Massive changes could be coming to the way the stock market functions | CNN Business

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Wall Street’s top cop has voted in favor of major changes to the way millions of everyday investors buy and sell stocks.

The Securities and Exchange Commission Wednesday proposed a rule that it says would add competition to an unseen — but potentially costly — part of the stock trading system for retail investors. The changes won’t be implemented just yet — a vote in the spring could finalize the rules. But the agency is majority controlled by Democrats and the proposal is expected to be adopted next year.

Today, when you buy or sell a stock on an app, the trade appears to be instantaneous. But beneath that simple buy/sell action is a complex web of Wall Street players exploiting tiny differences in price to rake in huge amounts of cash.

When you tap buy or sell, the broker, such as Robinhood or E*Trade, takes your order to a firm known as a wholesaler or market maker — middlemen firms that are supposed to get you the best price. Wholesalers pay the brokers for the privilege of executing the trades.

That process is known as “payment for order flow.” To support free trading, brokers typically make pennies from wholesalers off each transaction — but those pennies add up, accounting for the bulk of brokerages’ revenues. The SEC said the six largest wholesalers collectively paid retail brokers $235 million in payment for order flow for stock orders in the first quarter of 2022.

Payment for order flow has come under intense scrutiny by regulators following the fallout from the January 2021 run-up in meme stocks like GameStop. The SEC notes that wholesalers typically execute trades “without providing any opportunity for other market participants to compete to provide a better price.”

The SEC’s proposed changes would add more competition at the middleman level to ensure retail investors are actually getting the best prices. Orders would be routed into auctions where trading firms would have to compete to execute them.

SEC Chair Gary Gensler has been a longtime critic of the way the current payment for order flow market operates, arguing that it lacks transparency and competition to the detriment of investors.

Gensler and other critics of the process say the brokers and market makers have conflicts of interest, and that payment for order flow hurts everyday investors while amassing huge wealth for Wall Street firms.

“Today’s markets are not as fair and competitive as possible for individual investors — everyday retail investors,” Gensler said. “This is in part because there isn’t a level playing field among different parts of the market: wholesalers, dark pools, and lit exchanges.”

Gensler noted that everyday folks don’t have the same benefits as larger, deeper-pocketed investors who are often able to execute orders at the best price possible.

“The markets have become increasingly hidden from view, especially for individual investors,” Gensler said. “Thus, today’s proposal is designed to bring greater competition in the marketplace for retail market orders.”

– CNN’s Allison Morrow contributed to this report