SEC Decides Not to Ban Controversial Plan Of CBOE Calling for Order-Flow Payments
By Steven M. Sears, 09/07/2000, The Wall Street Journal, (Copyright (c) 2000, Dow Jones & Company, Inc.)

NEW YORK -- The Securities and Exchange Commission decided against banning "payment for order flow" in the options market, a much-anticipated decision that Wall Street could interpret as a regulatory blessing of a controversial practice.

The SEC ruling also could prompt an increasing number of brokerage houses to sell their customers' orders for execution to specific exchanges or trading firms. Many options traders said investors will suffer because options prices will be adjusted to reflect the money that specialists and dealers spend to attract orders.

The SEC had until Friday to rule on the payment-for-order-flow plan that was filed this summer by the Chicago Board Options Exchange. The CBOE's plan involves taxing its member specialists and dealers 40 cents for nearly every options contract they trade in order to build a war chest that could be used by the specialists to buy orders. The plan was designed to help its specialists compete with better-capitalized specialists at rival exchanges. Specialist firms had been buying orders from brokerage houses in the CBOE's most active options listings, only to execute those orders at competing exchanges.

The CBOE's plan stabilized, and may increase, its market share, but it ignited a chain reaction in the options market that many people in the industry hoped the SEC would end by repealing the CBOE's plan. "Payment for order will kill the [dealers] and widen the [trading] spreads and it gets the exchanges, who are supposed to be regulators, involved in a tawdry business," said Sandy Frucher, chairman of the Philadelphia Stock Exchange.

The American Stock Exchange, Pacific and Philadelphia exchanges adopted plans similar to the CBOE's.

Dealers said they can't afford to both improve prices and pay an exchange-levied "marketing fee" of between 40 cents to $1, depending on the exchange, every time they trade an options contract.

SEC Chairman Arthur Levitt said he doesn't like the payment-for-order-flow system, but noted that it is difficult to ban the practice. Mr. Levitt said the SEC will regulate the CBOE plan by making brokers disclose how much money they receive from selling orders. Specialists firms, which ultimately fill all customer orders, will be subject to stringent execution-quality reports.