How PFOF Works, Step by Step
When you place a market order on Robinhood, TD Ameritrade, E*Trade, or another discount broker, your order does not go directly to a stock exchange. Instead, it is routed to a wholesale market maker like Citadel Securities. Citadel executes your trade, capturing the bid-ask spread, and pays the broker a per-share fee for delivering the order. The broker uses these payments to fund 'commission-free' trading.
Citadel's Dominant Position
Citadel Securities receives order flow from virtually every major discount broker. It executes approximately 28% of all U.S. equity trades and more than 40% of retail equity orders. This concentration means that when you click 'buy' or 'sell' on a discount app, the odds are better than even that Citadel Securities is on the other side — profiting from the spread.
The Best Execution Problem
SEC Rule 605 and Rule 606 require brokers to disclose their order routing practices and the execution quality they achieve. However, studies by the SEC and independent researchers have consistently found that PFOF-dependent brokers achieve materially worse execution prices than non-PFOF brokers. The 'price improvement' that Citadel claims to provide is frequently less than what a direct exchange order would achieve.
What Regulators Have Said
The SEC has proposed rules to reform PFOF, including mandating 'order competition' auctions. FINRA has brought enforcement actions against brokers that failed best execution standards. The UK and Canada have banned PFOF entirely. The EU's MiFID II framework substantially restricts it. U.S. federal regulators have discussed reform for years — but Citadel's lobbying operation and political donations have helped delay meaningful action.
What Investors Can Do
Investors who believe they have been harmed by PFOF-driven routing can file complaints with the SEC, FINRA, and their state securities regulator. Some investors have joined class action lawsuits against brokers. Choosing a broker that routes directly to exchanges — like Interactive Brokers' direct routing option or IEX — is one practical alternative.