Payment for order flow (PFOF) is compensation that a broker receives from a third party, usually a wholesale market maker, for directing its customers' buy and sell orders to that party rather than to an exchange. The market maker executes the orders against its own account and pays the broker a small amount per share or per contract. The practice is most closely associated with retail share and options trading in the United States, where it is a principal source of revenue for brokers that charge customers no commission.
PFOF is controversial because it places the broker's income in potential conflict with its duty of best execution. It is permitted with disclosure in the United States, and prohibited in the United Kingdom, Canada and, following recent legislation, the European Union.
How it works
A retail investor enters an order in a brokerage app. The broker's order routing system sends it not to a stock exchange but to one of a handful of wholesalers with which the broker has an arrangement. The wholesaler fills the order itself, as principal, typically at a price slightly better than the best bid or offer displayed on the exchanges at that moment. This betterment is called price improvement. The wholesaler then pays the broker an agreed rate for the flow.
In effect, the wholesaler divides the bid-ask spread it would otherwise earn three ways: part is given to the customer as price improvement, part is paid to the broker, and part is kept as profit. Payments are generally higher for options than for shares, because option spreads are wider.
Why market makers pay for retail orders
A market maker's main risk is trading with someone better informed than itself. Orders arriving on an exchange come from all kinds of participants, including professional firms whose trades tend to precede price moves. Orders from individual investors are, on average, small and unrelated to short-term price movements, so they are less likely to leave the market maker with a losing position. They also tend to arrive on both sides of the market, letting the firm offset buys against sells and capture the spread with little inventory risk.
Because this flow is more profitable to trade against than anonymous exchange flow, wholesalers compete to obtain it, and payment to the broker is one of the forms that competition takes. Such segmentation is studied in market microstructure.
History
The practice dates from the 1980s, when off-exchange dealers in the United States began paying brokers for orders in exchange-listed shares; Bernard Madoff's market-making firm was among its early promoters. In 2019 the largest US retail brokers cut their share trading commissions to zero, which increased their reliance on PFOF and on interest income. The surge in retail trading in 2020 and 2021, including the episode involving so-called meme stocks in January 2021, brought the practice to wide public attention and prompted regulatory and congressional inquiries.
The debate
The arguments on each side are well established:
- In favour. Supporters point out that retail investors pay no commission and usually receive a better price than the public quote, so their total cost of trading has fallen to historically low levels. Wholesalers also guarantee execution of small orders in a wide range of securities.
- Conflict of interest. Critics argue that a broker has an incentive to route to whoever pays most rather than whoever gives the customer the best price, and that the cost is hidden in the execution price where customers cannot easily see it.
- The benchmark. Price improvement is measured against the best displayed quote, which may itself be wider than it would be if retail orders traded on exchanges. On this view the saving is partly an illusion.
- Market quality. Diverting uninformed orders away from exchanges leaves a more informed, more costly mix behind, which may widen public spreads for everyone.
Empirical studies have reached mixed conclusions, and results differ between shares and options.
Regulation by jurisdiction
In the United States, PFOF is lawful provided the broker meets its best execution duty and discloses the arrangements. Rules of the Securities and Exchange Commission require brokers to publish quarterly reports on where they route orders and the payments they receive. In December 2020 the retail broker Robinhood agreed to pay 65 million dollars to settle charges that it had failed to disclose its receipt of such payments properly and had not obtained best execution in an earlier period.
In the United Kingdom, the Financial Conduct Authority and its predecessor have treated PFOF as incompatible with the rules on inducements and conflicts of interest since guidance issued in 2012. Canada prohibits the practice for listed shares. In the European Union, the position under MiFID II was contested, with some member states tolerating it; an amendment to the accompanying regulation adopted in 2024 introduced an explicit ban, with a transitional period for countries where the practice already existed that ran until the end of June 2026.
Alternatives
Where PFOF is not allowed, brokers earn revenue from commissions, currency conversion charges, subscription fees, interest on customer cash and securities lending. Some route retail orders to exchange programmes designed for retail liquidity or to a systematic internaliser without receiving payment.