Who Makes Money When Your Order Is Sold to a Market Maker?
Direct answer: When a retail broker routes your order to a wholesale market maker through payment for order flow, three parties benefit economically: your broker receives the PFOF payment (a fraction of a cent per share), the market maker profits from executing your order within the bid-ask spread, and you theoretically receive price improvement over the quoted spread. The extent to which price improvement offsets the broker's PFOF incentive is the central question in the PFOF debate.
Step-by-Step: What Happens to Your Order
When you press Buy in your brokerage app, a sequence of events unfolds that most retail investors never see:
- Order submission. Your brokerage receives your market order to buy 10 shares of a stock at the current market price. The national best bid is $50.00 and the national best offer is $50.01, so the current quoted spread is $0.01.
- Routing decision. Your broker's order routing system decides where to send the order. Rather than routing to the NYSE or Nasdaq, the broker routes it to a wholesale market maker with whom it has a PFOF arrangement.
- Market maker execution. The market maker receives your order. It sells you 10 shares at $50.008, which is below the national best offer of $50.01. You receive $0.002 per share in price improvement compared to the quoted ask.
- PFOF payment. The market maker pays your broker $0.001 per share in PFOF for the order. On your 10-share order, that is $0.01 total to the broker.
- Market maker profit. The market maker bought the shares it just sold you from somewhere else (or held them in inventory) at or near $50.00. Its profit on this trade is approximately $50.008 minus $50.00 minus $0.001 (PFOF) = roughly $0.007 per share, before its own costs. On 10 shares, that is $0.07.
In this scenario, the broker earned $0.01, the market maker earned approximately $0.07, and you received $0.02 in price improvement. Whether this outcome is better for you than exchange execution depends on what would have happened on an exchange, where you might have paid the full $50.01 ask but also might have found a better price if the market is competitive.
Who Are the Wholesale Market Makers?
The wholesale market maker segment is highly concentrated. A small number of firms dominate the internalization of U.S. retail equity and options order flow.
Citadel Securities is the largest wholesale market maker by U.S. equity volume. It is the market-making arm of the Citadel group of companies (distinct from the Citadel hedge fund). Citadel Securities is privately held and does not publish detailed financial results, but industry estimates suggest it handles approximately 25% to 40% of all U.S. equity trading on peak days. It processes enormous volumes of retail orders from brokers including Robinhood, TD Ameritrade (now Schwab), E-Trade (now Morgan Stanley), and others.
Virtu Financial (NASDAQ: VIRT) is the largest publicly traded wholesale market maker. Its quarterly earnings releases provide unusual transparency into the economics of market making: revenue from capturing the bid-ask spread, expenses from technology and compliance, and net income. Virtu earns through high-volume, low-margin execution across millions of retail orders daily. It also operates as a market maker on exchanges globally.
Susquehanna International Group (SIG) is a privately held quantitative trading firm that is the dominant market maker in U.S. listed options markets. Its options market-making business processes enormous volumes of retail options order flow. Two Sigma Securities and G1 Execution Services are other significant wholesale market makers.
Price Improvement: The Central Claim
Market makers and brokers who support PFOF argue that retail investors benefit through price improvement. The argument: market makers compete for retail order flow not just by paying PFOF to brokers but by offering slightly better prices than the posted national best bid or offer. Because competition between market makers drives both the PFOF payments they offer and the price improvement they provide, retail investors end up with better execution than they would get routing to a public exchange at the quoted price.
The price improvement argument has empirical support. Several academic studies comparing execution quality between PFOF brokers and non-PFOF execution found that retail orders executed through internalization receive price improvement on a majority of trades. The question is whether that improvement is as large as it would be in a more competitive market structure.
Critics of PFOF make a structural argument: the routing incentive (PFOF) distorts the broker's decision about where to send orders. A broker that earns more PFOF from one market maker has a financial incentive to route to that market maker even if a different venue would provide better execution for the customer. This conflict is inherent regardless of whether any individual order receives price improvement. The SEC's best execution requirements require brokers to consider execution quality, not just PFOF revenue, when routing decisions are made. But regulators have consistently found it difficult to prove that PFOF causes systematically worse execution, because the empirical record on price improvement is mixed.
SEC Rule 606: What Disclosures Tell You
Under SEC Rule 606, broker-dealers must file quarterly reports disclosing how they route non-directed orders in exchange-listed stocks. These reports show which market makers or exchanges receive orders, the percentages routed to each venue, and aggregate PFOF received by the broker. Brokers must also produce a report on request for an individual customer's orders.
