"Flash Boys" get green light to launch stock exchange

Originally published on Bankrate.com, June 20, 2016.

In an investing environment ruled by fast, the newest U.S. public stock exchange is banking on slow.

Well, slower.

IEX Group, which won Securities and Exchange Commission approval on Friday to go head-to-head with the New York Stock Exchange and Nasdaq, routes its trades through 38 miles of fiber-optic coil. The purpose? To create a "speed bump" before the broader market can see trades on its platform.

The delay amounts to 350 microseconds. For perspective, a blink of an eye is about 400,000 microseconds.

IEX says the delay is enough to thwart high-frequency traders who profit by "front-running" on trades by less-sophisticated retail investors, pension plans and the mutual funds that fill 401(k) plans.

The firm's founders were the heroes of Michael Lewis' 2014 book "Flash Boys," which argued that high-speed trading results in higher prices for slower investors.

"We are grateful and humbled by the support we've received from the investor community," IEX CEO Brad Katsuyama said in a statement. "Without it, we may have faced a different result."

Katsuyama, a former trader at the Royal Bank of Canada, launched IEX in October of 2013. Among the supporters of its application to become a public exchange were Goldman Sachs (GS), Jefferies and Oppenheimer Funds, while investors included star hedge fund manager David Einhorn of Greenlight Capital.

Naturally, the villains of Lewis's tale aren't thrilled the SEC gave its blessing to IEX, short for the "investor's exchange," and in doing so rewrote a longstanding requirement that every exchange make trade information available immediately.

At issue: the meaning of immediately.

The SEC described a delay of less than one millisecond as "de minimus" and said that "a small delay will not prevent investors from accessing stock prices in a fair and efficient manner." High-speed traders and hedge funds, who argued against approval for IEX, said even a tiny delay could make stock quotes stale and unreliable.

D. Keith Ross, CEO of the parent company of the PDQ automated trading system (also known as a dark pool), said IEX could reduce fairness for investors by creating a market filled with "ghost quotes" already in the process of being traded or canceled.

The problem is investors would see shares that aren't actually available at the price shown, which could destabilize the market. Copycats may also follow IEX with their own speed bumps, further complicating the marketplace.

"Even though IEX says their speed bump is more fair for their customers, as a protected quote it will make the market unfair for any other customer that doesn't trade at IEX, " Ross said in an email. "It is really amazing the SEC didn't seem to understand this."

IEX is also unlikely to do much for average investors, said Chuck Fulkerson, director of education at California-based Online Trading Academy, which trains investors at dozens of campuses around the world.

"The high-frequency traders are trading in hundredths of pennies, and the difference to an everyday investor would not be realized," he said in an email. "Any benefit that the individual investors might see would still be greatly outpaced by the fees these mutual funds charge over their lifetime, along with their reliance on the market to go up for an investor to profit."

IEX handles just 2 percent of trades, but could gain market share since brokers must route trades to the exchange offering the best price.

The SEC pledged to conduct a study within two years to determine whether speed bumps are helping on harming investors.

Nathan Garcia, managing director of Virginia-based Westbourne Investments, said the new exchange should help reveal who benefits from conflicts of interest inherent in the structure of exchanges, including co-location of servers and trading in dark pools.

"With better understanding of the plumbing of markets, I believe consumers will make more educated decisions about where their trades will be executed, and by whom," Garcia said.

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