venues that oppose payment for order flow.

Tabb opposes eliminating payment for order flow

Tabb, however, opposes eliminating the practice while proposing the behind closed door payments be brought to the surface and viewed in a transparent environment.

“No matter how bad payment for order flow sounds, payment for order flow is a legitimate practice governed by the SEC,” Tabb wrote in a letter to Levin. “Orders must be priced at least as well as the national best bid offer (NBBO), and all executions are covered by best execution rules, which require brokers to execute orders at the most advantageous price to the client.”

In an interview with ValueWalk, Tabb was more blunt and to the point, noting that eliminating the practice of payment for order flow might have harmful unintended consequences, potentially corrupting the system. What type of corruption does Tabb mean?

“I mean down right corruption,” he said in the interview, noting the power and influence the person who makes trade routing decisions might have. Touching on an old issue in the trading pits, where floor brokers filling institutional orders were known be be showered with gifts from grateful pit traders who provided them a riskless edge, Tabb said “there are millions of reasons to give the person influencing stock order flow routing decisions a really sweet gift like a pool, car, suitcase of cash… Who would know?”

Banning the practice doesn’t mean it would disappear.

“The problem with banning payment for order flow is that retail flow is valuable and just banning the practice doesn’t change the value of this order stream; rather, it changes, and possibly corrupts, how that value is harvested,” he wrote in the letter.

Allow mandated minimum spreads

Tabb likes the idea of mandated minimum spreads that “allow market makers to capture a greater amount of the economics than if markets were free to trade with no minimum spread.”

HFT observers have noted that traditional “market making,” posting consistent two sided markets to both buy and sell, has been transformed into a directional strategy that is forced to sometimes rely on questionable HFT trading strategies.  Widening the bid-ask spread allows these market makers to focus on generating two-sided liquidity and doesn’t require them to engage in other, sometimes market moving HFT tactics that are considered damaging to market structure.

Tabb previously told ValueWalk that markets should be more expensive in order to generate more stable behavior.

Link to the full letter to Senator Levin, obtained by ValueWalk: Tabb letter to Levin