Reluctantly, Philadelphia Exchange Joins Order-Flow-Payment Fray

The options exchange gets in step with bigger competitors, allowing payment to brokerages for business.
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The

Philadelphia Stock Exchange

announced plans Friday to assess specialists and registered options traders up to $1 a contract for certain orders.

The exchange said details of the payment-for-order-flow proposal haven't been nailed down, but it expects that the specialist for an option will be able to set the amount paid to firms providing orders. The plan will initially apply only to stock options among the top 120 options, based on national trading volume, not to the exchange's popular index or currency options.

The announcement comes in the wake of similar plans rolled out by the

Chicago Board Options Exchange

and the

American Stock Exchange

. (

TSC

covered these

developments.) Under the Chicago plan, the exchange will collect 40 cents on each contract from designated primary market makers as well as from market makers in all equity options.

Philadelphia exchange head Meyer "Sandy" Frucher says the exchange "believes that exchange-sponsored payment-for-order-flow plans, where the exchange effects a compulsory assessment from its trading crowds, represents bad public policy. We felt that we needed to establish the PHLX plan to maintain and enhance our competitive position in light of the CBOE plan."

Frucher also said the Chicago plan, which involves a self-regulatory organization in payment for order flow, "is inappropriate for a regulator. Although the PHLX does not believe that payment for order flow is, or should be, illegal generally, or that it represents a threat to best execution and the discharge of brokers' fiduciary obligations in all circumstances, we believe that the CBOE has opened the dam to a flood of order-flow payments, which will achieve an order of magnitude which will be unhealthy for price competition and investors."

The Philadelphia exchange also asked the

Securities and Exchange Commission

to annul the CBOE plan.

A Chicago board spokesman said its plan was devised in response to a loss of market share to exchanges where market makers or specialists pay for order flow in options. Under the plan, market makers and brokerages would negotiate the payment on each order, with settlement made monthly by the board from the money collected under the 40-cent fee.

A similar plan unveiled by the Amex Tuesday will use funds collected from trading-floor firms to provide the capital for payment to brokers. Amex didn't reveal further details of its plan.

Critics of the practice of payment for order flow argue that it discourages finding the best price for executing orders because the final repository of the order is determined by the payment arrangement.

The Philadelphia plan is subject to filing with the SEC.