Over the last decade, Wall Street has experienced a boom in retail stock trading. Trading by individual investors has gone from roughly 10% of overall market volume in 2010 to about 20% today, according to Bloomberg Intelligence.

A lot of that growth has been fueled by the advent of no-commission stock trading. It started with brokerages including Robinhood and Schwab — which is a Marketplace underwriter — but by now, a lot of brokerages have dropped commissions for buying or selling stock. 

That sounds like good news for retail investors. But the chairman of the Securities and Exchange Commission has been arguing that commission-free trading might not be such a good thing.

“Even though the trade is commission-free, that doesn’t mean that the trade is actually free,” said Karyn Cavanaugh, chief investment officer of Carolinas Wealth Management.

When brokers offer commission-free trading, what they’re really saying is that retail customers won’t be paying the commission. Instead, brokerages are getting someone else to pay. 

“And that’s where the market makers come into play,” Cavanaugh said.

Market makers are big companies you might not have heard of. They essentially serve as stock wholesalers, working to match buyers with sellers. That ensures that when someone wants to buy a stock, they can find someone else who wants to sell it.

To understand the way this works, think of a supermarket. If you’re headed there to buy a box of frozen pizza rolls, you’d expect that the store has worked with the pizza roll wholesaler to ensure the pizza rolls you want are sitting in the frozen section, waiting to be placed into a cart.

That’s kind of the way the stock market works too. In this example, the brokerage lets me buy the pizza rolls by connecting me directly with the wholesaler.

“The broker will route the trade to a market maker, who will actually do the physical execution of the trade,” said Jonathan Macey, a professor at Yale Law School.

The market maker can then earn a few pennies for every trade.

“The business model of the market makers is not to make a killing on any given trade, it’s to slice off a tiny fraction of a penny each time,” said James Angel, a finance professor at Georgetown University. “But if you’re doing that on a billion shares a day, it adds up.”

To make more money, the pizza roll wholesaler — or the market maker — needs to increase its sales volume. So it makes an offer to the retailer.

“The market maker’s going, ‘Hey, I know I can make money on those orders. As a matter of fact, I can share some of that with the brokers,’” Angel said.

In other words, the pizza roll wholesaler pays the supermarket for every pizza roll I buy. This is how retail brokers have been able to offer commission-free trading.

But if the supermarket is getting paid basically a referral fee every time it works with the same wholesaler, what happens if another wholesaler has a lower price for pizza rolls? In other words, does the broker have the retail traders’ best interests in mind?

“Is the broker working for you?” Angel said. “Or is the broker working for [whatever market maker] pays them the most for the order?”

Part of SEC Chair Gary Gensler’s concern is whether the market maker wholesalers should be paying retail brokers.

“Instead of paying your broker to send your order to them, why don’t they just give Robinhood customers better prices?” said Thomas Ernst, a finance professor at the University of Maryland.

Regulators in the United Kingdom and Canada have prohibited wholesale market makers from paying retail brokers. If that were to happen in the United States, Ernst said brokerages would have to change their commission-free business model.

“Their employees are not volunteers, their computer systems cost money to run,” Ernst said. “So they would have to find some other source of revenue, like going back to charging commissions.”

SEC Chair Gensler has suggested a system of open, transparent auctions, where wholesalers bid against each other. The goal is to help retail investors know that they’re getting the best price for a stock. But so far, the commission hasn’t proposed any changes yet.