Trader Talk

SEC gives its blessing to the IEX's 'speed bump' trading

Author Michael Lewis and Brad Katsuyama, president and CEO IEX Group Inc.
Adam Jeffery | CNBC

In a world where markets move at lightning speed, the IEX Group has won a victory by staking its business model on (marginally) slower trading.

Late Friday, the Securities and Exchanges Commission approved IEX's application to join the ranks of the New York Stock Exchange (NYSE), Nasdaq and BATS Global Markets. In the process, the SEC updated a rule that will compel other markets to honor trades subject to a small delay—referred to as a "speed" bump —that will effectively slow down trading by a fraction of a second even as other markets process trades in the blink of an eye.

"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.

"A critical role of the Commission's regulatory framework is to facilitate the ability of market participants to craft appropriate market-based initiatives, consistent with our mission to protect investors, maintain market integrity, and promote capital formation," she added.

The IEX argues that it wants to use the speed bump to protect investors from potentially harmful trading that may involve the front-running of orders.

Yet the start-up's application to become a stock exchange has been embroiled in controversy over a small but important issue: How much latitude do stock exchanges have to slow down trading?

The U.S. stock market is composed of a dozen markets that have data exchanges spread out over long distances. When changes in stock prices and quotes occur, there can sometimes be very small delays in the time it takes to register the changes.

Some faster traders can take advantage of those time discrepancies. The IEX, for example, inserts a 350-microsecond speed bump that it says reduces those opportunities.

However, that idea has been controversial. The NYSE and NASDAQ have both opposed the application, arguing that existing stock market rules say you cannot deliberately slow the markets down.

So who's right? The SEC delayed the decision in March, and released a reinterpretation of their own rules that said any delay below one millisecond would be consistent with its rules. Yet with Friday's decision, IEX's 350-millisecond delay would be OK.

Today, the SEC commissioners supported their staff recommendation.

Still, that too may result in more controversy. NASDAQ head Bob Greifeld told CNBC that allowing sub-millisecond delays could open the door to many new order types, taking advantage of the various sub-millisecond time delays.

He implied he could sue the SEC for violating its own rules. Stay tuned.