Trading venue IEX is supposed to be the good guy. The startup pitches itself as the stock market where high-frequency traders don't have an unfair advantage. Michael Lewis paid special attention to the company in his 2014 book Flash Boys: A Wall Street Revolt, framing IEX as a fairer platform than other "dark pool" or alternative trading systems.
If you ask IEX CEO and cofounder Brad Katsuyama, the 67-person company is indeed the fair alternative to a corrupt system that puts regular traders -- the folks investing your 401(k) and pension funds -- in the back seat to traders that have faster access to stock prices as they change. Yet over the past several weeks, IEX's name has been splashed across financial news headlines in ways that aren't always flattering.
It's a classic controversy about a startup with the potential to disrupt an entrenched industry. In fact, Katsuyama sees some striking similarities between IEX and Uber, another startup that sees itself as the hero but is often cast as villain. Perhaps the most obvious similarity is IEX's refusal to change how it does business in the face of criticism from the trading industry. "We're not willing to compromise the model," says Katsuyama. Here's an explainer about the conflict over IEX's practices.
Wait, what does IEX even do?
IEX is a dark pool, or private, stock exchange that operates in a way slightly different than other exchanges. The trading venue automatically waits 350 microseconds to post or execute an order, and another 350 microseconds to send out notification that the order went through. These 350 microseconds amount to a fraction of the time it takes you to blink your eye, says Katsuyama, and for slower traders like asset managers they don't affect performance. But for high-frequency traders accustomed to having an edge by knowing about changes in stock values the microsecond they change, these split seconds amount to a significant slow down, explains IEX marketing and communications head Gerald Lam. High-frequency trading is a type of superfast automated trading platform used by large investment banks and other big players. The controversy surrounding it centers on how that speed gives those with access to high frequency trading an edge over those who don't.
What's wrong with that?
Here's where the controversy comes in: IEX itself doesn't have to wait 350 microseconds to know when a sale price has changed. So when a client has a pegged-to-market order, meaning they have charged IEX with buying or selling a stock when it hits a certain price, IEX will complete the order at the actual time of price change. As Matt Levine explains writing for Bloomberg View, the question is whether this practice is fair to high-frequency traders. "The question for the SEC is, roughly speaking, does fairness require being fair to high-frequency traders (who lots of people think are themselves unfair)[sic]?" he writes. But Katsuyama says not applying the speedbump in the case of pegged orders is a feature key to IEX's fulfillment of its mission of preventing high-frequency traders from having an unfair advantage.
So, why all the fuss now?
The SEC is slated to hand down a decision by March 21 on whether it will allow IEX to become a public stock exchange, after the startup granted the regulator a 90-day extension. If the application to become a public exchange is granted, IEX will basically be legitimized as a mainstream trading venue subject to the same regulations and disclosure requirements of more established stock exchanges like the New York Stock Exchange and NASDAQ. (Becoming a public exchange is not the same as IEX making an initial public offering; the startup would still be a private company.)
Why the wait to approve IEX?
People have a lot to say about IEX. The exchange has received more comment letters on its application with the SEC than any other exchange to go public. "Right now, we have 330-something (letters), so it's gotten kind of crazy," Katsuyama told MarketWatch last week. "We have more comments than every exchange in the history of the United States combined. Nasdaq was second largest with 97." The high volume of comments is one reason SEC asked for more time to consider the application, Katsuyama has said.
What does this have to do with Uber?
Katsuyama says Uber's recent conflict with the Licensed Taxi Drivers Association (LTDA) in London is strikingly analogous to IEX's situation with opponents of how the exchange operates. "There are so many parallels. We're kind of like, hey, that sounds like our story," he says. LTDA proposed restrictions on Uber including forbidding the app from showing Uber vehicles on the map and a requirement that drivers wait a minimum of five minutes to pick up riders after they agree to pick the riders up. These proposed restrictions -- especially the imposed wait time -- would have gone against the grain of Uber's goal to be as fast as possible at picking up users. London's transportation authority rejected the restrictions. Katsuyama says critics of IEX who think the company should change how it applies its speed bump are trying to bar IEX from fulfilling its core utility to users in the same way.
This story has been modified to correctly state the time IEX waits to send out notification that an order went through. The exchange waits 350 microseconds.