If U.S. regulators crack down on the controversial practice of payment for order flow, it may have one unintended consequence.
Big trading outfits could become much larger and even more influential in markets, explains Interactive Brokers chairman and founder Thomas Peterffy.
"If they were to prohibit payment for order flow, what has to happen is you would have Citadel [Securities] buy Robinhood and Schwab would buy Virtu, and the two sides would be put together into one company," Peterffy said on Yahoo Finance Live.
Payment for order flow — known as PFOF on Wall Street — became a top concern for lawmakers earlier this year during insane surges and volatility in shares of GameStop and AMC and other heavily shorted names now called meme stocks.
The concerns down in D.C. reflect two factors inherent to the PFOF model.
[Read more: How do brokerage firms make money]
As Yahoo Finance's Brian Cheung explains in an edition of Yahoo U, in a payment for order flow model a brokerage processes orders from investors and passes them on to a wholesaler such as Citadel Securities or Virtu Americas. These market makers then execute the purchase or sale of a stock at publicly quoted prices, in turn paying brokerage firms for routing the trade through them.
Fueled by Robinhood's disruptive elimination of trading commissions, the major brokerages — TD Ameritrade, E*Trade (now owned by Morgan Stanley), Charles Schwab — have followed suit in turning to payment for order flow as a key source of revenue.
For instance, Robinhood hauled in $331 million in revenue from order flow in the first quarter, according to regulatory filings ahead of the company's Nasdaq listing later this week. That represented about 63% of Robinhood's first-quarter sales.
The worry among lawmakers is if Robinhood and others like it have their clients' best interests at heart given the revenue generation from PFOF.
There is also concern among regulators that average investors are being duped on best prices for stocks as Citadel Securities and others get an advanced look at prices.
"I am writing to understand the 'quiet but critical' role that Citadel LLC (Citadel) and its affiliated entities have played in 'the recent wild swings in the price of GameStop Inc. and other heavily shorted stocks' driven largely by trades on Robinhood," Sen. Elizabeth Warren (D., Mass.) wrote in a letter to Citadel founder and CEO Ken Griffin in February. "In particular, I am seeking to understand in detail the relationships between Citadel and Robinhood, to understand how Citadel profits from these arrangements, and to understand if these relationships help create an uneven playing field that harms individual investors."
Peterffy remains of the view that the PFOF model will persist.
"I don't believe that regulators will crack down on payment for order flow because payment for order flow has been going on on Wall Street for over 200 years," says Peterffy.