U.S. Retail Brokerage Industry Faces Regulatory Probes

For the past few years, regulators, including the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), which regulates brokerage firms, have been probing into how retail customers’ orders are routed, executed, and filled by the brokerage firms.

In August 2017, collecting information related to such practices, Massachusetts’ top securities regulator of FINRA initiated an investigation over the matter.

Notably, the U.S. Treasury Department expressed its concern in the October 2017 blueprint released for streamlining financial regulations. The department was concerned related to payments to brokerages which “may create misaligned incentives” for brokers and their customers. Therefore, the SEC had been requested to increase regulations and disclosures for the firms related to such payments.

The SEC was probing whether retail customers received the best prices and if there was proper execution of their trades. Also, the law enforcement agency was looking into the cash fees, received by brokerage firms from stock exchanges and other trading firms, for routing retail investors’ order through them.

Therefore, this March, the SEC proposed to temporarily restrict fee and rebate payments of stock exchanges, and notice the impact of such move on clients’ order routing and trade execution quality. Following this, last week, an agency has been moved on with the proposal to make the stock market more transparent and fair for clients, on demand of an SEC commissioner.

On increased scrutiny over brokerages’ handling of customer orders, recently, Judge Joseph Bataillon, in the federal court in Omaha, NE, granted his consent for a class-action lawsuit against one of the largest U.S. discount brokerage firms, TD Ameritrade Holding Corporation AMTD. This firm was alleged for breaching its duty in serving customers with best execution of orders.

Per the plaintiffs, in order to earn more profits and gain incentives from stock exchanges and large electronic trading firms, TD Ameritrade routed clients’ orders to these firms. This, in turn, deprived customers from getting the best prices available, referred as “best execution”.

In his ruling, the judge referred to “serious and credible allegations of securities fraud” which is expected from the company’s order routing practices. Per the spokeswoman of TD Ameritrade, the company disagreed with the judge and intends to appeal the ruling.

The SEC regulations permit the practice of ‘payment for order flow’ as long as these are clearly disclosed. The rules related to getting the best possible price in the shortest duration must also be revealed properly.

Therefore, acceptance of incentives for order flow has resulted in various litigation cases. Notably, The Charles Schwab Corporation SCHW and E*TRADE Financial Corporation ETFC are also under the purview of lawsuits seeking class-action status similar to TD Ameritrade.

Conclusion

In the last few years, the SEC has taken enforcement actions against brokerage firms, including Scottrade Inc. and Morgan Stanley MS, for their alleged violation of disclosure norms and other issues.

Nevertheless, we cannot state for sure that the aforesaid investigation against brokerage firms will lead to any enforcement actions. However, even if no actions are taken, we believe this probe will make brokerage firms cautious about complying with the rules and revealing all necessary disclosures to retail investors.

Among the above-mentioned stocks, TD Ameritrade, Schwab and E*TRADE currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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The Charles Schwab Corporation (SCHW) : Free Stock Analysis Report
 
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