Rethinking retail trades: SMU research explores US proposal amid global push for investor welfare

By Vince Chong

SMU Office of Research Governance & Administration – At any single time, retail investor welfare constitutes a key focus for regulators, and this is ramping up with the surge of retail investment activity in the stock markets following COVID. 

Similarly for SMU Assistant Professor of Finance Sun Jian, the topic motivates and influences his research projects, including a recent paper that dives deep into a new proposal by the US Securities and Exchange Commission (SEC) to resolve US retail trades by auction, rather than the current broker routing structure. 

Formed in the 1930s to restore investor trust after the 1929 US stock market crash that crippled many global economies, the SEC is followed keenly by global counterparts when it comes to the prudential evolution of money markets. 

The paper Would Order-by-Order Auctions Be Competitive studies the two ways – broker routing and order-by-order auctions – that stock trades for retail US market investors can be handled, and how they influence retail investment welfare through price efficiencies. It was co-authored by Assistant Professor Thomas Ernst, Smith School of Business, University of Maryland, US; and Professor Chester Spatt, Tepper School of Business, Carnegie Mellon University, US.

Closer to home, the research also serves as a timely contribution to current policy debates on the structure of the equity market and its implications for retail investors, even if the retail order execution mechanism in Singapore differs from the one in the US. Case in point: authorities are striving to strengthen and increase liquidity in Singapore’s stock market through a S$5 billion Equity Market Development Programme. 

Published in the August 2025 issue of The Journal of Finance, a leading academic title in global financial research, Would Order-by-Order adroitly sets out pros and cons for each of the two structures that it studies. As Professor Sun told the Office of Research Governance & Administration (ORGA), the proposed auction is neither the first mechanism suggested for retail orders, nor will it be the last.

“The key contribution of this paper is to highlight the potential trade-offs inherent in any new market mechanism for retail order execution,” he said. 

Investor welfare

Under the SEC’s current broker routing system, as its name implies, trading orders are sent by brokers to market makers, or wholesalers, for execution. The proposed order-by-order auctions system, however, will see market makers compete to bid on individual trades. One advantage of this is better pricing but as the research shows, it is not an overriding edge.

Market makers, for the uninitiated, are little-known but pivotal players in the share market that provide buy and sell quotes for trades. By doing so constantly, they ensure that there is a ready market that allows investors to trade efficiently without the delays that could arise if, for instance, a seller had to wait for a buyer before obtaining a final price. 

These companies, going by less-than-household monikers like Citadel Securities, Virtu Financial, and Two Sigma Securities, also ensure prices are kept stable by, say, absorbing excess buying or selling pressure and hence preventing excessive price swings.

For example, Professor Sun explained, when a retail investor places a market order to buy one share of stock immediately, the final price to be paid remains unknown at that point in time. What happens, and it happens very quickly, is that the investor’s broker receives the order and sends it off to a market maker, who then sells the stock to the investor. The investor, naturally, will want to buy at a low price, which then translates to higher investor welfare. 

“Similarly, if the retail investor wants to sell one share of stock, higher welfare means selling at higher price,” the academic continued. 

To give a sense of magnitude, albeit “very roughly,” he explained, the efficiency of a trading system could translate to potential price differences of as high as one percent of a stock’s share price.

“We are interested in a market mechanism that can give the retail investor better price, meaning higher welfare. This will be more significant if the investor is trading more often, or trading illiquid stocks, both of which are common retail investor behaviour.”

Ultimately, in financial terms, this difference in welfare can be “huge” considering the aggregated potential of all retail investor activity, he added.

Efficiencies vary

The key difference between the two systems, the research paper points out, is that now, when brokers send trades to market makers – which must then be accepted – there is no pre-trade communication between parties. This means a trade may be routed to a company that has high inventory costs: the financial risks and expenses incurred to hold a stock before it is sold or bought, such as funding costs and capital charges. This, the paper sets out, could then lead to “inefficient order allocation and inventory management”. 

Under the auctions structure, a market maker is forced to consider its costs before bidding. Theoretically, the paper notes, “the participant with the lowest realized inventory cost will always win the auction with the most aggressive bid, leading to first-best allocative efficiency.” 

However, it adds, this could result in the “winner’s curse” whereby market makers bid conservatively to win the auction and so maximise profit. This can reduce the sell price of a stock and hence investor welfare, subject to contributory factors like the presence of institutional investors, bidding volume, and market liquidity. The research further addresses such factors and games them out under varying scenarios.

The main aim of the research, Professor Sun said, “is to challenge the simple intuition underlying the order-by-order auction proposal.”

“We highlight that the proposed mechanism may not necessarily improve retail investor welfare,” he noted.

“Based on current developments, it appears unlikely that this new auction system will be adopted.”

Next steps

The academic and his team have since gone ahead to collaborate with several large brokers in the US market in new research focusing on the effectiveness of the current broker routing system. The new results are in their working paper What Does Best Execution Look Like? 

Professor Sun also hoped his work can help shape public policy such as Singapore’s plans to boost its stock market. After all, he said, “designing a system that provides retail investors with the best possible prices is a natural way to encourage their participation.”

Back to Research@SMU November 2025 Issue