You drive Uber. You know that a good way to get a big tip is to drive people from luxury hotels to the airport. However, you never get those kinds of clients. You've tried gaming the app, but whatever you do, you end up with lower-end dregs...like, driving drunk frat guys home from Jimmy McDougel's Wing and Whiskey Irish-Style Barroom Experience and Lounge.
So, instead of waiting for the app, you come up with a different plan. You'll tip the bellhops at the luxury hotels to steer clients to you. The clients will pay you cash instead of going through Uber...and you'll give the bellhops $5 for every rider they bring you.
That situation describes how payment for order flow works. Except, in this case, we're talking stock orders instead of rides from hotels.
You put in an order to your broker. They need to route the order through a third party (an exchange or market maker). They accept a kickback from a firm to steer the business to them. The broker makes money...not from you, but from the company it uses to complete your transaction.
The SEC requires that brokers disclose whether they receive revenue through payment for order flow.
Related or Semi-related Video
Finance: What is the Securities Act of 1...60 Views
Finance a la Shmoop! What is the Securities Act of 1933? Hey, is it these
axes? No, it's a different act, or a whole bunch of Acts in the 30s and the
40s. All right, well for a long time the
little guy had, well not really much more than a prayer, when it came to investing [man praying in church]
his money. Like investing it well. The stock market appeared to be this wild,
wild, Westy thing, with few rules and a whole lot of insider trading information,
driving the bus, or carriage, or whatever they had back then. In fact before 1933,
securities laws were a, state thing. Each state had its own view as to how much
the poor uneducated farmer should be protected by the government. In fact
most really weren't protected at all. Making matters even worse, States [man and woman trading on map]
citizens, invested in each other all the time. Like across the state border. So
what would then happen when one set of state's laws, applied to one side of the
trade and one state set of laws, was conjoined to another set of laws, applied
to the other in a different state. Yeah that was a problem. Clearly we needed,
national laws and that's when the 1933 Securities Act was born, setting federal
law above state law. But keeping state laws generally intact when the [Uncle Sam]
intrastate activities were happening. What did all that mean? Well it
meant that the default laws generally revolved around whatever the state had
already in place. Except in the case where transactions, required a federal
purview, or look-see. Because the transactions happened among, two or more
states, or that they violated some major federal law. Like discrimination or
something like that down the line. Well the notion here, was that, farmers were
being sold acres of, quote, Blue Sky, unquote. Like you had to pay for the blue [two men in field]
sky and we're not talking about smog here. Instead of things of real value.
Right, like farmers would believe that they could buy an acre of blue sky.
Sorry, farmer Joe, we're just keeping it real there, you really did try to buy
acres of blue sky. Was solely because, farmer Joe, did not possess the education, [squirrels in head]
to determine the difference between a real investment opportunity and a fake
one. Finally the government, well they just had to step in and protect the
average Joe, from the average, you know Schmo.[man talking in front of parchment]
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What is the 1934 Securities Exchange Act? The 1934 Securities Exchange Act brought about the SEC, or the Securities Exchange Commission. This act,...