Can Brokers Have It All?
Robert Battalio, University of Notre Dame
Shane A. Corwin, University of Notre Dame
Robert Jennings, Indiana University

We identify retail brokers that seemingly route orders to maximize order flow payments: selling market orders and routing limit orders to venues paying large liquidity rebates. Because venues offering high rebates also charge liquidity demanding investors high fees, fee structure may affect the arrival rate of marketable orders. If limit orders on low-fee venues fill when similarly priced orders on high-fee venues do not, routing orders to maximize rebates might not always be in customers’ best interests. Using proprietary limit order data, we document a negative relation between several measures of limit order execution quality and the relative fee level. Specifically, we show that when ‘identical’ limit orders are concurrently displayed on two venues, orders routed to the low-fee venue execute more frequently and suffer lower adverse selection. Using the NYSE’s TAQ data, we show that the negative relation between take fees and execution quality extends beyond our proprietary data set.

Exchange maker-taker pricing schemes can affect order submission decisions that brokers make to the disadvantage of their traders. Investment managers must be familiar with how these decisions can disadvantage them.