Saturday, June 18, 2016 04:28 PM / By Dave Michaels / WSJ
IEX Group Inc. won regulatory approval to launch a new stock exchange that slows the speed of trading, clinching a hard-fought win over competitors that said its model threatens investor benefits flowing from ever-faster markets.
The Securities and Exchange Commission voted Friday to certify IEX as the U.S.’s 13th national stock exchange, giving the startup a license to challenge Intercontinental Exchange Inc.,Nasdaq Inc.and Bats Global Markets Inc.
The SEC’s decision resolved a clash over whether its rules, which sped the transition to fully electronic markets, allow IEX to use a “speed bump” that slows orders by just 350 millionths of a second.
IEX says its delay is just long enough to protect investors from predatory high-speed trading that can front-run the orders of slower investors. Opponents such as Citadel LLC, the hedge-fund manager and electronic market maker, had warned that any delays would create stale prices and the potential for manipulation.
“It does mark a pendulum shift where ‘speed is king’ may have reached the furthest point it can go,” said Andrew Upward, head of market structure at brokerage Weeden & Co. “They’ve had a victory in this debate about the importance of speed in markets, and it’s a setback for those who think speed and efficiency are the end all and be all.”
Launched in October 2013 as a private trading venue, IEX—and its chief executive, Brad Katsuyama—shot to fame on the back of the 2014 Michael Lewis book, “Flash Boys,” which cast its founders as heroes trying to restore balance to the stock market. Mr. Lewis’s book argued the market was rigged by other stock exchanges that sold preferential treatment to high-frequency traders.
SEC Chairman Mary Jo White, an independent, and Commissioner Kara Stein, a Democrat, approved IEX’s bid. Republican Commissioner Michael Piwowar backed the broader move to approve IEX as an exchange, but dissented from a decision to give IEX what is known as a “protected quote,” which requires brokers to send orders to IEX when it shows the best price across all 13 national stock exchanges.
During the long battle, IEX’s opponents had lobbied the SEC to deny IEX that privilege, which would have essentially given IEX a hollow victory.
“We are grateful and humbled by the support we’ve received from the investor community. Without it, we may have faced a different result,” Mr. Katsuyama said. “This is a milestone for all of those who have supported IEX and we look forward to becoming a stock exchange, which will provide us the opportunity to have an even greater impact on the markets.”
Citadel and high-frequency trading firms deluged the SEC with letters that argued IEX’s speed bump would violate rules that require orders be “immediately accessible” to traders. Intercontinental Exchange Chief Executive Jeff Sprecher, whose firm owns the New York Stock Exchange, told analysts in February that granting IEX permission would be “un-American” because it would create a new “monopoly,” with IEX as the only exchange with a speed bump.
Citadel’s founder, billionaire Kenneth Griffin, got personally involved in the fight against IEX, meeting with the SEC as recently as June 3 to lobby against its exchange bid, according to a regulatory notice.
IEX countered by appealing to mutual funds and pension funds—which have backed its private venue, known as a dark pool—and asked them to send the SEC supportive letters. It also beefed up its lobbying heft in February, hiring a former lobbyist for the NYSE after banks, including Goldman Sachs Group Inc., told the firm it was losing the lobbying battle to Citadel and others, according to a person familiar with the matter.
On Capitol Hill, lawmakers were asked to weigh in for one side or the other. Adam Cooper, Citadel’s chief legal officer, reiterated to Senate staff members at a closed-door meeting on Monday that market quality would suffer if IEX was approved, according to people familiar with the matter. On Thursday, Rep. Steve Israel (D., N.Y.) told the SEC in a letter that IEX had developed a “market-driven solution” to address some investors’ concerns about high-frequency trading.
“Today’s decision will test and potentially reverse the gains in fairness, efficiency and transparency that have been made to our markets over the last decade,” Citadel said. “We must be vigilant to identify unintended consequences, and firm in our commitment to equitable and consistent treatment for all investors.”
The SEC’s decision may not be the end of the fight. Last month, attorneys for Nasdaq argued that the SEC could be sued if it approves IEX. The lawyers said the SEC would first have to change its own rules to explicitly allow for a speed bump. Absent that step, the lawyers wrote, the SEC lacked the authority to approve IEX’s proposal.
Not all of IEX’s competitors were as aggressive. Bats, whose CEO previously said high-frequency traders would find a way to manipulate the speed bump, said Friday: “Bats congratulates IEX and appreciates the significant changes they made to their application to address industry concerns.”
Responding to concerns about the legality of speed bumps, the SEC separately said that delays of less than one millisecond—or less than the time it takes to blink an eye—are consistent with its rule book, known as Regulation NMS.
However, it didn’t offer a blanket sanction for such delays and wrote any other speed bumps would have to be “scrutinized on an individual basis” by the commission. The SEC said it would conduct a study within two years to examine the impact of any speed bumps on broader market quality, including the prices that investors received on trades.
The call to revisit the SEC’s rules will probably grow now that the SEC has, in the eyes of some critics, granted an exemption for one firm. “The debate surrounding IEX’s exchange application confirms that the SEC’s current piecemeal approach to equity market structure reforms is wholly insufficient,” Mr. Piwowar said. “A truly comprehensive review of equity market structure, including Regulation NMS, is long overdue.”
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