NASD Releases Report Finding No Legal Basis for Restricting Madoff's "Pay for Order Flow" Business Model

[Madoff developed] a solid, but sometimes controversial, reputation as a market maker.

During the [90's], his market-making operation was handling trades equaling 9 percent of all trading on the New York Stock Exchange. He serves as non-executive chairman of Nasdaq from 1990 to 1993 and uses the position to lobby Washington.

The controversy over "pay for order flow" continues to dog him. In 1990, the NASD forms a study committee; it releases a report in 1991 saying it found "no legal basis to restrict the practice."

Payment for Order Flow

As a way to attract orders from brokers, some exchanges or market-makers will pay your broker's firm for routing your order to them – perhaps a penny or more per share. This is called "payment for order flow." Payment for order flow is one of the ways your broker's firm can make money from executing your trade. The firm can also make money by internalizing your order.

Upon opening a new account and on an annual basis, firms must inform their customers in writing whether they receive payment for order flow and, if they do, a detailed description of the type of the payments. Firms must also disclose on trade confirmations whether they receive payment for order flow and that customers can make a written request to find out the source and type of the payment as to that particular transaction.