Massachusetts securities chief William Galvin launches investigation of broker ‘kickbacks’

Massachusetts’ top securities regulator, Commonwealth Secretary William Galvin, launched an investigation Tuesday into charges that brokers were receiving ‘kickbacks’ for routing sales orders to certain stock exchanges.

The probe was inspired in part by a recent New York Times oped by Jonathan Macey, a Yale law professor, and David Swensen, Yale’s chief investment officer, who claimed that brokers seeking payment for order flows — instead of choosing the exchange with the best prices for their clients — are taking money out of their clients’ pockets.

“Brokers routinely take kickbacks, euphemistically referred to as ‘rebates,’ for routing orders to a particular exchange,” Mr. Macey and Mr. Swensen wrote in a July 18 piece. “As a result, the brokers produce worse outcomes for their institutional investor clients — and therefore, for individual pension beneficiaries, mutual fund investors and insurance policy holders — and ill-gotten gains for the brokers.”

Mr. Galvin said in a statement that his office is “looking into the veracity of these assertions.”

In an interview, he added that he is also motivated by what he called the Trump administration’s effort to cut back financial regulations.

“As it was in previous administrations when this was the attitude, it’s up to the states to take the lead,” Mr. Galvin said.

He has sent inquiry letters to Charles Schwab & Co. Inc., Scottrade Inc., TD Ameritrade Inc., Fidelity Brokerage Services, E*Trade Securities, Edward D. Jones & Co. and Morgan Stanley & Co. His office did not release the letters.

“Institutional brokers are responsible for placing millions of dollars of average investors’ life savings in their employers’ pension plans, as well as in mutual funds and variable annuities,” Mr. Galvin said in the statement. “If financial rebates or kickbacks create a conflict that results in less than the best deal for the investors, this practice must stop. It is the obligation of regulators to have reasonable assurance that the customer is not being harmed, and that is the reason I instructed my Securities Division to begin this investigation.”

The Securities and Exchange Commission has wrestled with best execution for decades. It’s a topic that doesn’t lend itself to easy solutions, according to Todd Cipperman, principal at Cipperman Compliance Services, because other factors, such as timing and order size, go into calculating best execution.

“There’s more to execution than price,” Mr. Cipperman said. “Often, the lowest commission is not what determines the best execution. Just because they’re paying [a broker] doesn’t mean it’s not the lowest price. It’s a really complicated issue.”

In order to protect themselves, Mr. Cipperman recommends that brokers demonstrate why they choose an exchange.

“Make sure you do some best-execution testing so you can justify why you used a particular trading venue,” he said.