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April 14, 2016

The SEC Needs to Approve IEX’s Market Solution

Our public securities markets are essential for companies large and small to access capital and for our economy to grow. That requires investors, also large and small, to have faith and confidence in our markets and trust that they are relatively fraud-free and fair. Without that, people don’t invest in stocks, companies don’t get funded, jobs don’t get created and everyone’s standard of living declines.

That’s why the Securities and Exchange Commission (SEC) was created after the massive frauds and crimes that lead to the Great Crash of 1929 and the Great Depression of the 1930s: to protect investors and markets while facilitating capital formation by policing the markets with disclosure and enforcement. The SEC is supposed to be the securities cops on the Wall Street beat.

But, too often, the interests of investors, markets and capital formation – the public interests – are subordinated to the private interests of incumbent financial firms with political connections, lobbying might, an army of high-paid lawyers and lucrative job offers. An example of that problem is the current pending application from the upstart stock-trading platform Investors Exchange (IEX) to become a public stock exchange. That application has sparked a ferocious debate about market structure, high-frequency trading, predatory conduct and the overall state of the equity markets.

Today, those markets are highly fragmented among more than 12 exchanges and 40 or so private trading platforms (called dark pools, internalizers, etc.). This has set off an arms race among financial firms seeking to develop the fastest technology, which is being used too often to exploit time differences of microseconds (one millionth of a second) and soon nanoseconds (one billionth of a second) between and among those many trading venues.

This all exploded into the public consciousness in 2014 when some of these practices and IEX were featured in Michael Lewis’ bestselling book, “Flash Boys: A Wall Street Revolt” and when Mr. Lewis, in promoting the book, described the markets as “rigged.” This one word was like lighting a match in a gasoline factory: it ignited a long-overdue debate about our markets that continues to this day, exemplified by IEX’s exchange application awaiting action by the SEC.

For those unfamiliar with the IEX saga, you can find background information here(in addition to Mr. Lewis’ book) and, if you’re unfamiliar with the market structure issues, this terrific book explains them: “Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio.”

Those who have been following the story know that IEX is currently an alternative trading venue where investors can trade without being ripped off by predatory high-frequency traders using high speed technology to prey on their orders. If you don’t think this is happening, why are nearly 99% of all orders cancelled before filled? If you want to see this happening, sit next to an independent trader trying to execute an order of just 50,000 shares of a highly liquid stock of a fortune 500 company for a few minutes. You will be amazed at the amount of work, effort and time it takes to prevent that order from being picked off as multiple market venues are manipulated time and again by computer programs that detect, decipher and trade around your every move.

Given the damage to investors, markets and capital formation, what has the SEC done about this? Very little and certainly not enough. Its principal response to the furor set off by Mr. Lewis’ book was to do what bureaucracies do when they want to look like they are doing something when they are really doing nothing: set up a committee to “investigate.” Rather than ramping up enforcement or writing rules to stop the predatory practices, the SEC instead formed the Equity Markets Structure Advisory Committee. Adding insult to injury, the SEC stacked the committee with industry insiders who benefit from maintaining the status quo. And it even includedsome representatives from firms who have been sanctioned by the SEC for egregious violations of the very laws and rules the committee is supposed to review.

In the midst of all this, a private company, IEX, developed a market based solution to the problem of predatory high frequency trading, which is complicated to explain but suffice it to say it outwits the predators by eliminating their time advantage by imposing a 350 microsecond delay, called a “speed bump.” If you don’t think it works, again, sit next to an independent trader trying to execute the same order described above and watch what happens.

IEX has operated as a dark pool for a few years now, but wants to become an exchange. If its solution works, it will attract investors and market share. That is a direct threat to the (tens of) billions of dollars currently siphoned off by predatory high frequency traders and their market enablers like exchanges selling co-location and direct feeds.

Thus, the IEX application has become ground zero in the war over market structure and fragmentation and predatory high frequency trading. Those profiting from the current system are lobbying all out to get the SEC to deny the application. This is little more than an attempt to kill the competition and prevent investors from having the marketplace option of choosing an exchange that stops predators from picking off their orders.

The SEC must act on IEX’s application by June 18, 2016. This will be a momentous decision that will likely have a dramatic impact on investors, our markets and the capital that is necessary to fuel businesses, jobs and growth throughout the country.


This article first appeared on the Huffington Post here.



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