Since becoming publicly held entities securities and commodities exchanges have been under increased pressure to generate profits.
As it is well known, the NYSE has long charged a pretty penny for a “seat” on the Big Board to execute transactions. But now the exchanges need to make even greater profits for their investors. One way to do so is to charge deal managers fees for initial public offerings. And another way, and new way, is to pay rebates to brokers in return for sending exchanges business.
As previously been reported the recent Facebook IPO was a costly undertaking for Morgan Stanley not only for the Nasdaq related fees but also because of the so-called “technical glitches.” It triggered a wave of legal actions and SEC probes to determine whether exchanges lack adequate controls and favor select investors.
This leads to next consideration: the practice of exchanges paying rebates to broker dealers in exchange for their business. Some market experts argue that these rebates give brokers an incentive to profit at the expense of other investors. In fact a recent study by Woodbine Associates claims that rebates might be costing funds and investors almost $5 billion per year!
The report further highlights how the practice of rebates is related to high frequency trades. And high frequency trades, in turn, are increasingly being employed in the exchange traded funds sector, a sector that was once seen as a safe harbor for ordinary investors. And complicating matters even further, potential investor losses are often gains for firms and banks engaged in the high frequency trade game.
Now, connect automated trading practices and “technical glitches” to the rebates being paid to firms, and it becomes a recipe for legal and regulatory actions across the market place. And that’s one of the dangers of the rebate practice hiding in plain sight.
Also, offering “rebates” is a potential conflict of interest because exchanges may be inclined to favor select investors over others. And this issue is being examined by the SEC in Facebook IPO.
Of course, the SEC has the option of banning the practice by deeming rebates to be a so-called “kickback.” But this solution would raise further questions.
The Woodbine report available on website:
http://www.woodbineassociates.com/Exchange_Performance_2011.html
