Massachusetts regulator probes brokerages over trading 'kickbacks'

By Ross Kerber and John McCrank

BOSTON/NEW YORK (Reuters) - Massachusetts' top securities regulator said on Tuesday that his office is examining whether brokerages route orders to stock exchanges that pay them additional fees regardless of whether investor clients are getting the best price.

The regulator, William Galvin, the secretary of the Commonwealth of Massachusetts, has sent inquiry letters to affiliates of Charles Schwab Corp, TD Ameritrade Holdings Corp, Fidelity Investments, E-Trade Financial Corp, Edward Jones and Morgan Stanley.

"If financial rebates or kickbacks create a conflict that results in less than the best deal for the investors, this practice must stop," Galvin said in a statement announcing the probe.

To attract liquidity, most U.S. exchanges charge a fee for orders that are immediately executed and pay a rebate for orders that sit idle for others to trade against. The rebates can create conflicts because brokers receive an incentive to send customer orders to exchanges that pay them the most, experts say.

The U.S. Securities and Exchange Commission is planning a proposal to test how lower fees and rebates would affect market behavior, its chairman, Jay Clayton, said in July. That pilot program, if approved, could help inform the SEC on whether the current pricing model, known as "maker taker," needs to be changed or eliminated.

IEX Group NV, which operates the Investors' Exchange, does not offer rebates. Bats, which is owned by CBOE Holdings Inc, recently said it would stop offering rebates on one of its smaller exchanges.

Galvin in his statement cited an essay by Yale Law School Professor Jonathan Macey and Yale University's chief investment officer, David Swensen, who argued that brokers choose exchanges at a price disadvantage to investors.

Fidelity and Schwab are reviewing the matter, representatives said. Edward Jones has not yet received a letter from Galvin's office, a spokesman said.

TD Ameritrade does not comment on regulatory inquiries, a spokeswoman said. A Morgan Stanley representative declined to comment, and E*Trade representatives did not return requests for comment.

(Reporting by Ross Kerber in Boston and John McCrank in New York; Additional reporting by Tim McLaughlin and Elizabeth Dilts; Editing by Marcy Nicholson and Leslie Adler)