The Rule 606 reports are public and available on the SEC's EDGAR system under the broker's filings. For options orders specifically, the PFOF payments tend to be larger (options spreads are wider, so market makers earn more per order), and Rule 606 reports show these payments separately from equity payments.
In practice, the reports are technical and difficult for retail investors to interpret without context. The data shows how much PFOF was received but does not directly compare execution quality to the alternative of exchange routing. The SEC's proposed amendments to Rule 606 in 2022 sought to require more granular disclosure and benchmarking, but those reforms were not finalized.
The Regulatory Divide: U.S. vs. EU and UK
The most fundamental regulatory question about PFOF is whether its benefits (funding zero-commission trading, providing price improvement to retail investors) outweigh its costs (a structural conflict of interest in broker routing decisions). The U.S. and Europe have reached different conclusions.
In the European Union, PFOF has been restricted under MiFID II's best execution requirements. The Markets in Crypto-Assets Regulation and subsequent EU Capital Markets Union proposals have moved toward a broader ban. The UK's Financial Conduct Authority (FCA) has stated that PFOF is incompatible with its best execution rules for retail clients.
The EU and UK reasoning is not primarily empirical (that each individual order receives a worse price) but structural: that the payment itself creates a conflict that cannot be adequately managed through disclosure. An adviser paid to recommend a particular product has a conflict even if the product sometimes turns out to be the best available. The U.S. has taken the view that disclosure plus best execution standards are sufficient to manage the conflict, though the SEC has continued to revisit this position.
Regulation Best Interest and Its Limits
Regulation Best Interest (Reg BI), which took effect in June 2020, requires broker-dealers to act in the best interest of retail customers when making recommendations, going beyond the prior suitability standard. However, Reg BI does not prohibit PFOF and does not require that the best available execution outcome be achieved on every order. It requires that brokers have policies and procedures in place to identify and manage conflicts of interest, including those arising from PFOF arrangements.
Critics have argued that Reg BI's requirements for managing PFOF conflicts are insufficiently specific, allowing brokers to continue receiving substantial PFOF as long as they have documented policies for reviewing execution quality. The rule does not require the best execution that theoretically competitive markets would produce.
Who are the major wholesale market makers that receive PFOF?
The dominant wholesale market makers in U.S. equity markets are Citadel Securities, Virtu Financial (NASDAQ: VIRT), Susquehanna International Group (SIG), and Two Sigma Securities. These firms handle the majority of retail equity and options order flow in the U.S. According to various industry estimates, Citadel Securities alone handles approximately 25% to 40% of all U.S. equity trading volume on some days. Virtu is the largest publicly traded firm and provides the most public transparency about the economics of retail market making.
What is SEC Rule 606 and what does it require?
SEC Rule 606 requires broker-dealers to file quarterly reports disclosing their order routing practices, including which market makers they route orders to and the PFOF payments received. The reports are publicly filed on the SEC's EDGAR system. Rule 606 also requires brokers to disclose their order routing practices to individual customers upon request. The rule was updated in 2018 to require more granular disclosure for institutional-size orders.
Does price improvement actually benefit retail investors net of PFOF?
This is the central empirical question in the PFOF debate, and academics and regulators disagree. Proponents point to data showing retail investors receive meaningful price improvement above the quoted spread. Critics argue the counterfactual is a more competitive market without PFOF routing incentives, which would produce even better prices. The EU and UK concluded the structural conflict is too severe to manage, while the U.S. has maintained PFOF with disclosure requirements.
What is internalization and how is it related to PFOF?
Internalization is the practice of a market maker executing a customer's order against its own inventory rather than routing the order to an exchange. When Citadel Securities receives a retail buy order, it sells shares from its own inventory directly to the customer rather than matching the order with a resting sell order on an exchange. PFOF is the payment market makers make to brokers for the privilege of internalizing their customer flow, allowing the market maker to control the execution and capture the spread.
How did the Robinhood GameStop episode highlight PFOF issues?
During the January 2021 GameStop short squeeze, Robinhood temporarily restricted purchases of heavily traded meme stocks. One contributing factor was that elevated margin requirements from the clearinghouse created capital pressures. Some critics argued that Robinhood's PFOF relationships with market makers who were also prime brokers for hedge funds short GameStop created an apparent conflict. Robinhood denied that market maker relationships influenced its trading restrictions. The episode drew significant congressional attention to PFOF and Robinhood's business model.