Massachusetts securities regulators are looking into how broker-dealers route orders to certain exchanges offering rebates and if this practice leads to “something less than best execution” for investors while generating funds for BDs that “direct order flow to those exchanges.”

Inquiry letters about the matter have been sent to Charles Schwab, Scottrade, TD Ameritrade, Fidelity Brokerage Services, E-Trade Securities, Edward D. Jones and Morgan Stanley. TD Ameritrade says it does not comment on regulatory matters, while Edward Jones says it has not yet received the letter; Morgan Stanley declined to comment.

Yale Law professor Jonathan Macey and Yale CIO David Swensen argued last month in The New York Times that brokerage firms are choosing exchanges that pay kickbacks and “to fleece the hundreds of millions of Americans who have money invested in company pension plans, mutual funds and insurance policies.”  

Commonwealth Secretary William Galvin, Massachusetts’ top securities regulator, said, “My office is looking into the veracity of these assertions and whether the brokers are meeting their best execution obligation to their customers.”

Macey and Swensen assert: “Although the harm suffered on each trade is minuscule — fractions of a cent per share — the aggregate kickbacks amount to billions of dollars a year. The diffuse harm to individuals and the concentrated benefit to Wall Street create yet another way in which the system is rigged, justifiably eroding public confidence in the fairness of the financial system.”

Galvin said that institutional brokers have the responsibility of placing “millions of dollars of average investors’ life savings in their employers’ pension plans, as well as in mutual funds and variable annuities.”

His office will review if the financial rebates “or kickbacks create a conflict that results in less than the best deal for the investors,” and if so, he added, “this practice must stop.”

Requests for a comment from ther brokerage firms for were not returned as of press time.

In late July, Galvin criticized SEC Commissioner Michael Piwowar’s comments opposing the Labor Department’s fiduciary rule. Galvin has been urging Labor to “continue to staunchly defend” it.

In a letter to Labor, Galvin stated that “the horrific financial abuses associated with conflicted advice in the area of retirement rollovers have been well documented. I am therefore dismayed that a sitting SEC commissioner would so forcefully join with industry to attack the rule.”

— Check out Michael Lewis: A Warning for Index Investors From the Oakland A’s on ThinkAdvisor.