SEC approves IEX as new U.S. stock exchange

Capping a nearly year-long face off over the merits of high-frequency trading, a federal regulator Friday approved a new stock exchange that could boost small and long-term investors by using an electronic speed bump to slightly slow the speed of some stock transactions.

The Securities and Exchange Commission order greenlighted the application by Investors' Exchange LLC, or IEX, to compete for investors and stock listings with the New York Stock Exchange, the Nasdaq Stock Market, Bats and the nine other current U.S. financial markets.

Headed by Brad Katsuyama — a star of "Flash Boys," author Michael Lewis' 2014 best-selling criticism of high-frequency trading — IEX has become the latest flash point in a national debate over whether rapid-fire traders using powerful computers and automated algorithms have an advantage over average traders and institutional investors such as pension funds.

Backed by a consortium of mutual funds, hedge funds and other buy-side investors, IEX currently operates an alternative trading system, or so-called dark pool, which is mainly used by sophisticated professional traders.

By seeking approval as a stock exchange, IEX aims to draw a broader share of traders and counter a shift toward high-frequency trading in recent years as government rules and ever-faster technology made U.S. financial markets more complex and geared for speed.

Handing IEX a victory, the SEC order said brokers would have to send trading orders to IEX when the new exchange has the best available price among all U.S. financial markets. Opponents had fought such a provision.

The SEC approval also came with staff guidance that said programmed-in trading delays of less than one millisecond are  "at a de minimis level." The interpretation determined that a small delay would not prevent investors from gaining access to stock prices "in a fair and efficient manner."

The Wall Street regulator also said IEX must participate in national financial market plans and take other steps before transitioning to an exchange.

"Today's actions promote competition and innovation, which our equity markets depend on to continue to deliver robust, efficient service to both retail and institutional investors," said SEC Chair Mary Jo White in a statement announcing the approval.

Katsuyama, whose trading venue is billed as a "fair simple and transparent market" that's "dedicated to investor protection," said widespread investor support contributed to the outcome.

"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," he said.

The Modern Markets Initiative, a financial industry advocate that promotes benefits of high-frequency trading, said its members would provide trading liquidity on the IEX platform, as they do on all U.S. exchanges. "We expect brokers, who are required to get the best deal for their clients, will be watching IEX closely to monitor the quality of their trading execution," said Bill Harts, the group's chief executive.

The SEC approval came after two postponements in a regulatory review that began last August and drew hundreds of public comments for and against the proposed new exchange. Much of the debate over the IEX application focused on a unique system designed to put average investors on equal footing with high-frequency traders.

Broker-dealers would submit customers' orders by connecting to the new exchange electronically through a so-called point of presence in Secaucus, N.J. The messages would then enter a box of coiled optical fiber cable that would require the transmissions to travel the physical equivalent of 38 miles. After that, the messages would go to the IEX trading system in Weehawken, N.J. for execution.

In all, the system would delay the messages by 350 microseconds, less than the blink of an eye. Though tiny, the speed bump could neutralize high-frequency traders' current ability to profit by buying, selling or canceling transactions before other participants can react to quickly-shifting market conditions.

The delay would enable IEX operators to make sure the system is up to date on the latest prices in all financial markets before a high-speed trader can execute a transaction based on data the system hasn't yet received.

High-frequency trading specialists generally focus on high volumes of short-term transactions, in some cases holding stock positions for less than a single second.

Katsuyama and other IEX executives are betting the new exchange will attract average traders, institutional investors and pension funds that typically focus on longer-term stock holdings. They also hope to convince publicly-traded companies to list their shares on IEX.

New York Stock Exchange President Tom Farley contended IEX would make markets more complex, not less. Questioning the rationale for the new exchange during a CNBC Squawk Box interview Friday before the SEC announcement, Farley said "No one can trade faster than someone else."

But Themis Trading, an independent, New Jersey-based brokerage that supported the IEX application, said the approval would benefit long-term investors who "have watched from the sidelines as markets have morphed drastically over the last two decades, with ever increasing speed."

"Today they can witness the SEC’s approval of a stock exchange solution that goes the other way and slows things down," the brokerage said.

Follow Paste BN reporter Kevin McCoy on Twitter: @kmccoynyc