What is payment for order flow, and what did GameStop show about it?

Payment for order flow, or PFOF, is money a market maker pays a broker for sending it the broker's customers' orders. When you press "buy" in a free trading app, the app may not send your order to a stock exchange at all. It may send it to a market maker, which fills it from its own inventory, earns the spread, and rebates a slice of that profit to the broker. That rebate is how an app can charge zero commission. Some of the benefit may also reach you as price improvement, a better price than the one quoted publicly, often measured in fractions of a cent per share.

Is it a good deal? The two camps disagree sharply. Critics call PFOF a "kickback" and say it creates conflicts of interest and reduces market transparency, because brokers may choose where to route orders based on what they are paid rather than on how well the order is executed. Supporters defend it for funding low-cost trading and new investment apps. A 2022 study by Schwarz, Barber and Odean argued that, for stocks, retail customers get slightly better prices than those quoted on exchanges; but the study did not look at options, where PFOF is larger.

The practice came under the spotlight in January 2021. About 140 percent of GameStop's shares available to the public had been sold short, and as the price rose, short sellers rushing to buy back shares pushed it even higher, though an SEC staff report published in October 2021 concluded that this buying to cover was not the main driver of the rise. On 28 January, Robinhood halted purchases of GameStop and other volatile stocks, though customers could still sell. The company and others said the cause was clearing houses raising collateral requirements.

Since much of Robinhood's revenue came from selling customer orders to market makers such as Citadel Securities, social media asked whether the two were connected. Citadel and Robinhood denied it. The SEC staff report listed payment for order flow, and trading in dark pools and wholesalers, among the questions for further study. In the EU, a ban on PFOF took legal effect on 28 March 2024, with transition periods for existing firms: Germany allowed the practice for domestic clients until 30 June 2026.